Financial Fairness, Formula-1 and Football

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White & Case LLPBy 30 June 2022, Formula 1 teams will have to submit their (interim) financial information to the International Automobile Federation ("FIA") under the Formula 1 Financial Regulations ("Financial Regulations").1 The information to be provided to the "Cost Cap Administration" to show compliance with the Cost Cap system which came into force on 1 January 2021 includes reporting group documentation and interim financial reporting documentation as well as declarations signed by the team principals that the budget cap is being complied with. After essentially a trial year, and in light of the many technical regulatory changes introduced for this 2022 season, it is of this year that the Cost Cap system is expected to start making a real impact on the sport. Teams that exceed the budget cap risk financial as well as sporting penalties. 

The Cost Cap of Formula 1 immediately recalls the UEFA Financial Fair Play system established in 2010. UEFA's Financial Fair Play system led to a lot of controversy in particular in terms of its enforcement and was actually reformed earlier this year into the UEFA "Club Licensing and Financial Sustainability Regulations" which apply as of this month of June 2022. 

The link between the two worlds became very clear recently.

In football, it was the non-transfer of Kylian Mbappe to Real Madrid that led to outrage in particular in Spain about the competition distorting nature of the money being thrown at the young star. The Spanish football league, La Liga, said that it intends to file a formal complaint with UEFA over the fact that Paris Saint Germain, a club that it alleged made a loss of 220 million EUR last year, was able to offer its star player a new 3 year contract that allegedly includes a "signing fee" (despite the fact that he already is a PSG player) of 125 million EUR, leaving aside the expected autonomous salary he is reported to receive for extending his contract with PSG of 5 million Euro per month, allegedly doubling his current salary. La Liga calls it a clear violation of the financial fair play rules of UEFA which effectively introduce a sort of cost cap based on qualifying income. To recall, PSG had to accept a settlement in 2014 over financial fair play violations and in 2018 narrowly escaped a finding of violation following a bizarre stand-off between two of UEFA's responsible bodies and a procedural rule upheld by the Court of Arbitration for Sport (CAS) preventing re-assessment of its case.2

Not too far from Spain, in Italy, rumours are growing about a possible a complaint over lack of respect for Formula-1's financial stability regulations focusing on the Honda-Red Bull team of current world champion Max Verstappen. It is being alleged that Red Bull would have already exceeded the cost cap, even though we are not even half way into the year. Red Bull denies any violation and its most recent response has been to argue in favour of revising the maximum spent set for 2022 under the cost cap mechanism arguing that this cap did not take into consideration sharp rising inflation and the significant increase in energy and raw material prices. Red Bull's call for increasing the budget cap has been echoed by a number of the other big teams, but appears to be opposed by the smaller teams. It is noteworthy that the rules already provide for "indexation" in case inflation exceeds 3%. 

Formula-1 only very recently introduced a financial stability system in the form of a Cost Cap mechanism that limits spending of Formula-1 teams to a fixed amount set at 140 million USD for 2022. As noted above, Formula-1 Financial Regulations imposing a Cost Cap were obviously inspired by the UEFA Financial Fair Play rules since they follow a very similar organizational structure: complaints are examined by the FIA's Cost Cap Administration (very similar to the UEFA Investigatory chamber) and a FIA Cost Cap Adjudication panel will assess any possible violations of the cost cap obligations (similar to what happened in the UEFA Adjudicatory Chamber). 

However, different from the cap in UEFA's system that links the maximum spend to the income generated by the club, the Formula-1 cost cap imposes a same fixed cost cap for all teams. The purpose of the cap in Formula-1 is not only to protect teams from over-spending that could lead to bankruptcy – a problem that Formula-1 has witnessed in the past with teams such as Force India that were put into administration during the 2018 season – but also to seek to achieve some sort of competitive balance so that the biggest budgets would not be able to dominate the sport. Article 1.3 of the Formula 1 Financial Regulations expressly makes promoting "the competitive balance of the Championship" as well as "sporting fairness" key parts of the "Objectives" of the Cost Cap system.3 This lack of competitive balance is an ongoing concern for Formula -1 and an existential threat to a sport that is too often reduced to a duel between two teams or drivers, leaving other teams without any genuine chance of ever winning a race let alone being in the running for the championship. While there are many costs that are excluded from the cost cap such as in particular, driver salaries and certain other personnel costs, the cost cap is supposed to give smaller teams a chance of competing on a more level playing field. 

In contrast, UEFA has always denied that its Financial Fair Play system was about restoring competitive balance (despite the name of the mechanism which clearly suggested some sort of aim to restore fairness). UEFA's system focused essentially on securing healthy financing of clubs to avoid potential distortions of competitions due to bankruptcies resulting from over spending. It is probably to avoid that alleged misunderstanding that UEFA recently re-named its system by focusing on financial "sustainability" rather than "fair play". The budget cap imposed by UEFA was not a one-size fits all that was aimed at supporting smaller team but rather a cap based on revenue, which effectively protected the historically stronger clubs while preventing up and coming clubs from over-spending in order to close the gap with the established teams and their big revenues. In a way, it has been argued that had UEFA enforced its own system in a stricter manner, Manchester City and Paris Saint Germain to name a few, may not have been able to join the top tier teams in a period of about 10 years as they did. 

And enforcement is probably the Achilles heel of every cost cap system in sports. 

In this respect, an important other difference between the two regimes is that a decision by UEFA's Adjudicatory Chamber can be appealed before the independent Court of Arbitration for Sport (CAS) in Lausanne. In contrast, an appeal against decisions of the Formula-1 Cost Cap Adjudication panel is possible but it will have to be brought before the International Court of Appeal ("ICA") of the FIA. While CAS has been recognized as fulfilling the requisites of an independent arbitration tribunal by the Swiss Federal Tribunal, the European Court of Human Rights4 and the European Court of Justice5, no similar approval has been provided with regard to the ICA which seems to be very closely linked to the FIA and is thus more akin to an internal tribunal. Additional differences are that the ICA will apply French law to fill any gaps left by the relevant rules and regulations while CAS relies on Swiss law. EU law has played a role in CAS but may be expected to play an even more important role in ICA judgments given the French law basis. 

The UEFA Financial Fair Play rules worked well at the technical level with a very skilled secretariat assisting the internal assessment of the respect of the rules. The problem however has been one of enforcement and consistency. One of the key issues has been the penalty of exclusion from the competition. It has been said that such a penalty may go against the commercial interests of UEFA itself when it concerns the top teams that make the European club competitions as interesting and commercially lucrative as they are. Consequently, observers have remarked that exclusion was practiced only for smaller clubs even when bigger clubs had committed comparable violations. The alternative as used by for example the European Commission in cases of violation of competition law (anti-trust) of imposing very high financial penalties is also difficult in the case of football as such penalties risk further aggravating a financially difficult situation for those clubs already failing to meet the financial stability targets. And in order to bring the really big budgets in line, the fines must really be huge, expressed perhaps as a percentage of the total value of the club. A 4 million EUR fine may be big for FC Krasnodar for example, but it would be peanuts for a top Premier League team. The Formula-1 cost cap-related penalties similarly range from financial penalties to be determined on a case by case basis, over reduction of the cost cap ceiling or limitations on certain spending, to race exclusions or even the exclusion from the Championship in case of the most material breaches.6

These two sports thus have a lot in common. Both are having increased and significant commercial success which attracts ever greater investments blurring the lines between sport and entertainment; both essentially turn on a limited group of top teams; both are global in nature. However, organizationally both are very different in a way that puts the discussion about the European sports model and the European Super League in a different light. This difference may also have an important impact on the question of enforcement of the cost cap rules. 

Formula-1 is a commercial organization that is the archetype of a closed league system. Only a certain number of teams can participate, there is no promotion or relegation and teams cannot participate in alternative competitions of the same kind. All of the concerns that were voiced at the time the European Super League was announced about the European sports model being based on a pyramid structure and the importance of openness and the principle of promotion and relegation are totally absent from Formula-1. At the same time, and without getting into the very complex origins and structure of Formula-1, it is interesting to reflect for a moment on the relationship between on the one hand, Formula-1, the commercial entity based in London and owned by a U.S. media group, Liberty Media, and, on the other hand, the FIA, which acts as the regulator. This separation came as the result of an investigation by the European Commission into a violation of competition law in the late nineties. It led to a settlement that was proposed by the European Commission and accepted by the FIA and Formula 1. As stated in the settlement agreement, "[t]he Commission's Statement of Objections issued in June 2000 made the preliminary assessment that FIA had a "conflict of interest" in that it was using its regulatory powers to block the organisation of races which competed with the events promoted or organised by FIA (i.e. those events from which FIA derived a commercial benefit)." The settlement thus consisted of a number of modifications "to establish a complete separation of the commercial and regulatory functions in relation to the FIA Formula One World Championship and the FIA World Rally Championship where new agreements are proposed which place the commercial exploitation of these championships at arm's length."7 While this was only a settlement based on the view of the Commission that was never tested before the European Courts, it is remarkable that the Commission has thus far never insisted on a similar "complete separation" between the commercial and regulatory function of UEFA when it comes to organizing European football competitions. What is good for the goose does not seem required for the gander. 

Returning to the question of enforcement of the cost cap mechanism in Formula-1, it will be interesting to see if this clear separation between regulatory and commercial functions is capable of preventing the above perception of lack of coherence in the enforcement of the financial fairness rules that plagued UEFA. Given that FIA has no commercial interests in the organization of Formula 1, it should be able to administer its budget cap rules in an objective manner that ensures a consistent and technically rigorous approach both in terms of the establishment of possible violations and in the context of the imposition of meaningful penalties. Of course, the rules are complex and will be lawyers' work as much as accounting work in order to navigate the exclusions, adjustments and other cost-related questions such as assessing cooperation with related parties and R&D costs made by legally speaking separate entities. In the world of international trade, cost accounting and cost-related lawyering is at the heart of what is called "anti-dumping", and forms the bread and butter of international trade law firms. It is also the single most litigated issue before the World Trade Organization. It can be expected that the same will soon become true in Formula-1. 

More so than for any other sport, the very thin basis on which Formula 1 is built with only a handful of teams genuinely competing over the top positions, it cannot afford to err in ensuring respect for the rules it has created to protect the sport. Not so long ago, Formula 1 teams had great difficulty finding major sponsors. Budgets were out of control while TV audiences were on the decline year after year until 2016 due to the races being too predictable and not exciting. It now has the wind in the back due to a new wave of young fans attracted by the success of Drive to Survive and a generation of new young drivers coming to the fore. Formula-1 cannot afford to lose them again. How the FIA decides to enforce these rules, with the help of the Formula-1 teams and their lawyers and accountants, will be key in this respect. 
 

1 See Article 5.2 of the Financial Regulations, https://www.fia.com/sites/default/files/formula_1_-_financial_regulations_-_iss_10_-_2022-04-29.pdf 
2 See, https://www.tas-cas.org/fileadmin/user_upload/CAS_Media_Release_5937_decision.pdf 
3 See, https://www.fia.com/sites/default/files/formula_1_-_financial_regulations_-_iss_10_-_2022-04-29.pdf
4 In the case of Mutu and Pechstein,v. Switzerland, see https://hudoc.echr.coe.int/eng#{%22itemid%22:[%22001-186434%22]} and for a reaction by CAS, see https://www.tas-cas.org/fileadmin/user_upload/Media_Release_Mutu_Pechstein_ECHR.pdf 
5 See, https://www.whitecase.com/publications/alert/eu-general-court-delivers-ruling-application-eu-competition-law-sports 
6 See Section 9 of Formula 1 Financial Regulations
7 See Notice published pursuant to Article 19(3) of Council Regulation No 17 concerning Cases COMP/35.163 — Notification of FIA Regulations, COMP/36.638 — Notification by FIA/FOA of agreements relating to the FIA Formula One World Championship, COMP/36.776 — GTR/FIA ' others (Text with EEA relevance) Official Journal C 169 , 13/06/2001 P. 0005 - 0011 EUR-Lex - 52001XC0613(01) - EN (europa.eu)

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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