The United States has experienced a dramatic shift in its gambling market which began with the 2018 US Supreme Court decision that overturned the Professional and Amateur Sports Protection Act of 1992. Prior to that decision, sportsbook wagering was largely confined to Nevada. Presently, over 30 states provide for some form of legal sports wagering while a few others are actively discussing legalization.

The momentum of gambling has transitioned into the market of online gambling or online casinos. Currently, six states allow this type of gambling. With the addition of the US, the estimated legalized global gambling market is expected to reach US$546 billion by 2028. While sports wagering and online gambling have seen significant growth and opportunity, the US market presents challenges to those companies that wish to participate.

Strict licensure requirements and licensing fees create a significant barrier to market entry. Some form of license is required from the operators to vendors. Generally, licenses can range from US$500 thousand for an operator down to several hundred dollars for a vendor. That time, expense and uncertainty caused many businesses to consider the social gaming market (gambling is not a component). It should be noted, there is not one universal license or fee but rather is dependent upon each state (jurisdiction) that has legalized gambling.

Social gaming.

Social gaming (entertainment that does not require consideration, be a game of skill or does not offer a prize) and social gaming regulations are relatively new to the US gaming landscape and are subject to little oversight. Social gaming offerings are likely to face similar regulatory uncertainty and political headwinds as loot boxes. Currently, there is little explicit regulation of social casinos and even less agreement over existing gaming laws' impact upon their legality. Although a series of interrelated federal and state statutes comprise the regulatory backdrop for social casino gaming, the crux of the issue revolves around three elements common to most every state definition of gambling, namely the presence of:

1. consideration,
2. chance, and
3. a prize or thing of value to be won.

Social gaming companies have advanced arguments on at least two of these three fronts in litigation dating back to 2015. First, these disputes have invited social gaming companies to argue, unsuccessfully, that freemium models lack consideration where a player need not buy an initial or even recurring allotment of chips. Second, companies have also contended awarding players more virtual in-game currency is not a "prize" with a given monetary value. It is from this latter point that most of the ambiguity in existing US law derives.

For example, the prominent federal appellate case on this topic is a Ninth Circuit Court of Appeals decision favoring plaintiffs challenging the legality of the Big Fish online casino platform. In finding for the Plaintiffs, the Court held that virtual chips awarded to a player within the game were tantamount to a prize, reasoning that "if a user runs out of virtual chips and wants to continue playing Big Fish Casino, s/he must buy more chips to have the privilege of playing the game. Likewise, if a user wins chips, the user wins the privilege of playing Big Fish Casino without charge. In sum, these virtual chips extend the privilege of playing Big Fish Casino."¹  Although not explicitly cited by the Court as rationale for its decision, the presence of a secondary market for virtual chips accumulated in the Big Fish Casino is also widely seen as a factor in favor of the Court's ruling that the game constituted illegal gambling. A strict reading of the decision, however, portends continued uncertainty over how prizes awarded in social games will be seen by diverse courts in different jurisdictions. If a prize is defined as broadly as it was in Kater, even additional time awarded for gameplay may ensnare a game in litigation with the odds of dismissal or a favorable verdict far from certain.

The split in US jurisprudence over the interpretation of a prize or "thing of value" is typified by a contrasting social gaming decision from the Northern District of Illinois in a case bearing striking resemblance to the Kater case. In this action, brought against a social casino game called "Castle Cash", the Court held that the absence of a cash-out option for in-game currency effectively nullified any argument the currency could be seen as a prize. The result was a ruling in favor of the game operator. The Court found that right to continue game-play was a prize in and of itself. The Court opined:

“Castle Clash players cannot “cash out” with [the game operator Sky Union]. The only way a person who wins a rare Hero may make money on his victory is by convincing another Castle Clash player to pay more to buy the winner's account than the winner paid to purchase gems for the Rolls it took to win desirable Heroes. Second, the tokens that one obtains from a winning round at a slot machine are exchangeable for money. By contrast, when Castle Clash players win Heroes or Talents, they do not turn to the secondary market to sell those Heroes and Talents; indeed, plaintiffs' complaint makes clear that the game is designed to make this impossible. Instead, players sell their entire accounts.”² In sum, the state of play in the United States on this issue is unsettled. It is, however, clear the presence of a number of factors would tend to hamper a legal defense against accusations of illegal online gaming for social gaming offerings:

1. Firstly, both the Terms of Use as well as the Official Rules for a given application should ex-plicitly clarify that chips/currencies accumulated in-app have no cash-out value and may not be transferred or exchanged with other users.
2. Secondly, the presence of a secondary market for these currencies and/or accounts with ac-cumulated stores of tokens should be actively monitored and disallowed by the developer and any subsequent operators of the game.
3. Another recommendation would be to clearly display any intervals or steps players may take to procure additional tokens without purchasing these from the developer. Whether a series of steps, a set time period, chance bonus feature, or some combination thereof, this alternative means of procuring new coins without cost will only help to diminish allegations the gameplay constituted gambling.

Finally, it is important to note the damages alleged in the aforementioned suits were relatively nominal, with players alleging losses of as little as several hundred dollars spent on virtual tokens. This underscores the risks associated with litigation when these suits are premised on statutes that may award fee-shifting and/or statutory fines to plaintiffs who establish either that the operator acted deceptively, facilitated illegal gambling activity, or ran afoul of other consumer protection statutes in a given jurisdiction. Any effort to actively combat underage and compulsive gaming will surely be met with approval from state regulators and legislators as they explore new avenues to potential regulation of social gaming.

In sum, the regulatory and legal environment for both loot boxes as well as social gaming is rapidly evolving. It is difficult to say with any certainty that these precautions will suffice as we anticipate additional legislative efforts to emerge over the next twelve to eighteen months that may impose additional requirements on developers with respect to loot boxes and social gaming more broadly.

Presence of chance in skill-based gaming.

When courts analyze the presence of chance while assessing whether gaming applications are to be considered gambling, they tend to focus on the role chance plays in the outcome of the gaming application. Games tend to fall on a spectrum between being skill-based versus entirely chance-based in their outcomes. For example, chess is traditionally thought of as being at the skill-based end of the spectrum, whereas dice or roulette are at the chance-based end of the spectrum.

With the rise of social gaming online, courts have determined that the myriad gaming applications have fallen somewhere in between. Courts may rely on mathematical analyses of skill-to-chance ratios when assessing games or the testimony of expert witnesses. Some state courts have ruled that games like fantasy sports, which contain elements of winning outcomes based on the knowledge and ability of the participant, are skill-based. Other factors, like the presence of loot boxes, have not been thoroughly explored by state courts, but the random nature of loot boxes tend to make games with them lean to be more chance-based. Courts must make a determination whether, in most jurisdictions, a game is predominantly a chance game or a skill-based game.

State courts use different tests to assess whether a game is skill-based or chance-based. They commonly use one of three tests (Dominant Factor, Material Element, or Any Chance). There are also a handful of states whose courts either do not use those tests or who have not heard cases regarding the issue. Each test is detailed below, as well as an explanation of the states’ jurisprudence where their approach falls outside of those three tests.

1. Dominant factor: Is the outcome of the game determined more by participants’ relative skills as opposed to chance? The least restrictive of the three tests, the Dominant Factor test balance the effects of skill and chance in games. If skill outweighs chance in the outcome of a game, the game is deemed to be skill-based. Factors to be considered can include: objective judging crite-ria, communication to entrants about the criteria before entering a competition, using judges who are qualified to employ the criteria, ensuring that judges use the criteria to evaluate competitors, and breaking ties between contestants on the basis of skill. The subjective nature of these fac-tors may lead to different state courts arriving at different conclusions on whether a game is skill-based as opposed to chance-based.
2. Material element: Does chance play any significant role in determining the outcome of the game? States that use the Material Element test tend to be even more restrictive in what they consider to be gambling and requiring licensure. Material Element jurisdictions are even more subjective than those observing the Dominant Factor test.
3. Any chance: Does chance play any role in determining the outcome of the game? The most re-strictive of the three, the Any Chance Test prohibits any games that contain any element of chance. So long as activity tends to appeal to a player’s gambling instinct, the activity is prohib-ited.

In addition to the tests outlined above, some states have not clearly defined which test their courts will follow. For example, South Carolina courts have held that the determination of skill involved does not matter as much as whether something of value is wagered on the game’s outcome.³ Wisconsin’s courts use the Gambling Instinct Test, which assesses whether the game appeals to a user’s “gambling instinct.” If it does, the game is considered to be gambling.⁴ The issue has not generated significant case law in Colorado, Montana, Tennessee, and Vermont, but we expect the courts to apply the majority Dominant Factor test if and when an issue is reached.

Additionally, individual law enforcement actions vary widely from state to state. Any law enforcement action of this nature is ultimately subject to a court’s interpretation of the law they are seeking to enforce, but it should be noted that the nature and breadth of these enforcement actions can vary widely from one jurisdiction to another.

Gaming applications operating as skill-based games may have additional hurdles to overcome in certain states. For example, some states require that skills-based games do not (1) award prizes made up of entry fees, (2) award prizes that vary based on entry fees collected, (3) allow their operators to compete for the prize, and (4) wait until the contest has begun to announce prizes. If a skill-based games violates one of those requirements, it may be unlawful, depending on the jurisdiction.

Author of the article:

Joseph L. Champion, Partner, Indianapolis, United States.

More insights together with some numbers and statistics in our Video games industry report

1. See Kater v. Churchill Downs Inc., 886 F.3d 784, 787 (9th Cir. 2018).

2. See Soto v. Sky Union, LLC, 159 F. Supp. 3d 871, 880 (N.D. Ill. 2016).

3. See Town of Mount Pleasant v. Chimento, 737 S.E.2d 830, 838 (2012).

4. City of Milwaukee v. Burns, 225 Wis. 296, 274 (1937).