Sweepstakes Casinos Face Long Legal Odds To Survive ‘Substance-Over-Form’ Court Scrutiny

States have been slow to legalize iGaming in the United States – at present, only seven states have done so. This has created a marketplace vacuum that has been filled by a new vertical that is not waiting around for legalization: online sweepstakes casinos. These online gaming platforms, which are rapidly gaining in popularity (with more than 1 million U.S.-based players and a projected handle this year of more than $10 billion) offer traditional casino games such as slots, roulette, blackjack, poker, sports betting, and even lottery games under a “sweepstakes-based” model.

Unlike licensed casinos, online sweepstakes casinos do not operate under U.S. gaming regulations and do not pay any gaming taxes to the states. These platforms also lack statutorily mandated consumer protections that are required for regulated gaming platforms, such as know-your-customer (KYC), anti-money laundering (AML), and responsible gaming (RG) safeguards. Underscoring this legitimate concern, especially with respect to problem gambling, is that these platforms advertise directly to young people and the minimum age to play on many sweepstakes casino websites is only 18, whereas it’s 21 or older for most state-regulated casinos.

We know it’s unregulated and untaxed, but is it “legal”?

A roadmap for assessing legality

The American Gaming Association – a trade group representing the U.S. casino industry –posed that very question in late August when it released a two-page memo urging gaming regulators and state attorneys general “to investigate companies or platforms that offer casino games or a form of sports betting under the ‘sweepstakes’ model to determine whether or not these operators are in compliance with their respective laws and regulations.”

The influential trade group also called on state lawmakers to enact legislation “where the laws and regulations are not clear” in order to “prevent unlicensed operators from exploiting loopholes In sweepstakes regulations to offer online real money gambling.”

The presumed need for legal “clarity” likely stems from the fact that this is such a nascent vertical and there is a relative dearth of published analysis concerning its legal status.

Although more than a dozen class action lawsuits have been filed against sweepstakes casino operators alleging that they are illegal gambling enterprises – and three legalized iGaming states have issued ‘cease-and-desist’ orders against several of those companies – none of those proceedings have yielded a judicial opinion on the merits or any type of fulsome legal analysis that can assist gaming regulators, state attorneys general, and state legislators.

The analytical framework for assessing the legality of online sweepstakes casinos already exists.

Close parallels to the Internet café business model

In determining whether a given operation constitutes illegal gambling, courts and state agencies will look to “substance” rather than “form.”

And that’s where the business model of the online sweepstakes casino vertical will face its greatest challenge.

Sweepstakes casinos use a ‘dual-currency system’ consisting of two virtual coins – Gold Coins and Sweeps Coins. When you buy Gold Coins – which can only be used for “social” online casino play that is not redeemable for real-world prizes– you also get an allocation of Sweeps Coins as a “bonus,” which can be used to play the same ‘casino-style’ games (such as slot machines, roulette, and poker) but for cash prizes.

This two-step process — i.e., buy Gold Coins and get free Sweeps Coins as a bonus — is intended to create a “separation” between the customer spending money and their playing games of chance for the opportunity to win real money.

This is a subterfuge in an attempt to sidestep the elements of gambling. Illegal gambling has three components: prize, chance, and consideration (payment). To be legal, the elements of consideration must be absent from a sweepstakes. By implementing a two-step process, sweeps casinos attempt to negate the element of consideration that would otherwise lead to a finding of illegal gambling.

Recent lawsuits have alleged that this is the same artifice that Internet sweepstakes cafés employed over a decade ago to offer real-money casino-style gambling under the guise of a sweepstakes promotion.

In the now-commonly outlawed Internet café model, a business establishment typically located in a suburban strip mall would sell prepaid phone cards or Internet time that would entitle the paying customer to a certain number of ‘free’ “sweepstakes” entries as a bonus allowing them to play casino-style games for prizes at computer terminals provided at the sweepstakes cafes.

“The gambling internet café operations have transitioned into calling the internet home,” one recent lawsuit proclaims, describing Australian-based sweepstakes market leader VGW as having “pioneered this migration of ‘sweepstakes casinos’ to the world wide web.”

Indeed, there are close parallels between the Internet sweepstakes café business model – which the appellate courts have uniformly found to be “incontestably gambling“ – and the dual-currency system employed by many online sweepstakes casinos:

• Both sell a “product” that comes with “free” sweepstakes entries to play ‘casino-style’ games of chance in a ‘casino-like’ setting. (Instead of the cafes selling a “prepaid phone card,” the online sweeps sell a “virtual gold coin.”).
• Both run sweepstakes games perpetually and not on a “limited and occasional” basis, as is typical with legitimate promotional sweepstakes like the McDonald’s monopoly sweepstakes.
• Both offer casino-like payouts, typically 80% or more of revenues, whereas legitimate promotional sweepstakes normally have very low prize to entrant ratios.
• Both offer ways to get free entries without requiring a product purchase, in an attempt to negate the element of consideration.

They even advance the same legal arguments – namely, that the consideration was paid solely for the product (phone card or gold coins), not the sweepstakes entries, and that there were several alternative methods for obtaining free entries, such as by mailing a postcard to a designated address.

That’s why the vast body of case law that has developed around Internet sweepstakes cafés – which address the same issues in a similar factual setting – should inform the analysis of whether their cyber successors – online sweepstakes casinos – are legal.

You know the old maxim: “there are no new cases, just new faces.”

Artificial separation of “consideration” from the scheme of chance

In the Internet café context, the courts (and state attorney generals) have repeatedly seen through the so-called ‘consideration subterfuge’ and rejected business establishments’ efforts to conceal a gambling transaction behind the façade of product purchase.

For example, in Telesweeps of Butler Valley, Inc. v. Kelley, a Pennsylvania federal court held that the purchase of a long distance telephone card that comes with a commensurate number of free entries to participate in a ‘casino-style’ sweepstakes game constituted “indirect consideration” to participate in the sweepstakes, even though no purchase was necessary and alternative methods of free entry were available. In rejecting the business establishment’s argument that the customer was simply paying for telephone time and not the sweepstakes entries, the Pennsylvania court declared that “plaintiff’s attempt to separate the consideration from the chance to win by inserting a step between the two elements is clever, but it merely elevates form over substance. At bottom, what Telesweeps is doing constitutes gambling.”

In rejecting a similar sweepstakes scheme in City of Cleveland v. Thorne, the Ohio Court of Appeals memorably observed that “the justice system is not some lumbering oaf who must ignore the patently obvious gambling scheme apparent here simply because of a contrived separation between consideration and the scheme of chance.” The Ohio appellate court added that “there is no justification for ignoring the nature of the transaction simply because the system is designed in such a way as to artificially isolate one part of the illegal transaction from another. The justice system is not so blinded by chicanery.”

Or, as one state attorney general put it, “a gambling scheme cannot be transformed into legitimacy merely by splitting it into two parts. . . . To try and conceal gambling behind the façade of the purchase of Internet time is . . . nothing more than legal trickery.”

This precedent points heavily to the courts being similarly cynical about the attempted “separation” of a virtual currency purchase from the real-money gambling transaction.

The substance-over-form based approach to consideration

The preferred approach for analyzing the issue of consideration in the sweepstakes context is to focus on the “substance” of the transaction. Indeed, it is the duty of courts to look to the substance rather than to the form of a transaction, especially in matters involving gambling given the recognized constant “ingenuity [that] is at work to evolve some scheme of evasion of anti-gambling laws.” Thus, courts and state agencies must “look through the shadow and veil of dissimulation to the substance.”

1. ‘Casino-like’ environment

Courts have held that a ‘casino-like’ atmosphere is compelling evidence that a defendant’s “true purpose” is to promote the playing of a sweepstakes and not the sale of a product. For example, in Texas v. Ysleta del sur Pueblo, a Texas federal court found “troubling” the “clear intent” of a sweepstakes operator “to create a casino-like” business model,” as characterized by: (1) “‘rows and rows’ of sweepstakes Kiosks that look similar to slot machines”; and (2) an “environment” similar to “legal casinos, including low lighting, participants rubbing the gaming kiosks in superstitious ways, and the distinctive sounds of bells, whistles, and coins falling into trays.”

Further, as the district court explained:

• “It is additionally indisputable that the Kiosks are designed to look and function similar to slot machines. The Kiosks are ‘upright cabinets with two video displays, a bill acceptor and a printer.’ . . . When a participant makes a donation, the Kiosk allows the participant to choose a game theme resembling roulette, blackjack, poker, or other common casino games. . . . The Kiosks further make distinctive sounds, mimicking bells, whistles, and coins falling into a tray whenever a participant pushes the Kiosks’ buttons. . . . Indeed, the Kiosks’ simulated gaming displays are ‘designed to create the look and feel of casino-like games.’. . . Accordingly, it is beyond dispute that the Entertainment Centers are designed to look and feel like casinos.”

The “casino-like business model,” the district court declared, was “clear and convincing evidence” that the “true purpose” of the defendant’s business establishment “is to ‘create a place where people [are] comfortable staying . . . and playing the sweepstakes,’ and not to promote a . . . product.” Because the “clear and convincing evidence” demonstrated that “the true purpose of the sweepstakes is to play the sweepstakes game itself, and not to promote a product, the element of consideration is present,” the district court concluded.

Using similarly emphatic language, a Pennsylvania federal court, in Telesweeps of Butler Valley, Inc. v. Kelley, pointed to the ‘casino-style’ gaming experience in holding that a sweepstakes promoting the sale of telephone calling cards constituted illegal gambling:

• “The exhibits presented at the evidentiary hearing show that the games look like the very same slot machines or video poker games that one would find in a casino. . . . For Plaintiff to argue that its sweepstakes is not gambling when it works to create a player experience which mimics casino-style games as closely as possible is too much for this Court to accept.”

The sharp rebuke from the Telesweeps court portends the outcome of every case uncovered in a search for cases where there was a product purchase that came with “free” sweepstakes entries which enabled the patron to play ‘casino-style’ games of chance for cash prizes.

In every one of those cases, the courts found those sweepstakes to be illegal gambling.

(Here’s just a partial list: [1] Telesweeps of Butler Valley, Inc. v. Kelley; [2] City of Cleveland v. Thorne; [3] Barber v. Jefferson County Racing Association; [4] People ex rel. Green v. Grewal; [5] Texas v. Ysleta del Sur Pueblo (see here and here); [6] United States v. Davis; [7] Moore v. Mississippi Gaming Comm’n; [8] People ex rel. Lockyer v. Pacific Gaming Technologies; [9] Trinkle v. Stroh; [10] Jester v. State; [11] Lucky Bob’s Internet Café, LLC v. California Dep’t of Justice; [12] Lucky Tunes #3, L.L.C. v. Smith; [13] State v. Fellows; and [14] Midwestern Enterprises, Inc. v. Stenehjem; and [15] Mississippi Gaming Comm’n v. Six Electronic Video Gambling Devices].

By contrast, you’d be hard-pressed to find even one judicial decision from this century that has upheld a sweepstakes promotion which incorporates casino-style games of chance.

If a sweepstakes which mimics casino-style games was “too much” for one federal court to accept and constituted “clear and convincing” evidence of an illegal lottery in the view of another federal court – and with the case-law so overwhelmingly one-sided – you almost have to assume that a casino-like atmosphere is an automatic “three-strikes and you’re out.”

2. Perpetual duration and high payout percentages

The duration of a sweepstakes promotion and payout percentage are also indicative of its “true purpose” – i.e., is it intended to promote a bona fide consumer good or service, or does it in actuality just promote play of the sweepstakes?

A traditional sweepstakes promotion “is a limited-term event designed to attract consumer attention to a product or a business, and ordinarily expires after a few weeks or months.” For sweepstakes casinos, on the other hand, the sweepstakes games run perpetually.

In addition, the typical payout percentage for a temporary promotional sweepstakes is “a trivial share of the revenue earned by the company.” By contrast, sweepstakes casinos are believed to pay out in prize money more than 80% of their revenues; notably, slot machines at commercial casinos also pay out between 80 to 95 percent (depending on the state).

These are not “arbitrary distinctions.” To the contrary, these characteristics have repeatedly been cited by courts and state attorney generals as key factors in determining that a sweepstakes promotion was in fact a guise for illegal gambling.

For example, in Barber v. Jefferson County Racing Association, the Alabama Supreme Court specifically found that the “payout percentage and duration of the operation” were indicative of “the true purpose” of a sweepstakes involving casino-style games. As the Court explained:

• “The payout percentage is 92%. This percentage coincides with the industry standard for casino-style slot machines, which ‘typically pay back 90% to 98% of all money played, thus providing a hold for the house of 2% to 10%.” . . . By contrast, the typical payout percentage for a “temporary promotional sweepstakes” is “one half of one percent.’ . . . Moreover, the duration of ‘promotional sweepstakes occasionally offered by fast food chains, or in connection with candy, sodas, miscellaneous food or other established retail products,” is typically ‘limited,’ . . . as opposed to the duration of the MegaSweeps, which is indefinite. The payout percentage and duration of the operation are indicative of “the true purpose of the game.”

Likewise, in Midwestern Enterprises, Inc. v. Stenehjem, the North Dakota Supreme Court characterized the “high payout rate” of a perpetual casino-style sweepstakes promotion as “a distinguishing feature because it goes to the true purpose of the game.”

This dramatically increases the risk exposure for online sweepstakes casinos in all states, but especially so in Florida and California, which have included durational limitations in their sweepstakes laws.

3. The playthrough requirement and other roadblocks to redemption

Another factor to consider is the length of time that users play the sweepstakes games. If the sweepstakes games are designed to keep users playing longer, then that would be an indicator that the ‘primary subject’ of the transaction is sweepstakes play, not the promoted product.

Along those lines, many sweepstakes casinos impose restrictions on prize redemption that may cause users to play longer. Unlike traditional sweepstakes where prizes can be claimed immediately, many sweepstakes casinos have a “minimum permitted redemption” threshold that limits a user’s ability to redeem prizes unless their sweeps coins balance is above a certain amount. In most cases, the withdrawal threshold is 50 sweeps coins or 100 sweeps coins. Because of this minimum, “any balance below the threshold remains stuck on the site and cannot be withdrawn or deposited.”

This is further compounded by a “playthrough requirement,” which refers to the number of times that a patron must play through his allotted sweeps coins before they are eligible for redemption. For example, if a user receives 100 sweeps coins and those sweeps coins have a playthrough requirement multiplier of 2x, a user must play games totaling 200 sweeps coins prior to those coins being eligible for redemption as a prize. Many sites have a 2x or greater playthrough requirement multiplier, with the discretion to increase the multiplier up to a maximum of 20x. This forces users to continue playing – even after a successful first spin – and increases the likelihood that they will gamble – and lose – all of their sweeps coins, leading them to purchase more gold coins so that they can get an additional allotment of sweeps coins to continue playing the sweepstakes casino games.

The Fifth Circuit has stated that conditions designed to keep patrons playing longer are indicative of the ‘true purpose’ being the promotion of the sweepstakes, not the purported “product.” In United States v. Davis, the Court found the evidence established that “the defendants’ true purpose for the cafes was to create a place where people would be comfortable staying for a long time, purchasing Internet time and playing the sweepstakes . . . .” Thus, the Court concluded that “the main purpose and function” of the business “was to induce people to play the sweepstakes, and that the Internet time sold by the cafés—albeit at fair market value—was not the primary subject of the transaction, but instead mere subterfuge.”

4. Evidence that the customers did not value the purchased product

The degree to which customers valued the sweepstakes entries over the product is also indicative of whether the “true purpose” of the transaction is to promote sweepstakes play.

This can be assessed by reviewing the customers’ purchase and game-play history.

There are two obvious lines of inquiry.

First, as to those customers who purchased gold coins and received sweeps coins as a bonus, to what extent, if any, are those users playing the gold coins vs. the sweeps coins?

Notably, when a player makes a purchase at an online sweepstakes casino, they typically receive a very large number (say, 10,000) gold coins and then receive “bonus” sweeps coins on a 1:1 basis with the number of dollars spent. (For example, $10 gets you 10,000 gold coins and 10 sweeps coins). The player can then toggle the site experience to either only play with gold coins, or only play with sweeps coins. By choosing the sweeps coins setting, players can play for real money using only the sweeps coins, disregarding the tens of thousands gold coins.

If a significant percentage of purchasing customers bypass the gold coins in favor of playing the sweeps coins, that would be a clear indication that the sweepstakes entries (sweeps coins), and not the promoted product (gold coins), are the “primary subject” of the transaction.

For example, in People ex rel. Green v. Grewal, the California Supreme Court found that the element of consideration was satisfied through evidence showing that the customers “who bought Internet time seemed to spend more time playing the games than using the Internet” and that “two-thirds of the purchased telephone time” was never used. Based on this disparity of sweepstakes play to actual product use, the Court concluded that the internet café’s customers were “clearly paying, at least in part, and, it appears in large part, for the opportunity to play the casino-style sweepstakes games and win cash prizes.”

Second, what typically happens when purchasing customers run out of sweeps coins following unsuccessful sweepstakes play? Do they go back to their stockpile of gold coins and play social casino games purely for entertainment? Or do they seek to replenish their sweeps coins balance – and continue playing real money casino-style games – by “purchasing additional gold coins” that come with a “bonus” allotment of sweeps coins?

If a significant percentage of customers opted to replenish their depleted sweeps coin balances by purchasing additional gold coins – despite already having large quantities of gold coins in their accounts (even relatively small purchases can garner “hundreds of thousands” of gold coins) – that would be compelling evidence that consumers valued the sweepstakes entries more than the promoted product (i.e., the gold coins), creating a reasonable inference that the sweeps coins were the “primary subject” of transaction.

This was the outcome in Barber v. Jefferson County Racing Association, where the Alabama Supreme Court found that the element of consideration was present in a sweepstakes game called “Megasweeps” based on the undisputed evidence showing that the defendants’ customers “were lined up at all hours to use the readers” and “purchased additional cybertime—with the accompanying entries—even though they already had large quantities of unused cybertime.” The Court concluded that these facts established that “a substantial number, if not a majority, of customers pay to play the readers [i.e., which were slot machine-style gaming devices], rather than to acquire, or in addition to acquiring, cybertime.”

The “legitimacy” of the product is not a substitute for a consideration analysis

Those urging the legality of sweepstakes casinos do not appear to engage in a ‘substance-over-form’ legal analysis, and, instead, assert that the business model is legal because it purportedly promotes a “bona fide good or service.” Putting aside the debate over whether a virtual social casino coin is a “bona fide product” – and, by the way, that’s a ‘hard no’ in California (with case after case after case holding that virtual currency is not a consumer “good” or “service” in California because it is an intangible product falling outside the scope of the Consumer Legal Remedies Act) – such an assessment is merely the starting point of the multi-faceted “consideration” inquiry and not the end (or entirety) of it.

As the district court made quite clear in Texas v. Ysleta del Sur Pueblo, the sweepstakes operator “must do more than merely identify a bona fide product.” For a sweepstakes to be considered legal, the operator must also demonstrate that there is no consideration paid by patrons to participate in the sweepstakes and that the product “is valued as the ‘primary subject’ of the transaction,’ and not ‘mere subterfuge’ to promote an illegal lottery.”

The existence of a free method of entry does not negate consideration

Another core argument advanced by sweepstakes casino proponents is that the availability of free play – such as by offering an alternative means of free entry (AMOE) – negates the element of consideration because there is “no purchase necessary” to play or win prizes. However, compliance with general sweepstakes requirements (such as the availability of a free alternative method of entry) cannot save a contest that is illegal under another law.

Sweepstakes laws do not allow operators to bypass strict anti-gambling laws merely by offering free ways to enter. This is reflected in scores of judicial decisions and statutes (see here and here). As the Colorado Attorney General observed in a formal opinion addressing the legality of internet sweepstakes cafes, “we are aware of no state appellate court that has held that compliance with the technical requirements for a ‘sweepstakes’ has rendered the activity legal.” “To the contrary,” the Attorney General acknowledged, “these states—most of which have elaborate sweepstakes requirements—uniformly decline to analyze compliance or non-compliance with such requirements. Instead, these states have looked to broader anti-gambling statutes to hold that the activity conducted at the sweepstakes cafes — whether or not it constituted a ‘sweepstakes’ — is nonetheless illegal activity.”

Indeed, courts throughout the country have consistently rejected AMOE-based defenses where the promoted product was a “mere subterfuge” to legitimize illegal gambling. In Stenehjem, the North Dakota Supreme Court observed that “the limited availability of free play does not exempt [a sweepstakes] game from being defined as gambling,” adding that “a number of states, rather than finding gambling is acceptable because it has one characteristic of limited free play in common with promotional sweepstakes, have concluded retail promotions violate gambling and lottery statutes despite the availability of limited free play.”

Similarly, in Barber, the Alabama Supreme Court stated that “gratuitous entries obtained by mail or at the race track do not legitimize the high-stakes Megasweeps any more than some opportunity for free plays could render innocuous a conventional slot machine.”

This should put to rest the false notion that the existence of a free alternative method of entry in a sweepstakes promotion will somehow rescue it from a finding of illegal gambling.

It is not the gaming law equivalent of a ‘get-out-of-jail-free’ card.

It’s not so ‘murky’ after all, but legislative changes might help

In the final analysis, it turns out that the anti-gambling laws are not “unclear” or “murky” when it comes to sweepstakes enterprises that offer illegal gambling games under the guise of a sweepstakes promotion. Even when a statute or regulation does not address a specific fact-pattern, the case-law (both judicial rulings and state attorney general opinions) provide clear-cut guidance on how to assess the legality of a sweepstakes game.

Applying a “substance-over-form” analysis, these authorities have identified the ‘tell-tale’ signs of an illegal gambling transaction hiding behind the façade of a product promotion. These include but are not limited to: (1) sweepstakes games that mimic the ‘look and feel’ of a casino; (2) a perpetual sweepstakes promotion (rather than “limited and occasional”); (3) high payout percentages more akin to a commercial casino; (4) conditions designed to ensure that customers spend more time and money playing the sweepstakes games; and (5) evidence that customers valued the sweepstakes entries more than the purchased product.

Sweepstakes promotions that possess even one of these characteristics – particularly those that incorporate a ‘casino-themed’ environment with ‘casino-like’ payouts and perpetual promotions (i.e., 24/7/365) – face a heightened risk of being deemed an illegal lottery under the decisional law arising out of the Internet sweepstakes café controversies.

The case law is one-sided when those characteristics are present.

Are there “loopholes” that are being exploited?

Perhaps, but they are more “perceived” than “actual” and likely stem from the misconception that technical compliance with state-law sweepstakes requirements vitiates any need to comply with anti-gambling laws. The case law and statutes make clear that even a technically compliant sweepstakes must not run afoul of other laws, such as those prohibiting gambling.

To the extent that any clarifying legislation is desirable, state lawmakers should consider the legislative approaches taken in California and Florida, which responded to the internet sweepstakes café crisis by amending their sweepstakes laws to, among other things: (i) impose durational limits (see Florida’s “limited and occasional” language); (ii) address ‘casino-themed’ sweepstakes – either by allowing or restricting their use; and (iii) make it clear and explicit that state gambling laws remain applicable to sweepstakes promotions.

These changes could help clear up some of the misconceptions surrounding sweepstakes and game promotions.