Post#2 » by answerthink » Tue Aug 10, 2010 10:39 pm
Below is a more detailed attempt to explain how Option Buy-outs work. It is a confusing concept, so the explanation is somewhat complex.
Contracts that contain an option or ETO may provide for an option buy-out amount, which is payable to a player in connection with either the exercise of the ETO or the non-exercise of an option. The buyout amount can’t exceed 50% of the salary called for in the year(s) following the option or ETO.
The buyout amount is determined at the start of a contract, and applied to the player’s salary in the same manner as is a signing bonus. In essence, the buyout amount is spread among the guaranteed seasons of the contract (but not to option years or years following an ETO), in proportion to the percentage of salary in each of those seasons that is guaranteed.
If the buyout amount is ultimately paid (i.e. the ETO is exercised or the option is not exercised), that’s it. End of story.
If it is ultimately determined that the buyout amount will not be paid, the buyout allocations will have effectively been overstating the player’s true salary. This wouldn't be fair to the team, in that they may have been able to deploy that erroneously reduced cap space elsewhere. So the agreement provides an adjustment mechanism to correct for this issue.
The first adjustment is to exclude the allocated portion of the buyout amount from the player’s salary for any future seasons of the contract. This is the easy adjustment.
The second adjustment is more complex. The basic concept is to aggregate the amounts that were erroneously added to the player’s salary in historical seasons, apply certain adjustments, total it up (the “credit amount”), and then credit it back to the team’s team salary in future seasons.
The initial question is how to calculate the “credit amount.”
The first step is to sum up all of the allocations that were erroneously applied in the current and historical seasons (the “unpaid amounts”).The second step is to make adjustments to that amount under certain circumstances. For every historical season in which (i) the allocation was erroneously applied to the player’s salary and (ii) the team’s team salary was over the salary cap, subtract the smallest amount by which the team’s team salary was over the salary cap during the year. The net total is the “credit amount.”
The second step is confusing, but it does make intuitive sense (though one can certainly make the argument it is not a perfect mechanism). If the team was over the salary cap in any historical year, it wouldn’t have mattered that the team was forced to erroneously add the allocation to the player’s salary anyway; the amount was not actually paid and it did not reduce the team’s financial flexibility. Teams that are over the salary cap, by definition, have no cap space anyway; they can only utilize exceptions. Therefore, the team shouldn’t receive a credit in future seasons for something that was not detrimental to the team in a past season.
The latter question is how to apply it to future seasons.
The “credit amount” is then credited to the team’s team salary in equal parts over the same number of future seasons as it was erroneously added to the player’s salary in historical seasons. If the number of future seasons is more than one, for each season after the initial season, the allocated amount is increased by 10% of the initial season amount. The 10% increase, in effect, can be thought of as the annual salary increase for a player who would have been signed in the first year utilizing the cap space that was erroneously eaten up by the allocated portion of the buyout amount.
If the allocated “credit amount” is applied to a future season in which the team’s team salary is over the salary cap, it is instead carried forward to a subsequent year (because it served no purpose in that year). A portion of the allocated "credit amount" is also instead carried to a future year if the team is under the salary cap by less than the value of the allocated "credit amount."
