The Internet and Entrepreneurs: A Special Niche is Developing
April 2006

With a global reach of more than a billion people, Internet entrepreneurs continue to look for ways to bring traditional promotions and competitive entertainment to a broader global audience. Recent federal regulations have cracked down on Internet gambling involving games of chance. As a result, companies are seeking new ways to capitalize on the Internet gaming industry, and two of the hottest emerging markets are Internet sweepstakes and skill-based gaming. And as Internet businesses continue to grow, the need for legal advisors who know the intricacies of this terrain increases. Lewis and Roca attorneys Tony Cabot and Leanne Dodds are among those gaming attorneys who practice in this special niche.

Rapid technological advancements and changes in federal regulations have made this an exciting practice niche. Internet sweepstakes, and particularly skill-based gaming, are finally getting the profile recognition needed for mass commercialization. According to Dodds, attorneys are just starting to climb the apex for these markets, and the challenge of executing these kinds of deals for clients with so many moving parts and players is exciting and cutting-edge.

"Activities like sweepstakes, promotions, and contests that appeal to the gambling instinct often have had a sordid legal history," said Dodds. "Most U.S. states have laws that generally prohibit gambling, but not all such activities are illegal. It creates some very interesting legal challenges when working in this area of the law."

As long as the public has an unfulfilled demand for a gambling experience, entrepreneurs will continue to test the boundaries of legal sweepstakes and contests to meet these demands.

"The variations of sweepstakes and contests are bound only by human imagination and unbound by tremendous leaps in technology, and this makes for a very exciting field of law," said Dodds.

Those wishing to use the Internet as a method to conduct sweepstakes face a daunting legal challenge. It is not enough that they comply with the laws where the company has its offices or houses its servers. They must also comply with federal law as well as the laws of all the states where they accept participants.

Prohibited gambling typically involves any activity in which a person pays "consideration," usually money, in an attempt to win a prize in an activity determined by chance. Nevertheless, there is no uniformity or consistency in what constitutes gambling in a particular state.

If you take away any one of the three elements of gambling—consideration, prize, or chance—you generally have an activity that is lawful in most states. A sweepstakes always contains the elements of chance and prize, so the element of consideration must be eliminated to avoid violating the various prohibitions against lotteries.

Internet Sweepstakes

For any Internet activity to qualify as a sweepstake, the site must remove the element of consideration from the promotion. Federal regulators and most states have adopted a pecuniary/economic value approach to determining "consideration." In this case, consideration requires some measurable economic value from the participant to the promoter. Consideration is usually in the form of the transfer of money either directly or indirectly. A promotion that requires participants to buy a product or pay a monetary amount to participate in the game clearly contains the element of consideration. A less-clear situation exists where a promotion requires participants to expend some degree of effort that ultimately benefits the promoter.

Neither federal nor state law specifies how much effort is required before it is deemed consideration. Often this is decided on a case-by-case basis.

"Because there are no clear-cut laws that govern Internet sweepstakes, attorneys working on cases in this field are establishing precedent-setting case law that will be called upon for years to come," said Dodds.

Skill Games

Skill games differ from sweepstakes in that they generally are played for money or prizes and are won based on skill because the elements of chance have either been eliminated or greatly reduced. Because the element of chance has been eliminated, the general prohibition against gambling is arguably avoided, making this an appealing alternative to capitalizing on the Internet gaming industry. About eight states, including Florida and Arizona, do not distinguish between games of chance and most skill games and prohibit risking any money on either type of game.

Pay-for-Play Games Without Prizes

Most skill-based games are "pay-for-play" games in which players pay a fee for the opportunity to engage in head-to-head competition on real-time gaming platforms. What makes this so exciting is that technological hurdles that traditionally limited this genre from taking off are rapidly being eliminated. This has opened the door to mass market commercialization, which is finally making this a lucrative industry, especially when undertaken as part of a co-branding partnership.

Not all skill-based games are pay-for-play. Doubters that people will pay for the opportunity to be part of a game that does not award prizes need only look to the masses that pay to vote for contestants on the hit television show American Idol. Moreover, several Internet business models exist where persons pay a fee to play a variety of games, including interactive video like City of Heroes, even though no traditional prizes are awarded. In these platforms, it's not the monetary reward that attracts players, it's the mere right to brag that you hold the high score, the ability to challenge and communicate with other players in real-time competition, and the opportunity to network with a worldwide community simultaneously.

There is significant ambiguity as to whether nontraditional prizes like free plays, avatars, or items useful in the game constitute prizes under the various state statutes and case decisions. Many states simply do not define what constitutes a "prize" for purposes of the statute prohibiting gambling and have no case law. Only a few states are like Alabama, where free plays are expressly mentioned in the statute. The states most likely to find "free plays" to be unlawful prizes because of case law or broadly written statutes (prize means something of value) include Alabama, Alaska, California, Hawaii, Kentucky, Maine, Massachusetts, Mississippi, Missouri, Nebraska, New Jersey, New York, Ohio, Oklahoma, and Washington.

And, according to Dodds, "in the year to come, we can expect to see a huge increase in online promotional sweepstakes and skill-based gaming."

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