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New York Court Declares Fantasy Sports Betting Unconstitutional

November 2018Advisories

Interactive fantasy sports (“IFS”) is a growing industry. According to the Fantasy Sports Trade Association, Americans spend over $7 billion annually on IFS. And IFS’s appeal isn’t restricted to players—states like IFS for the tax revenues. For approximately half of 2016, fantasy sports generated more than $2.3 million in tax revenues in New York.

But what is the legal status of IFS if a state criminalizes gambling or prohibits it under its constitution? A recent New York State Supreme Court decision attempted to split the baby by declaring a New York State law that authorizes fantasy sports betting unconstitutional, but also holding that the same law may properly carve IFS out of the criminal law’s definition of gambling.

Fantasy Sports

When competing in a fantasy sports league, a contestant pays an entry fee to select a fantasy roster of real-life players. Generally, leagues have a guaranteed pool for winners. The contestant’s roster is scored based on a combination of statistics of each player on the roster. Algorithms tally the scores by using calculations too complex for most contestants to do on their own. As IFS websites like to boast, creating a winning line-up involves many of the same skill-based judgments that a coach or general manager would make—evaluating match-ups, game conditions, players’ capabilities, momentum, motivation—all with the constraints of a salary cap and draft to limit player selection. A contestant can maximize her or his chances of success by following the news and interpreting the thousands of bits of sports info generated each day.

The Fantasy Sports Trade Association estimates that 59.3 million North Americans play either traditional or daily fantasy sports as of 2017, resulting in the IFS industry as a whole receiving over $3.2 billion in revenue in 2017. There are two major websites that run daily fantasy leagues and control over 90% of the market: DraftKings and FanDuel.

While DraftKings and FanDuel started with venture capital, investments have come from diverse sources including private equity firms, Major League Baseball, NBC Sports through NBC Sports Ventures, the National Hockey League, and the National Basketball Association.

However, there have been legal risks and issues, mostly at the state level. Many states question whether IFS is illegal gambling. If you ask FanDuel, the answer is no; if you ask Lisa Madigan, the State Attorney General of Illinois, the answer is yes.

One issue is whether paying the entry fee to play is like wagering. Another issue is whether IFS is a game of skill or chance. If it’s both, what proportion is skill and what is chance? How does this proportion fit into the state statutory scheme?

A number of state courts have ruled that IFS is gambling, including Illinois, Nevada, New York, Texas, and Hawaii. Other states permit IFS under a regulatory scheme that produces significant tax revenues. Those states include Massachusetts, Virginia, Illinois, and New York.  Still other states—Arizona, Iowa, Louisiana, Montana, and Washington—deem IFS illegal. 

The New York Experience

In 2015, the New York Attorney General commenced a lawsuit against DraftKings and FanDuel, seeking to stop the companies from doing business in New York. On December 11, 2015, the New York State Supreme Court granted the attorney general’s application for a preliminary injunction.

The court relied on Article I, Section 9, of the New York State Constitution. That Section prohibits lotteries, “pool-selling, book-making, or any other kind of gambling,” with a few specific exceptions like horse-racing or lottery sales exclusively for education.

The court also looked to New York Penal Law Section 225, which defines gambling as “stak[ing] or risk[ing] something of value upon the outcome of a contest of chance or a future contingent event not under [one’s] control or influence.” The same law defines a “contest of chance” as “any contest . . . in which the outcome depends in a material degree upon an element of chance, notwithstanding that skill of the contestants may also be a factor[.]”

For purposes of the preliminary injunction, the court held that IFS games played on the FanDuel and DraftKings websites constitute illegal sports gambling within the meaning of the New York State Constitution, Article I, Section 9, and the New York Penal Law Section 225.00–225.40. Central to the court’s decision was finding that the New York Attorney General would have greater success proving IFS games were games of chance than the defendants would have proving IFS games were games of skill.  FanDuel and DraftKings appealed.

The “New” New York Law

While the appeal was pending, New York State enacted a law to create an IFS exception to the prohibition against gambling.  Chapter 237 of the Laws of 2016 authorizes IFS contests that are registered with the state. The Legislature also made the following findings:

  1. IFS are “not games of chance because they consist of fantasy or simulation sports games or contests in which the fantasy or simulation sports teams are selected based upon the skill and knowledge of the participants[.]”
  2. IFS are not “wagers on future contingent events not under the contestants’ control or influence because contestants have control over which players they choose[.]”

Based on its findings, the Legislature declared that IFS games do not constitute gambling under the state’s penal law.

The New Challenge

In 2016, a group of individuals who claimed to have gambling addictions, or have relatives who do, challenged Chapter 237 as a violation of the New York State Constitution’s prohibition on gambling. Once former adversaries, the Attorney General, FanDuel, and DraftKings joined forces and argued the new law was constitutional.

The Decision

On October 26, 2018, Acting Justice Gerald Connolly of the New York State Supreme Court sided with the plaintiffs and held in relevant part that Chapter 237’s authorization of IFS is unconstitutional in New York.

The court initially tried to juxtapose its conclusion that IFS “involves, to a material degree, an element of chance, as the participants win or lose based on the actual statistical performance of groups of selected athletes in future events not under the [participant’s] control or influence” with the legislative findings that IFS involved skill more than chance. 

The court deferred to the legislative findings of skill.  But it nevertheless determined that Chapter 237 ran afoul of the New York Constitution in two ways. First, the constitution does not grant the Legislature authority to define what gambling is not, but instead grants authority to enact laws to prevent gambling. Second, the court held that the constitutional prohibition on gambling, which expressly includes “lottery or the sale of lottery tickets, pool-selling, book-making, or any other kind of gambling,” is sufficiently broad to include within its ambit games or contests that involve significant degrees of skill. (Emphasis in court decision).

But the court also found that the Legislature’s determination that IFS games were excluded from the definition of gambling under Penal Law, Article 225, did not violate the constitution. Because the Legislature has broad power to declare what conduct constitutes gambling for purposes of the Penal Act, the court lacks the authority to usurp the Legislature’s authority to “fashion[ ] such statute.”

The Effect of the Court’s Ruling

While the court has determined that it was unconstitutional for the legislature to exclude IFS from the definition of gambling in the state constitution, the court also found that the legislature could exclude IFS from the penal law prohibition against gambling. The effect would be that IFS, as offered by FanDuel and DraftKings, would not be subject to any penal law prohibition in New York and may continue to be offered in New York.

The problem left is one of uncertainty. Will IFS sponsors continue to offer contests to New Yorkers, while recognizing that the contests may be gambling within the meaning of the constitution (if not the penal law)? Initially, the response is yes. That is in no small part because of the volume and amount of IFS’s activity in New York. For approximately half of 2016, New York received over $2.3 million in tax revenues from IFS.

But there is uncertainty surrounding such a decision based on what other courts in New York may do. An appellate court may either affirm or overturn this decision. Will a New York appellate court find untenable the distinction that the trial court made between limiting the definition of “gambling” for constitutional purposes with not limiting the definition of “gambling” for penal law purposes? Will an appellate court reject the legislature’s finding that IFS games involve “skill” for purposes of the anti-gambling law? How will other states react? 

IFS participants and sponsors should check individual state gambling laws in states in which they participate to see if there are any IFS prohibitions. While the New York decision in White may provide a guide for anti-IFS activists to challenge state gambling laws, it also provides a playbook for developing the arguments that IFS is not gambling. 

To discuss how IFS may affect your state’s laws, we invite you to reach out directly to Marty Edel at (212) 878-5041 or [email protected].