Guide Through the Legal Jungle

The Malformed Referral Contest Promotion. How to Fix It. Part Two.

In my last blog posting, Autopsy of a Malformed Referral Contest Promotion. DOA., I deconstructed the potential legal and public relations problems a local business generated for itself with a lead-generating promotion. In this posting, I discuss how one might fix that malformed promotion.

Brevity Is Not Always a Good Thing

In the malformed promotion, a local gym seeking referrals for new gym members used the following three sentences to describe its referral promotion:

For every member you refer, you’ll receive one ticket for a drawing. For every referral that joins, you’ll receive two additional tickets. Once we hit 20 members, we will draw two prizes, one for the member that has brought in the most members, and the other will be drawn randomly from all tickets.

Mistakes Were Made

The gym made several of the mistakes included on my list of the 10 Common Legal Mistakes for Contests and Sweepstakes Promotions including the following:

1) The gym’s promotion (arguably) combined the elements of chance, consideration, and prize so that some states might view the promotion as an illegal lottery.

2) The gym did not provide entrants with complete rules for the promotion. This included a failure to explain how to enter and a failure to identify the prize.

3) The gym did not offer a free alternative method of entry.

The full analysis of the promotion’s mistakes is here.

One Potential Method to Fix this Malformed Promotion

Because of the consideration and skill/chance questions (discussed in Part One), I would discourage trying to structure this referral promotion as a contest or as a sweepstakes. Instead, I would explore a “you do this for us, and in exchange, we’ll do this for you” promotion.

For example, the gym could give every patron who refers a new member a complimentary personal training session, a free class that normally comes only with premium membership, a complimentary tropical smoothie from the juice bar – you get the idea. Of course, a business following this approach must still ensure that this exchange promotion does not trigger (or, if it does trigger, complies with) any of the federal and state laws applicable to gift cards and loyalty programs or any industry- specific regulations. For example, in some industries such as real estate and insurance, it is not permissible to pay anything to anyone for the production of business unless that person is licensed in the industry.

A Real-Life Example of this Approach

Refer a friend and Save $20.

All you have to do to start saving is refer ABC Company to a friend or neighbor. When your referral contacts us to schedule their free, no obligation consultation they must give your name as the referring customer. After your referral schedules service with ABC Company, you will receive a $20.00 credit toward your account. There is no limit to the number of friends or neighbors you recommend or the amount you can save.

This real-life example of the “you do this for us, and in exchange, we’ll do this for you” promotion works well for the service company offering it. Unlike the malformed promotion, the ABC Company promotion explains exactly how to participate, identifies the incentive, and has no element of chance or randomness (as viewed in promotion law terms).

Autopsy of a Malformed Referral Contest Promotion. DOA. Part One.

With just three sentences, a local business seeking leads for new customers illustrates how a seemingly simple promotion can generate legal and public relations complications when not structured properly. In this malformed promotion, a gym seeking new members described its lead-generating promotion to potential participants with the following three sentences:

For every member you refer, you’ll receive one ticket for a drawing. For every referral that joins, you’ll receive two additional tickets. Once we hit 20 members, we will draw two prizes, one for the member that has brought in the most members, and the other will be drawn randomly from all tickets.

So what’s wrong with this promotion? Wow, where do I start?

THE BASICS

For this discussion, you need to know that valid contests and sweepstakes may not combine the elements of prize, chance, and consideration. A promotion offered by a business may have one or two of these elements but it may not have all three:

• prize + chance = legal sweepstakes
• prize + consideration = legal contest (in most jurisdictions)
• prize + consideration + chance = illegal lottery or gambling

THIS PROMOTION IS NOT A CONTEST OR A SWEEPSTAKES

This business is actually offering two separate promotions – and each is poorly formed. The first promotion offers a prize to the person who brings in the most members. The second promotion selects a winner randomly from the people providing referrals.

Promotion One. The first promotion offers a prize for the “member that has brought in the most members”. This aspect of the promotion is trying to be a contest but it potentially fails due to the existence of prize, chance, and consideration. Some of the elements are easier to identify than others.

Prize. Easily identifiable. The business offers a prize for the promotion participant whose referrals generate the most new memberships.

Consideration. In this promotion, individuals receive a ticket in exchange for generating referrals and new memberships. Consideration is not limited to currency. Hence, some states might interpret this exchange as the individual providing payment (or consideration) for the ticket. While most states allow contests to charge an entry fee, the sponsor of the contest-with-an-entry-fee must select the winner based on a skill demonstrated by the winner. As discussed in the next paragraph, Promotion One arguably does not select the winner based on skill.

Chance. When a promotion charges consideration (which can be money or something else of value), the contest winner must be selected based on skill; not based on chance. The “chance or skill” issue is ambiguous in a promotion where the prize is awarded to “the member that has brought in the most members”. Is it a skill to generate new memberships? The answer depends on state law with some states likely to conclude that generating new memberships is NOT a valid skill for the selection of a contest winner.

Prognosis for Promotion One. The ultimate prognosis for Promotion One depends on the interpretation of law in the relevant state. For Promotion One to be legal, the applicable state must accept one or both of the following

1. Receiving an entry into a contest in return for generating referrals and/or memberships for the business sponsoring the contest does not constitute paying consideration (or an entry fee) for
2. Offering referrals that result in new memberships is a valid skill for a contest.

In states accepting one or both of these propositions, Promotion One is a valid contest since it does not have all three elements of prize, chance, and consideration. In states rejecting both propositions, Promotion One combines the three elements of a prize, chance, and consideration, and is, therefore, an illegal lottery.

Promotion Two. By awarding a prize to an individual drawn randomly from all tickets, Promotion Two is attempting to be a sweepstakes. Sweepstakes may have the elements of prize and chance but not consideration. The existence of prize and chance are clear in Promotion Two. The sponsor bestows a prize to a winner. The random drawing constitutes chance.

The existence of consideration is questionable. As discussed above, some jurisdictions might regard the exchange of promotion tickets for referrals as payment of consideration for the ticket. In such jurisdictions, Promotion Two is an illegal lottery as it combines prize, chance, and consideration.

PROMOTION DOES NOT EXPLAIN HOW TO MAKE A REFERRAL

The promotion offers a ticket in exchange for a referral. But what qualifies as a referral?

Suppose Michael is staffing the welcome desk and, as he checks me in, I mention that my co-worker Jen Smith is looking for a new exercise routine and might be interested in the gym. Is that a referral?

Can I just email the gym my Outlook contact list as an email attachment (NOT something I would do) and have each of the 430 people listed count as a referral that gets me a promotion ticket?

Does my friend need to come into the gym and take a tour to qualify as a referral? Can my friend come by himself and just mention my name, or do I need to bring my friend and physically make the introduction.

PROMOTION DOES NOT IDENTIFY THE PRIZE

What is the prize! Is it three extra towels lying around the locker room? A nice bracelet that’s been in the lost and found bin for a few weeks?

At a minimum, the business should tell participants the value of the prize. After ten of my friends join the gym adding a combined $10,000 to the gym’s annual revenue, I might not be satisfied finding out after-the-fact that my “prize” is a free tropical smoothie from the gym juice bar (even if that smoothie does retail for an outrageous $9.50).

IS THERE REALLY ANY RISK?

Do these missteps really generate any risk for a simple promotion targeted to local customers of a small business, you might ask.

There are federal and state laws regulating contests, sweepstakes, and other promotions. I advocate compliance with all those laws and regulations. Nevertheless, for a promotion in which the dollar amounts, number of participants, geographic region, and publicity outreach remain limited, it is possible that a poorly structured promotion will not generate much attention from federal and state regulators.

A more palpable risk comes from the promotion’s participants. If participants believe that the undisclosed prize is not commensurate with their efforts, do not have their recommendations count as referrals, or otherwise feel the business has not treated them fairly, those promotion participants become dissatisfied patrons.

Dissatisfied patrons might stop doing business with the company, give the company bad online reviews, and warn their friends to avoid the business – the opposite effect of what the business hoped to achieve with its promotion. A huge step in preventing a business promotion from generating such dissatisfaction is having adequate rules, and making promotion participants aware of those rules.

In a worst case scenario (where the administration of the promotion incorporates some “unfair business practices” – albeit inadvertently) – those customers might report the business to the better business bureau, the state attorney general office, or consumer protection bureau - or, less likely but by no means impossible, even file a lawsuit against the business. At that point, federal and state regulators just might become more interested in the simple promotion targeted to local customers of a small business.

IN PART TWO OF THIS BLOG POSTING, I WILL DISCUSS HOW TO FIX THIS MALFORMED REFERRAL CONTEST PROMOTION

Illegal Promotions All Around Me. A Real-Life Example of How Merchants Get Contests & Sweepstakes Wrong - and How to Fix It.

Promotions and give-aways can be a low-cost, easy, and engaging method of garnering positive attention for a business. However, some business owners do not realize that contests and sweepstakes must comply with an assortment of laws and regulations. That failure sometimes leads to well-intentioned businesses inadvertently engaging in illegal activity. Here is one real-life example that I recently encountered.

The Promotion

While the structure of this promotion remains intact, I have altered names and details.

Dr. Smith offers you an extra incentive to maintain your health - A FREE WEEKEND GET-AWAY.

Dr. Smith’s office will draw the name of one patient during {Health Awareness Day}, on June XX, 2017. You may enter the drawing in one of two ways:

1. Schedule and complete a wellness exam by June XX, 2017

2. Register to use our telemedicine service AND complete your first televisit by June XX, 2017

Why Is Dr. Smith’s Weekend-Getaway Promotion Likely Illegal?

Dr. Smith likely wants to offer a valid sweepstakes. Instead, he is offering what is likely a lottery. With few exceptions, only the federal and state governments can legally offer a lottery. Hence, Dr. Smith’s lottery is an illegal lottery. Inadvertently offering an illegal lottery or gambling game is mistake number one on my list of 10 Common Legal Mistakes for Contests and Sweepstakes Promotions.

A promotion in which participants pay consideration (e.g., money or other item of value) for the chance to win a prize is a lottery. For Dr. Smith’s promotion, payment for the wellness exam or televisit qualifies as the consideration, the free weekend get-away is the prize, and selection of the winner via random drawing injects chance.

How to Transform this Malformed Sweepstakes into a Legal Promotion

Successfully removing just one of the three elements – prize, consideration, or chance – lifts the illegal lottery stigma. Which one should be removed?

Remove the Prize? Possible but often not practical since removing the prize also removes much of the incentive for people to participate.

Remove Chance? Removing the element of chance to award the prize to one of many entrants means structuring the promotion as a skill-based contest. That is definitely possible and the method used by many promotion sponsors to avoid the illegal lottery issue. A skill-based contest requires entrants to demonstrate a skill (e.g., dance, photography, essay writing, etc.) and for a winner to be selected based on objective judging criteria. For this short discussion, assume that Dr. Smith wants to keep his office promotion very simple and avoid a structure requiring an objective evaluation of entrants’ skill.

Remove Consideration? Removing the element of consideration makes this promotion a valid sweepstakes – and that seems to be the structure Dr. Smith actually desires.

Removing Consideration as Method of Changing Illegal Lottery into a Legal Sweepstakes

There are a few approaches to removing the element of consideration from a promotion:

Offer a Free Alternative Method of Entry. Providing a free alternative method of entry can remove the element of consideration for a promotion where entry comes automatically with a purchase. In Dr. Smith’s promotion, entry for the weekend get-away might include the third option of entry by mail or by the internet without the requirement of scheduling a wellness exam or televisit.

Restrict Promotion to Existing Patients Who Have Already Paid for Dr. Smith’s Medical Services. For example, suppose Dr. Smith operates his practice as a concierge service where patients pay a fixed annual fee that covers certain services during the year including a wellness exam and televisits. The wellness exam and televisits are available to existing patients at no additional charge. Hence, while the wellness exam and televisits are not “free”, they do not serve as incentives for participation in the promotion. The success of this approach depends on the applicable state law. States have varying opinions on whether a promotion open only to existing customers, paying members, or event attendees qualifies as a promotion charging consideration.

Offer the Wellness Exam and Televisits Free to Anyone. Although perhaps unlikely, let’s imagine that there are circumstances in which Dr. Smith chooses to offer wellness exams and televisits to anyone free of charge for a period of time. If the free services are true “no-strings-attached” benefits to the recipients, this structure likely removes consideration. However, even “free” might be problematic if the offered “wellness exams” and “televisits” more closely resemble some type of sales pitch (e.g., persuading people to sign up for Dr. Smith’s annual concierge service). There are federal and state prize notice laws that specifically address and regulate any promotions offered as an incentive for consumers to attend a sales presentation or accept a telemarketing call.

Don’t Use Contest Rules Like These. A Real-Life Example of Deficient Contest Rules.

Recently, I encountered the following short paragraph that professed itself to be rules for a contest. The gist of the paragraph remains intact but I have altered details to protect the contest-rule-drafting challenged.

{Contest Sponsor} invites you to enter its 2017 writing contest. Entry Deadline: June 15, 2017. Word Limit: 500 words. Rules: You can submit a work of fiction, non-fiction, or poetry. Your entry must include all the following: the name of a flower, a reference to a 1930’s motion picture, a form of physical activity, and perseverance. The winner will receive {the contest prize}.

What’s Wrong with These Contest Rules? Quite a bit as these rules reflect many deficiencies. I discuss four significant deficiencies in this blog post:

Entry Requirements Are Incomplete.
A writing contest should specify requirements for language, length, and formatting (e.g., typed, double-spaced, file format for online submissions, etc.). While these rules place the word limit at 500, there is no clear indication that the sponsor would reject my essay composed in Egyptian hieroglyphics and chiseled onto a stone tablet.

No Information about Judges.
A sponsor does not necessarily need to identify the judges by name – and, in some cases, the better procedure is not to identify the specific judges in the rules. Nevertheless, a contest sponsor should at a minimum describe the pool from which judges come and provide details illustrating that the selected judges are qualified. For example, The New Yorker's weekly cartoon caption contest identifies its judges as members of the editorial staff of The New Yorker. Few would argue that members of that group are not qualified to select the cartoon caption contest winner  – even though the contest rules do not specifically identify any judge by name.

Lack of Specific Judging Criteria.
This example does not even take the partial – yet inadequate step – of saying the prize will be awarded to the best essay. I refer to a “best essay” award as inadequate – because what exactly does it mean to be the best. To some extent, most judging criteria for a writing contest will be subjective. Nevertheless, the sponsor places itself in a much better position to defend itself from participant-dissatisfaction and regulatory inquiries by explicitly itemizing judging criteria in its rules. Judging criteria for a writing contest might include originality, adherence to submission guidelines, writing skill, and overall appeal.

In a worst-case scenario, failing to establish objective criteria for awarding a contest prize can inadvertently alter a legal skill-based contest into an illegal lottery. Mistakenly offering an illegal lottery or gambling game is one of the 10 Common Legal Mistakes for Contests and Sweepstakes Promotions.

Full Rules Are Non-Existent or Gated.
If this paragraph is meant to be an abbreviated version of the full rules, the paragraph should indicate where the full rules can be found. If there are more complete rules, the sponsor has hidden them behind a social networking gate. People interested in participating in this particular writing contest need to register at the sponsor’s online contest platform in order to obtain additional information about the promotion.

This is similar to like-gating. Through like-gating, companies offer exclusive information, products, and promotion-participating opportunities only to those people who like or otherwise connect to the company’s social media account. While I am not aware of any court decision ruling that like-gating is illegal, it is not a best practice when offering promotions and has been discouraged by self-regulatory organizations within the advertising industry such as the Better Business Bureau’s National Advertising Division.

Legality of Fantasy Sports - Gambling or Not

The fantasy sports industry nearly imploded in 2015. While several factors fueled that near detonation, chief among them was a belief that fantasy sports games are actually illegal lotteries or illegal gambling games.

Since the 2015 implosion, eight states, including New York, have adopted laws legalizing (and, in most cases, heavily regulating) fantasy sports. Although daily fantasy sports remains banned or legally uncertain in about ¼ of the states, the industry seems to be recovering from its near-death experience. In fact, the fantasy sports industry’s experiences offer helpful lessons for companies and counsel in other industries.  I discuss those lessons in the article, “What In-house Counsel Can Learn From the Fantasy Sports Industry”, co-written with my colleague, Ellen Zavian, and appearing in the September 2016 issue of the Association of Corporate Counsel’s Docket Magazine.

This blog posting explains why state regulators and others viewed (or continue to view) fantasy sports as illegal.

What Are Fantasy Sports?

Fantasy sports competitions are games in which participants simulate the role of an owner or manager of a professional sports team. Other names for this type of promotion include rotisserie, roto, and owner simulation. There are fantasy sports leagues for many sports including football, baseball, basketball, hockey, NASCAR races, soccer, and golf. Currently, fantasy games based on the National Football League are by far the most popular in the United States, with games based on soccer being the most popular globally. The simulation game genre has even gone beyond sports and exists for politics, movies, and reality television programs.

In a fantasy sports competition, each participant selects a roster of athletes to play on that participant’s simulated team. The selected athletes are real people who actually belong to professional sports teams. A roster assembled by a fantasy sports team player typically consists of players from several teams. The participant gets points based on the real-life statistical performance in actual games by the athletes on his roster. The winner of the fantasy sports competition is the participant with the most points.

Fantasy sports can be divided into two broad categories: the more traditional season fantasy sports (SFS) and the newer daily fantasy sports (DFS). As the name implies, SFS games track athletes’ performance over the majority of a season. In contrast, DFS games track athletes’ performance over a single game or single week. The surge in DFS competitions sparked many of the industry’s recent woes.

Impact of Federal Unlawful Internet Gambling and Enforcement Act

In arguing their legality, fantasy sports companies relied heavily on the Unlawful Internet Gambling and Enforcement Act of 2006, 31 U.S.C. §§ 5361-5367 (UIGEA). The UIGEA is a federal law that prohibits funds transfers to businesses engaged in unlawful internet gambling. The act defines “unlawful internet gambling” as transmitting a bet or wager via the internet where the bet or wager violates the gambling laws of any state in which the bet is initiated, received, or otherwise made. The UIGEA specifically excludes from the definition of “bet” or “wager” money paid for participation in a fantasy or simulation sports game as long as the fantasy sports game satisfies the following conditions:

• The sponsor establishes the prizes to be awarded and makes all participants aware of that information prior to the start of the promotion.

• Neither the number of participants nor the amount of fees paid by participants determines the value of the prizes.

• Winning outcomes are determined predominately by accumulated statistical results of the performance of individuals (athletes in the case of sports events) in multiple real-world sporting or other events.

• No winning outcome is based on the score, point-spread, or any performance or performances of any one or more real-world teams.

• No winning outcome is based solely on any single performance of an individual athlete in any single real-world sporting or other event.

Daily fantasy sports providers inaccurately cited the UIGEA's fantasy sports exemption as authority for the legality of their business model. As state regulators highlighted, the exemption in the UIGEA for fantasy sports does not mean that fantasy sports are lawful in all states. The federal exemption means only that fantasy sports are not criminalized under the UIGEA.

Instead, whether or not a fantasy sports league comprises gambling within a particular state is state specific. It depends on the individual state’s gambling laws and how the state evaluates the structure of the particular fantasy sports game.

Impact of State Gambling Laws

For the most part, gambling is illegal in the United States. States that do allow gambling tend to regulate it heavily. In response to government scrutiny, fantasy sports companies describe their fantasy game offerings as skill-based contests, and, thus, not a gambling game or lottery.

Is a Fantasy Sports Competition a Skill-Based or Chance-Based Game?

Like many games, fantasy sports games combine elements of skill and chance. Skill comes from the fantasy sports participants’ use of their knowledge of athletes, statistics and strategy to pick a winning team. Chance exists because external factors that are beyond the fantasy sports participants’ control influence the outcome. These external factors injecting chance include the future performance, injury status, and time at play of athletes on the participants’ roster as well as the overall game plan.

The more direct impact participants have on the selection of their rosters, the more one can argue that skill rather than chance determines the game winner. The greater extent to which participants can trade, cut, and add players, and decide which players start or are benched for each game, the more opportunities participants have to use their knowledge and strategic thinking to influence the outcome of the competition.

Many state investigations into daily fantasy sports have focused on the fact that once a player places a wager and picks a lineup for a DFS promotion, those choices are locked in as soon as the real-world competition begins. This structure contrasts with that of a SFS game in which a participant can make changes to his roster over the course of a season.

How States Make the Chance-Skill Determination

The approach to a skill-chance determination is state specific. Most states apply the dominant factor doctrine or the material element test to determine whether chance or skill prevails in a game that combines elements of both. Variations in the states’ evaluations of fantasy sports illustrate the challenge to operators when offering fantasy sports competitions nationwide.

As an example, in his conclusions that DFS games such as FanDuel and DraftKings’ are illegal gambling in his state, Hawaii Attorney General Kevin Takata, applying the material element test, stated that chance is a material element for the vast majority of players and that skill made a difference in the outcome for only a tiny minority of top-performing players. The Hawaii opinion also cited sources from litigation between the State of New York and DraftKings indicating that the typical participant playing DraftKings' Major League Baseball-Fifty-Fifty game had a win ratio slightly worse than random chance (i.e., about 45%).

In a contrasting example, Rhode Island Attorney General Peter F. Kilmartin, applying the dominant factor doctrine, concluded chance does not dominate the outcome of DFS games and that therefore, DFS does not constitute a game of chance and is not an illegal gambling game or lottery in Rhode Island.

Existence of Chance Is Not the Whole Story

Some states have one set of laws for lotteries and a different set of laws for the broader category of gambling. While every lottery is a form of gambling, the converse is not true. Every gambling game is not a lottery. Offering a fantasy sports game viewed as either a gambling game or as a lottery creates problems with state regulators.

One major distinction between the two is the elements required to constitute a lottery versus the elements required to constitute gambling. With very few exceptions, each state requires a finding of prize, consideration, and chance before categorizing a game as a lottery. In contrast, as the fantasy sports industry has learned, some states designate a game as gambling even if it does not contain the element of chance.

In opining that fantasy sports is illegal in Nevada, Nevada regulators explained that “ . . . while a determination that an activity is a game of skill is relevant to determining whether that activity is a lottery, it is not relevant to determining whether that activity constitutes a gambling game”. In the Hawaii opinion letter discussed above, even had the attorney general concluded that daily fantasy sports games did not contain a material element of chance, the games would still be illegal gambling in Hawaii since they meet another prong of the Hawaii anti-gambling laws in that winning depends on future contingent events (i.e., performance by athletes in sporting events) that are outside the control of participants.

Tragedy Strikes Contest Promotion

Contests are designed to increase public awareness of a business or organization. Increase it in a positive way. That objective goes horribly awry if a contestant gets seriously injured or dies.

Eating Contest Tragedy in Albuquerque

That is unfortunately what happened at an Albuquerque nightclub-sponsored speed-eating contest. The contest tested who could eat a corn dog hotdog the fastest. Contestant, Debra Harbeck, choked while competing and, as a result, died a few days later from complications. Harbeck’s family has filed a wrongful death lawsuit against the club and others connected to the property and its liquor license

Takeaways for Companies Sponsoring Promotions

Implement Common Sense. Where the contest activity is inherently dangerous, perhaps the sponsor should choose an alternate activity. As an example, drinking excessive amounts of water can lead to water intoxication which can result in death. A Sacramento radio station’s ignorance or disregard of that fact resulted in a nearly $16.6 Million jury award against the station after a woman died while participating in the station’s water-drinking “Hold Your Wee for a Wii” contest.

If the activity is risky, at a minimum, the sponsor should be alert to and avoid conditions that increase the danger. For example, the sponsor of a speed-eating contest should prohibit inebriated people from participating as intoxication increases the risk of choking. According to the Harbeck complaint, Debra Harbeck’s blood alcohol level was between 0.13 and 0.14 percent as a result of being served three double shots and four double gin and tonics at the club immediately prior to the contest.

Tailor Official Rules to the Promotion. There are multiple reasons for a promotion sponsor to use written official rules. One (potentially more cynical) benefit is that if the worst happens, official rules can mandate arbitration where a sponsor might be less likely to be hit with a multi-million dollar jury verdict.Preparing official rules should not be a “cut and paste” job. Each promotion is unique and has its own challenges. Obviously, there are many considerations for an eating contest that do not apply to a best photo contest or dog contest or golf tournament or chess competition such as

• whether participants may use utensils
• whether a contestant who suffers what I’ll kindly refer to as a “reversal of fortune” is disqualified
• whether professional eaters may enter
• whether contestants may drink water during the eating contest

Use a Disclaimer and Waiver. If the contest involves a potentially risky activity, the sponsor should issue a disclaimer stating those potential risks and a waiver in which contestants acknowledge and expressly assume the risks.

Eight Facts about New York’s Legalization of Fantasy Sports

New York Governor Andrew Cuomo signed into law a bill legalizing fantasy sports on August 3, 2016 – a nail-biting seven  weeks after the New York legislature’s passage of the bill.

It’s Official. Fantasy Sports Games Are Not Illegal Gambling in New York.

In fantasy sports games, participants simulate the role of an owner or manager of a professional sports team, and then participants compete against each other to win points based on the real-world performance of the athletes on their rosters. Much of the legal clamor around the fantasy sports industry has focused on whether the games in which participants pay an entry fee qualify as legal skill-based contest or, alternatively, as illegal gambling. “Inadvertently offering an illegal lottery or gambling game” is mistake number one on my list of 10 Common Legal Mistakes for Contests and Sweepstakes Promotions. New York law now declares that fantasy sports games are legal and are neither games of chance nor illegal gambling.

What the New York Law Means for Fantasy Sports Operators

Fantasy sports operators that were active in New York prior to November 10, 2015 may return to New York as long as they receive a temporary permit from the New York State Gaming Commission and file a full registration application within ninety days of release of the registration regulations. November 10, 2015 is the date of New York Attorney General Eric Schneiderman’s letter ordering FanDuel and DraftKings, the two companies that dominate the daily fantasy sports industry, to cease operations in New York.

Operators eligible for quick re-entry include FanDuel and DraftKings. Those operators who were not active in New York prior to November 10, 2015 must wait for review and acceptance of a full registration application. Some view this November 10, 2015 cut-off date for temporary permit eligibility as an unintended punishment to fantasy sports operators who cautiously chose to stay out of the New York market due to the games’ questionable legality in the state.

About that Temporary Permit Application

I suspect the New York State Gaming Commission had a heads-up that Governor Cuomo would sign rather than veto the bill. The Interactive Fantasy Sports Contest Application for Temporary Permit was available on the Gaming Commission’s website the same day Cuomo signed.

The temporary permit application is not a perfunctory one. In response to twenty-three pointed questions, fantasy sports operators must provide descriptions, screen shots, documentary evidence, and illustrative examples of how they will comply with requirements of the new law – requirements that include prohibition of play by minors, use of non-misleading advertisements, identification of highly experienced players, and player privacy protections.

 

New York’s False Advertising Lawsuit Will Continue

New York fantasy sports legalization will not halt Attorney General Schneiderman’s pursuit of fraudulent conduct and false advertising claims against DraftKings and FanDuel. While stating he will uphold the new law in a statement about the new legislation, Schneiderman added that “Our false advertising and consumer fraud claims for past misconduct by DraftKings and FanDuel will continue to move forward.”

What the New York Law Requires of Fantasy Sports Operators

The New York requirements share many similarities with fantasy sports legislation recently passed in Indiana, Tennessee, and Virginia including the following:

• Prohibition of players under 18 and of players who are fantasy sports industry insiders

• Prohibition of fantasy sports games based on college or high school athletic events

• Requirement to identify highly experienced players (defined in New York law as players who have entered more than 1,000 fantasy sports contests or won more than three prizes valued at $1,000 each or more)

• Requirement to protect player funds and segregate those funds from the company’s operating funds

• Prohibition on allowing players to use third-party computer scripts and optimization software

No New York Fixed Registration or Licensing Fee

New York diverges from other states on the licensing fee structure. Instead of a set licensing fee, fantasy sports operators registering in New York will pay the following:

• a tax equal to 15% of their New York-generated fantasy sports gross revenue, payable on at least a monthly basis, plus

• a tax equal to .05% of such revenue, also payable on at least a monthly basis, but not to exceed $50,000 annually plus

• some potential additional nebulous annual assessment, as necessary to offset New York’s regulatory costs

The percentage fee structure is good news for smaller fantasy sports operators that have contemplated leaving states such as Indiana and Virginia where the initial registration fee is $50,000.

No New York Independent Annual Audit Requirement

Unlike other states, New York does not mandate an independent annual audit. At least not in the law – there might be additional regulatory requirements in the Gaming Commission’s forthcoming regulations. This is more good news for smaller operators that were concerned about the costs of such an audit. Instead, each New York registered operator must submit an annual report detailing the number of player accounts, revenue received, prizes awarded, and other operational information. After receiving the report, the Gaming Commission has the right to conduct a financial audit of the operator.

There Are Many More Legal Issues Swirling Around the Fantasy Sports Industry

And many of those issues are discussed in a forthcoming article, “What In-house Counsel Can Learn From the Fantasy Sports Industry”, to appear in the September 2016 issue of the Association of Corporate Counsel’s Docket Magazine and co-authored by my colleague, Ellen Zavian, and me.

Bay City, Michigan Shows How to Make Your Sweepstakes or Contest a Success Even When Very Few People Enter. Extending the Deadline Is Not Always the Best Solution.

What should you do when you launch your sweepstakes or contest and no one comes to play?

That was the situation recently confronting the city of Bay City, Michigan. In celebration of its sesquicentennial (150th) birthday celebration, the city invited residents and others to compete for a bundle of prizes with the grand prize valued at $2,000. Entry required submission of the Bay City-issued “passport” (A promotional brochure mailed to city residents. Pictured on left.) with stamps indicating that the entrant had visited the city’s top twenty-five attractions.

The problem. Only one person entered by the deadline. So Congratulations to the winner, native Bay City resident, Taylor Langstaff!

Maybe “1” Is Not the Loneliest Number

Relying on its strong media relationships, Bay City contacted the press prior to awarding the prizes. The Bay City promotion ended up receiving significant media coverage focusing on the fact that there was only one entrant. When asked whether Bay City considered the promotion to be a success despite the low participation, Deputy City Manager Dana L. Muscott responded with an enthusiastic, “Yes”. “. . . even if passports were not completely filled out, it was a great mailer for the events held in our City!” Ms. Muscott shared via email.

The primary purpose for a promotion is to promote – as in generate positive attention for a company, organization, person, cause, or, in the case of Bay City, a city. Hence, I wholeheartedly agree with Ms. Muscott that the one-participant promotion was successful. “I actually had people from outside of town contacting me for a book to have some kind of guide to all of the [Bay City] activities,” Ms. Muscott shared with a reporter covering the promotion results.

Now that is truly turning lemons into lemonade!

Some Lessons for All Promotion Sponsors

But what other options are available to sponsors whose promotions attract fewer entrants than hoped?

Can a Sponsor Extend the Deadline? While I have not yet encountered a case directly addressing a sponsor’s right to extend a promotion deadline, here are my thoughts on the issue. If in the official rules the sponsor reserves the right to modify the rules, the promoter can arguably extend the deadline of the promotion. The right to extend the deadline is one of several rights a sponsor should reserve in its official rules. If the sponsor does not reserve these rights, the sponsor arguably waives the right to take these actions.

But, Extending the Deadline Is Risky. It is risky to extend the deadline if the sponsor has not reserved that right in the official rules. Even with a reservation of the right in the official rules, deadline extensions are still risky - from both a legal perspective and a public relations perspective. The risk increases proportionally with the value of the prize, the number of participants, and the effort required from participants to enter. Sponsors implementing best practices will avoid deadline extensions.

Ability to Extend Deadline Varies by State and by Type of Promotion. A state’s prize promotion laws can also impact the sponsor’s ability to extend the deadline. Some state prize promotion laws explicitly prohibit the sponsor from changing the rules. However, not all state prize promotion laws govern all contests, sweepstakes, and other prize giveaways. Like the federal Deceptive Mail Prevention and Enforcement Act which many state prize promotion laws model, some states make their prize promotion laws applicable only to certain categories of promotions that use direct mail or telephone solicitations or require attendance at a sales presentation. Other states have broader prize promotion laws that can at least be interpreted to apply to more traditional sweepstakes and contests.

Problems with Offering (or Winning) Real Estate as a Contest or Sweepstakes Prize. Part Two.

Part One of this two-part blog posting reviewed the legal challenges of awarding real estate as a prize in a contest or sweepstakes. This Part Two highlights a few of the challenges confronting the winner of the real estate in such a promotion.

Initially, winning a property for an entry fee of approximately $150 might seem like a windfall. It is a windfall with a few potential downsides. If the promotion is well structured, the rules will signal many of those potential downsides.

Method of Transfer. Often, the owner transfers the property to the winner via quitclaim deed. With a quitclaim deed, the owner transfers any interest the owner has in the property; however, the owner does not warrant or guarantee the validity or existence of those property rights. Hence, if any title problems later emerge, the winner might need to resolve those problems without any assistance from the owner.

Liabilities and Taxes. Promotion rules often indicate that the winner takes the property “as is”. While the promotion rules hopefully indicate that there are no liens, back taxes or other liabilities on the property, the transfer documents might not include this statement or, if included, might not guarantee the accuracy of the statement. It might be advantageous for a winner to conduct a judgment and lien search on the property prior to accepting it. Otherwise, as the new proprietor, the winner might be responsible for payment of any back taxes and debts.

Outstanding Business Obligations. When the awarded property is a business property such as an inn or restaurant, the rules often require that the winner honor any advance reservations and outstanding gift certificates. Obviously, the resulting burden on the winner depends on the expense associated with honoring these pre-existing obligations as well as the winner’s intent to continue the business – which leads to the next point.

Property as a Going Concern. If the real estate is a business property that the winner plans to operate, a commitment by the owner to provide the winner with some consultation and/or training on running the business is an attractive promotion feature. The winner may need to obtain and pay for the permits and licenses legally required for operation of the business Existing government-issued permits and licenses do not necessarily automatically transfer along with the transfer of the property or the business. There might also be vendor relationships the winner needs to establish or continue as part of operating the business.

Problems with Offering (or Winning) Real Estate as a Contest or Sweepstakes Prize. Part One.

Owners of real property – ranging from luxury homes to country inns to movie theaters to yoga studios – sometimes offer their property as a promotional prize. The promotion often follows the owner’s unsuccessful attempts to sell the property in the conventional real estate market.

The owner’s hope is that aggregate entry fees will allow the owner to recoup the investment in the property. The winner receives a property at a cost far below the property’s value. While this result may at first glance seem like a win-win for everyone, it can cause legal and other problems for both owners and winners. I’ll briefly review some of the owner’s woes in this blog posting.

Lotteries Not Allowed

Charging an entry fee (known as consideration in promotion law lingo) is where the potential trouble begins. If the winner of the property is selected based on a random drawing or other chance-based method, the real estate promotion combines chance, consideration, and a prize, and is, therefore, a lottery. With few exceptions, private individuals and organizations are legally prohibited from operating lotteries. Inadvertently structuring a promotion as an illegal lottery is number one on my list of top ten legal mistakes for contests and sweepstakes promotions.

Promotion mechanisms that are legal, depending on the state, and that might allow a private individual or organization to charge entry fees include a non-profit raffle and a skill-based contest. There are several obstacles to both approaches.

The Non-Profit Raffle Approach

In most states, non-profit raffles are limited to non-profit organizations. Hence, to structure the real estate promotion as a non-profit raffle, the owner must first enlist a non-profit organization as a sponsor. Other potential obstacles to the real estate owner achieving his financial objectives through the non-profit raffle approach include the facts that

• non-profit raffle revenue is meant to benefit non-profit causes; not private real estate owners

• State real estate regulations might restrict awarding real property as a raffle prize

•   Geographic and internet restrictions on raffle ticket sales might limit potential raffle revenue

The Skill-Based Contest Approach

With this approach, the owner awards the real estate based on the participants’ demonstration of a skill. One challenge to this approach is structuring the contest so it can withstand legal scrutiny. In some actual-world situations, state attorneys general have re-classified poorly structured real estate contests as illegal lotteries. Structural features for a real estate contest which I would label as mistakes and contrary to best practices include the following:

No Rules. Failing to have and publish well-drafted contest rules

Insufficient Judging Criteria. Failing to specify the skills on which the entrants will be judged and the winner will be selected. For example, in an essay contest, it is insufficient to indicate the real estate will be awarded to the writer of the “best essay”. What exactly does it mean to be the best? An attorney general reviewing the contest will be looking for clearly established and stated criteria used for evaluating the essays.

Insufficient Information about Judges. While the sponsor does not necessarily need to identify the judges by name, the better practice is to describe why the selected judges are qualified to judge the contest. Indicating merely that "an independent panel of judges" will review the essays by may be insufficient for a contest structure to withstand legal scrutiny.

No Stated Minimum. Failing to specify the minimum number of entries for the promotion to go forward. Ideally, entry fees should be placed in an escrow or trust account so that the funds can be promptly returned if there is an insufficient number of entries. Delays in returning money can trigger legal scrutiny and accusations of fraud.

Part Two of this blog posting series will briefly discuss why one might not want to be the winner of real estate awarded in a promotion.