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Escrow, cap inflators, and HRR; what does that all mean?

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Never leave a lawyer and an accountant alone together. They come up with the weirdest stuff.

2010 NHL Draft - Round One Photo by Bruce Bennett/Getty Images

Sometime this week, perhaps as early as Friday, we’ll know for sure what the salary cap will be next year.

So, let’s get up to speed on all of this unholy marriage of finance and labour law.

The underlying principle of the current salary cap in the NHL is that it should split the revenue of the the league 50-50 between the teams and the players. Problem is you don’t know in advance what the revenue is, but you know the salaries of the players on a team. Enter “escrow”. The thing the players hate, and is often poorly explained and understood.

Escrow

The term escrow refers to money held by a third party for two others involved in a transaction. What it means in context of the NHL is a portion of the NHL player’s salaries is deducted from each pay cheque and put in a fund that sits there until the end of the season.

When the NHL has a decent estimate of their revenue just as the season is about to start, the escrow deduction amount is decided.

After the season is over, and the league knows its actual revenue, they can determine how much of that escrow account gets doled out to players, and how much teams get. The result is the 50-50 split in revenue.

It’s not a tax, but to a player it feels like one. And to a player today, post the 2012 lockout, the amount of escrow is large, and the amount that ever comes back is small.

Prior to the most recent CBA the split was not 50-50, and there were times, the players got more back than they’d put in the escrow account. Those days seem to be gone. In TSN’s story from last October, they had this table on the state of escrow over the years:

NHL Escrow by season

Season Withheld Refunded Salary Lost
Season Withheld Refunded Salary Lost
2009-10 4.1% 3% 1.1%
2010-11 12.4% 10% 2.4%
2011-12 8.5% 8% 0.5%
2012-13 16.3% 1.6% 14.7%
2013-14 14% 3.8% 10.2%
2014-15 15% 2.05% 12.95%
2015-16 17% TBD ???
2016-17 15.5% TBD ???

So, you can see that in recent years, total salaries, which have to conform to the salary cap, are way over 50 per cent of the revenue, and the players never make what their salary figures say they make.

Hockey Related Revenue

HRR, as hockey related revenue is usually known, is the total amount of income of each team that gets added up and then split in half. It includes things like ticket sales, TV deals and other forms of income.

One thing that affects HRR is the fluctuating Canadian dollar against the US dollar. A lot of HRR comes in to Canadian teams, and you can’t guess now what that’s worth in US dollars ten months from now, or ten days.

In general, the NHL is reporting flat or nearly flat revenue overall. That is one of the factors leading to a high escrow number and a low payout amount. And that is because of the “inflator”. Also known as the temptation that can’t be resisted.

Cap Inflator

The NHL and the NHLPA get together and mutually agree on the salary cap in the off-season. They’re hurrying this year because Vegas wants to know what it is before they make their expansion draft picks. Reasonable request.

If all there were to consider were revenue projections this would be easy. But there’s a winkle. The players can vote on an inflator to the cap of up to 5 per cent. Basically, it means the players are banking on the revenue outstripping projections and making the salaries to be paid under the inflated cap viable.

This is complicated by the fact that not all teams are “cap teams”. Some teams have much lower cap hits of their players. But the more parity you get, the fewer tear-downs there are in the league, the fewer budget teams running at the salary cap floor instead of the ceiling, the more total salaries there are. Cap or no cap.

The inflator means more escrow is deducted, and the gamble is it will pay off in the long run. It pays off for some players in allowing the cap space for lucrative (sometimes absurd) free agent contracts or extensions to be signed. It fails to pay off when the actual revenue and total salaries in a season don’t allow very much of the escrow account to be paid back to players. A guy on league minimum loses because he can’t afford to shave percentages off his salary. While the big star wins on signing day, just not by as much as his CapFriendly page says he does, because what’s a million lost to escrow now and again?

If the players resisted the temptation to inflate, they’d all end up with a more stable and predictable income, escrow would feel less punitive, and the owners would be forced to not get drunk on July 1 and overspend.

Wait. Who is it who is supposed to be the sober, fiscally responsible party here, again? Who is giving in to temptation?

So, the cap is likely to go up, just not by the fully inflated amount. And we’ll know by Friday how much play money there is to spend on fantasy trades and signings.

Meanwhile, the players will still hate escrow, and are likely going to try to make it an issue at the next round of CBA negotiations. But the very definition of hard cap demands a system like this to equalize the split when the revenue is finally calculated. It’s not a punishment or a tax, and the best way to fix the problem is to abolish the inflator so everyone can learn to live in the real world where the numbers add up.