10 Legal Issues with Fantasy Sports

By: James Gatto, Sheppard Mullin

LEXIS PRACTICE ADVISOR RESEARCH PATH: Business & Commercial > E-Commerce > Social Media > Articles > Sweepstakes, Contests and Prize Promotions

1. Fantasy Sports Models Need to Avoid Federal and State Gambling and Lottery Laws

Many federal and state laws are potentially relevant to fantasy sports models, including gambling and anti-lottery laws. Broadly stated, in most cases, if the model involves the user paying consideration (money or something of value) for a chance to win a prize (money or something of value), then the model may constitute an illegal lottery or illegal gambling. Most fantasy sports models are premised on the outcome being determined predominantly by skill rather than chance.

2. The Legality of Alternative Models (e.g., Daily Fantasy and Quick Pick) Must Be Evaluated Based on the Facts

Some of the more innovative and emerging business models run a risk of being more chance-based than skill-based. If entry fees make up the prize pool, there is increased risk that the fees are a bet or wager and that the offering is illegal gambling. Other factors may trigger other legal concerns. For example, the shorter the duration of the contest (daily vs. season long) and the less skill exerted (randomly picked teams vs. player selection and management), the more likely the legal risk. Each business model is different and all of the facts need to be considered to assess its legality.

3. The UIGEA Does Not Make All Fantasy Sports Legal

The Unlawful Internet Gambling Enforcement Act (UIGEA) was enacted in 2006 and is primarily an enforcement statute targeted at preventing entities from processing payments associated with illegal gambling. The UIGEA does not precisely define what constitutes unlawful Internet gambling. Instead, it refers to activities that are otherwise illegal gambling under federal or state law. While, as discussed below, the UIGEA has a limited carve-out for fantasy sports, it does not necessarily make them legal.

4. The UIGEA Does Have a Limited Carve-Out for Fantasy Sports

As stated above, the UIGEA has a limited exception for certain fantasy sports activities. This means that qualifying fantasy sports models are not subject to enforcement under the UIGEA. This is not a blanket exemption for all fantasy sports models. The UIGEA’s fantasy sports exemption applies if:

• (a) no fantasy team is based solely on the current membership of an actual team;
• (b) all winning outcomes reflect the relative knowledge and skill of the participants and are determined predominantly by the accumulated statistical performance of individual athletes in real-world sporting events;
• (c) no winning outcome is based:

• (i) on the score, point spread, or any performance of a single real-world team, or
• (ii) solely on the performance of a single athlete in a single real-world sporting event; and

• (d) all prizes offered to the winning participants are established and made known to the participants in advance of the game and the value of the prize pool is not determined by the number of participants or the amount of fees paid by the participants.

If your fantasy sports model does not meet all of these requirements, it may be at risk of running afoul of the law.

5. Other Federal Laws May Be Relevant to Certain Fantasy Sports Models

The 1961 Wire Act has applicability to online gambling by prohibiting the use of most interstate telecommunications media for transmitting bets, wagers, or information assisting in placing bets or wagers on any sporting event or contest. The Act had been interpreted to prohibit all forms of gambling across state lines or the transfer of gambling-related funds between states or in and out of the country. However, in December 2011, the Department of Justice issued a memorandum that declared the scope of the Wire Act limited to sports betting. To the extent that a fantasy sports model is deemed to be a bet or wager on a sporting event or contest, then such betting or wagering may be illegal under the Wire Act.

Additionally, the Professional & Amateur Sports Protection Act makes it unlawful for:

• (1) a government entity to sponsor, operate, advertise, promote, license, or authorize by law or compact, or
• (2) a person to sponsor, operate, advertise, or promote, pursuant to the law or compact of a governmental entity, a lottery, sweepstakes, or other betting, gambling, or wagering scheme based, directly or indirectly (through the use of geographical references or otherwise), on one or more competitive games in which amateur or professional athletes participate, or are intended to participate, or on one or more performances of such athletes in such games.

Other federal statutes may be relevant to certain fantasy sports models.

6. The UIGEA Does Not Impact the Applicability of State Law

Contrary to a common misperception, the UIGEA does not make fantasy sports legal. Rather, as stated above, it exempts certain fantasy sports models from enforcement under the UIGEA. The UIGEA does not preclude the applicability of state law. Thus, it is important to ensure that your business model is legal under the laws of the 50 states.

7. The UIGEA Exempts Certain Uses of Points or Virtual Currency

If you are using points or a virtual currency as entry fees, you should ensure that your model is legal. It is a common misconception that if a business model uses virtual currency instead of money it avoids the associated legal issues. It may, but that is not necessarily so.

In the UIGEA, Congress defined “bet or wager” to include “staking or risking something of value upon the outcome of a contest of others, a sporting event or a game subject to chance, upon an agreement or understanding that the person or another person will receive something of value based on a certain outcome.” However, Congress excluded the following from this definition: “participation in any game or contest in which participants do not stake or risk anything of value other than . . . points or credits that the sponsor of the game or contest provides to participants free of charge and that can be used or redeemed only for participation in games or contests offered by the sponsor.” Points (or virtual currency) that can be purchased or redeemed for goods or services from someone other than the issuer of the points may not fall within this exception.

8. It Is Not Just Regulators You Need to Worry About

Many states have gambling loss recovery statutes that enable a gambling loser to sue a gambling winner to recover illegal gambling losses. Recently, at least three game companies had class actions filed against them for allegedly using game mechanics that involved gambling. The suits allege that the companies illegally earned hundreds of millions in revenue from in-app micro-transactions that allegedly involve unlawful gambling. These types of suits, referred to as qui tam actions, are likely to increase.

9. Prior Qui Tam Cases Have Targeted Fantasy Sports

In Humphrey v. Viacom, Inc., 2007 U.S. Dist. LEXIS 44679 (D.N.J. June 19, 2007), the court made some helpful findings in a qui tam action alleging that fantasy sports constituted illegal gambling. Based on the facts and governing law in that case (NJ state law), the court stated in its findings:

• (a) The entry fees for Defendants’ fantasy sports leagues are not “bets” or “wagers” because (1) the entry fees are paid unconditionally; (2) the prizes offered to fantasy sports contestants are for amounts certain and are guaranteed to be awarded; and (3) Defendants do not compete for the prizes.
• (b) A qui tam plaintiff . . . has no right to recovery unless a participant in gambling activity wins money from one who loses money in that activity. . . . No fantasy league participant suffered any such “loss.” To the contrary, participants pay Defendants a one-time, non-refundable entry fee to participate in the leagues, and receive in consideration for that fee the benefit of Defendants’ extensive administrative, statistical and analytical services throughout the relevant sports season. . . . [P]articipants simply do not lose anything and certainly suffer no cognizable “gambling” loss.
• (c) Defendants [were] not “winners” as a matter of law, but merely parties to an enforceable contract. Defendants provide substantial consideration in the form of administration of the leagues and the provisions of extensive statistical and analytical services, in exchange for the entry fees paid for participation in the fantasy leagues. At no time do Defendants participate in any bet. Absent such participation, Defendants cannot be “winners” as a matter of law. . . . To suggest that one can be a winner without risking the possibility of being a loser defies logic and finds no support in the law.

These findings may be helpful in other cases, where the facts and the law are similar. However, if the facts or law are different, a court may not adopt these same findings. For example, if a business model includes a very high entry fee, would another court find it to be merely an administrative fee? Other factors may give rise to different results. Again, all of the facts must be considered.

Additionally, the court in Humphrey only addressed illegal gambling; it did not decide whether online fantasy leagues constitute illegal lotteries, which exist when there is the presence of prize, chance, and consideration. Not all illegal lotteries are illegal gambling.

10. In Some States, Illegal Gambling Exists Even If the Outcome Is Based on Skill

Some states’ gambling laws are such that even if the outcome of a bet or wager is determined based on skill, it is still illegal gambling. Some states have other challenging provisions for some fantasy sports models. To address these issues, it may be advisable to preclude players from certain states. The list of states to be excluded is subject to some debate and may depend on the business model.

James Gatto is a Partner at Sheppard Mullin and is co-leader of Sheppard Mullin’s Social Media and Games Team

LEXIS PRACTICE ADVISOR RESEARCH PATH: Business & Commercial > E-Commerce > Social Media > Articles > Sweepstakes, Contests and Prize Promotions