While some fans of the Cleveland Indians have long complained about the frugality of owner Paul Dolan, at least Mr. Dolan has never had trouble making payroll. In perhaps the biggest event to occur off the field since Walter O'Malley moved the team from Brooklyn, the Los Angeles Dodgers filed for chapter 11 bankruptcy protection in the U.S. Bankruptcy Court for the District of Delaware on June 27, 2011. Lacking the funds necessary to make payroll and other related payments by a June 30, 2011, deadline, the case was filed to obtain the financing necessary for the current owner, Frank McCourt, to maintain ownership and control of the club. The filing is the culmination of McCourt's highly publicized divorce proceedings and his ongoing feud with Major League Baseball (MLB) Commissioner Bud Selig.
While other professional sports franchises have filed for bankruptcy, the filing by the Dodgers is unique in that the protections afforded by the Bankruptcy Code are being used by an owner to keep ownership of the team in a battle with MLB. Other franchises have filed in order to sell the team in a transaction approved by the bankruptcy court. The case is also unique because of the tension between the broad authority of MLB to regulate its members and the protections afforded by the Bankruptcy Code.

The bankruptcy filing is the latest chapter in the long and contentious divorce proceedings of Frank and Jamie McCourt. Mrs. McCourt was fired from her position as Dodgers' CEO in October, 2009, and filed for divorce soon after. Case filings have revealed that the couple are alleged to have diverted more than $100 million from the team to fund their lavish lifestyle including several vacation homes, private jets and a personal hairstylist with a six-figure salary. After the judge invalidated a postnuptial marital property agreement that would have given Mr. McCourt sole ownership of the team, Mrs. McCourt's attorneys argued that the team was community property under California state law. If the court agrees, Mr. and Mrs. McCourt would jointly own the team and Mrs. McCourt might be able to force a sale of the Dodgers.

Personal and professional differences

Underlying the bankruptcy proceeding is the feud between McCourt and Selig. Selig has cited the tremendous amount of debt McCourt incurred to purchase the team and the diversion of $100 million in team revenue as evidence that McCourt's ownership of the Dodgers is "bad for baseball." McCourt accuses Selig of having a personal vendetta against him.

The fight with Selig came to a head on April 20, 2011, when MLB exercised its right under its constitution and officially took over control of the day-to-day operations of the Dodgers. Selig then appointed Tom Schieffer, a former ambassador to Japan and president of the Texas Rangers, to oversee the finances of the team and approve any expenditure over $5,000.

With the team's financial problems mounting and his control weakening, McCourt sought to sell the Dodgers' television broadcast rights to Fox Sports in a $2.7 billion deal. Mrs. McCourt was to have been paid $150 million from the deal to settle the divorce proceedings in exchange for relinquishing any claim of ownership of the team. McCourt argued that the payment was necessary because Fox would not consummate the transaction without certainty regarding the ownership of the team. However, Selig exercised the broad powers afforded to him as Commissioner and vetoed the deal, leaving McCourt with the choice of either turning complete control of the Dodgers over to MLB by defaulting on financial obligations or filing for bankruptcy.

The Court makes the call

A bankruptcy filing is a relatively common maneuver for an owner trying to retain or regain control over a business where some event has divested the owner of that control. Such maneuvers often succeed under bankruptcy law. But not always. Here, the Dodgers asked the court to approve a $150 million Debtor in Possession (DIP) financing facility that would allow McCourt back in as the man in charge. The Dodgers argued that because of the filing, MLB could no longer exercise control over the operation of the club and its finances. MLB objected and countered with its own DIP financing facility on allegedly more favorable terms than those offered by the club's proposed DIP lender. McCourt and the Dodgers claimed that the Commissioner's true goal was to take control of the club and sell it to a buyer approved by the Commissioner. They further argued that they had no obligation to accept financing from a direct adversary and that the business judgment rule allowed them to choose their proposed DIP lender.

On July 20, 2011, the Court heard arguments from both parties on the issue. Two days later, the Court rejected McCourt's attempt to use the chapter 11 case to circumvent MLB when the league-proffered financing was superior. Comparing the two proposed loans, the Court noted that MLB's proposed loan was clearly economically superior. Ultimately, the Court denied the club's motion based on 11 U.S.C. § 364(b), which requires that before a court may allow a debtor to obtain secured financing, the debtor must prove that it was "unable to obtain unsecured credit allowable under section 503(b)(1) . . . as an administrative expense." The Court explained that it could not approve financing on a secured basis, as the loan from the hedge fund would be, because the debtors had not attempted to obtain unsecured credit from MLB.

The Court further found that because Mr. McCourt would personally owe $5.25 million to the Club's preferred DIP lender if he did not seek court approval of the loan, his independent judgment was compromised and the decision was not entitled to review under the deferential business judgment rule standard, which generally accommodates the debtor in possession. Instead, the Court applied the entire fairness standard and found that the Dodgers could not establish that the loan was the result of fair dealing at a fair price. The Court did, however, explain that any MLB loan must be independent and uncoupled from MLB's oversight and governance of the Dodgers under the league's constitution.

Now that the Court has found that the Dodgers must negotiate with MLB on a DIP financing package, the bankruptcy court will turn its attention to other aspects of the bankruptcy. While this case is certainly high-profile, the core issues are similar to those in most bankruptcy proceedings. No matter what the ultimate result is, there can be no denying that this ugly episode is a low mark in the history of a proud and storied franchise.