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By: Travis A. Knobbe
Let us start by stating the obvious. It is not often that a large, national law firm writes an article or blog entry focusing specifically on college athletics. That said, the sea changes sweeping the NCAA and college athletics over the last five years have created issues that are either currently swept up in litigation or could soon become litigation “trends” in the coming years. Those changes include the NCAA’s decision to allow players to profit from the use of their name, image, and likeness (NIL); the NCAA’s lack of key guidance and regulation on how NIL should work; and inconsistent application of certain rules relating to student-athletes who transfer between schools more than one time. As with many “new” things in our society, changes create uncertainty, and that uncertainty results in litigation. This is what we are seeing.
Antitrust Litigation Attacking Transfer Rules
Several years ago, the NCAA sought to normalize and streamline the process through which student athletes are able to transfer from one school to another while competing in college athletics. This resulted in the creation of the NCAA Transfer Portal, through which a student athlete may enter his/her name and begin the process of withdrawing from competition at his/her current school to transfer to a second school to begin competing there. This mechanism to streamline the transfer process predictably created an impetus for a growing number of student athletes to elect to transfer, and the process was accelerated more when the NCAA decided to deviate from its previous rules that required all players, with the exception of players who had already graduated from their previous institution, to comply with the residency requirement (stating that a player who had not yet graduated must sit out from competition for one full year after enrolling in the new institution). The NCAA created a new exception stating that a first-time transfer did not have to comply with the residency requirement. Along with that, the NCAA also allowed transferring athletes to apply for a waiver from the residency requirement.
This latter process has created a problem for the NCAA, as its standards for applying for and granting such waivers contain subjective criteria that have been, according to many, applied arbitrarily, at worst, and inconsistently, at best. As a result, several states and student-athletes filed a lawsuit in the Northern District of West Virginia challenging the NCAA’s limitations of transfers as violative of the Sherman Antitrust Act. In that case, the plaintiffs also filed a Motion for a Temporary Restraining Order to prohibit the NCAA from enforcing its residency requirement while the case remained pending. In an early test of the merits of the case, the District Judge granted the motion, restraining the NCAA from enforcing this requirement, among other things.
Since then, the Department of Justice has intervened in the case, signaling that the federal government believes the residency requirement is an obvious restraint on trade. Ultimately, the NCAA will likely rewrite its transfer rules to remove the residency requirement to “moot” the case instead of potentially suffering another devastating antitrust loss that weakens its regulatory authority even further.
That said, if it does not, or if it writes new rules, we can anticipate that new cases will emerge challenging other actions the NCAA takes in the future, as there is already Supreme Court precedent stating that the NCAA is subject to the Sherman Antitrust Act. Players and their families should pay particular attention to this trend, particularly when they are faced with decisions by the NCAA that would seem to limit a student-athlete’s ability to capitalize on his/her NIL or to freely move from one institution to another (as the decisions made by the Northern District of West Virginia and other courts that have weighed in on the question have taken a circumspect view of when and whether the NCAA can limit the freedom of student athletes to compete).
NIL Collectives and their “Tax Exempt” Status
Almost as quickly as the NCAA relented in the face of pressure to allow student-athletes to capitalize on their NIL, groups of individuals supportive of certain schools rushed to form “collectives” as a way to raise money to pay players for their NIL. Many of the earliest collectives were formed as nonprofit organizations under Section 501(c)(3) of the Internal Revenue Code. The rationale for their creation was simple: groups of fans and alumni sought to ensure that their schools would be able to meet growing demands of student-athletes for NIL compensation to avoid losing existing talent and to attract new talent to those schools.
The rationale for their application for tax-exempt status was not as simple. In idea, the thought was that at least one outcropping of NIL efforts would focus on paying players for the use of their NIL to host events benefitting various charitable causes. That said, the most relevant question is who benefits most from an entity’s existence. The IRS’ chief counsel issued AM 2023-004 and opined that many NIL collectives do not qualify as tax-exempt under Section 501(c)(3) because the primary beneficiaries were student-athletes, not charitable causes.
For better or worse, however, many individuals donated to these collectives on the basis that their donations would be tax exempt, providing those donors a break on their tax returns. Generally, the IRS conditionally approves most 501(c)(3) applications as long as the applicant checks the appropriate boxes and completes the form correctly. The IRS, however, approves those applications subject to subsequent review and can disallow their prior grant after that review. Given the inventiveness of nonprofit NIL collectives, many of them applied for and received 501(c)(3) status, at least based on that initial application. That said, many of those that received that initial status run a great risk of subsequent disallowance.
What does this mean for the directors of those collectives? Well, disallowance could mean that donations accepted by the collectives that chose to organize in this way were initially treated by the donors as tax write offs would be disallowed, leading to an increase in taxable income several years after the fact, meaning amended filings and tax liabilities (sometimes very large ones for the largest donors). Could this lead to litigation? Any time you are talking about millions of dollars in donation pools being subsequently disallowed leading to hundreds of thousands of dollars in unplanned liabilities, you run the risk of ensuing litigation. This is something to keep an eye on.
Increased NIL Regulation and Enforcement of Existing Rules
One thing the NCAA said when it initially allowed student-athletes to profit from the use of their NIL is that the NCAA did not intend to rewrite its existing rules governing its member institutions. That said, because of the growth of the transfer portal and the arms race towards bigger and better NIL deals for players, schools have felt compelled to skirt existing lines. Technically, a school itself cannot be involved in NIL negotiations for players. However, a coaching staff certainly had to be aware of student-athletes’ asking prices and be prepared to rally the troops to see what the collectives could offer those student athletes. The precise demarcation between universities and collectives seemed to fade over the last several years.
Perhaps not surprisingly, the NCAA has been announcing stiff penalties (or intention to impose stiff penalties) for a few big-named programs over the last couple of years. Florida State is the latest example of this trend. For Florida State’s part, they ultimately negotiated a resolution that almost certainly led to fewer institutional-focused penalties than the NCAA has levied in the past. Ultimately, the NCAA gave Florida State two years of probation, three years of disassociation with the booster at the center of the issues the NCAA targets, one year of disassociation with the collective at issue, a fine of $5,000.00 plus 1% of the football budget, a 5% reduction in football scholarships, and reductions of the number of official visits and limitations on the contacts and in-person visiting periods. This certainly could have been worse.
That said, the NCAA’s actions tell us a few things. First, the NCAA may have been content to watch the first phase of the NIL era play out from the sidelines, but it has not been blind to the actions being taken by schools and collectives during that phase. The NCAA certainly has shown an intention to enforce its pre-existing rules that limit donor participation into the affairs of its athletic programs and rules governing school involvement in NIL negotiations. These types of enforcement actions may become the rule, not the exception, over the next several years. If they do, it could lead to additional types of litigation against or on behalf of the NCAA as the participants may look to test the limits of the NCAA’s enforcement power (see the antitrust trend above). It may also lead to liability of collectives and their directors depending on whether those collectives intentionally encouraged or participated in knowing rules violations.
Second, while the penalties against Florida State certainly matter, things could have been much worse. Just ask SMU how they fared in the face of NCAA’s broad enforcement power in the late 80s. This negotiated result may give athletic departments a framework within which to work that counsels in favor of cooperation and negotiation instead of letting the NCAA do its worst and hoping the courts come to the rescue later.