New Liability Trends In Online Gaming

Friday, October 1, 2004 - 01:00

As the popularity of online gambling (let's call it "gaming") and entertainment grows, so does the complexity of related liability. Gamers who lose money don't want to pay. Astonished parents are shocked at online gambling debts of teenaged offspring. Even where it is legal - in some countries outside of the U.S. - many users get angry and do not want to pay debts, feeling that they might have been cheated.

It all leads to lawsuits against each service provider in the chain, from content provider, to payment processor, to ISP. Particularly in the U.S. - despite efforts to ban it - online gambling has become a billion dollar industry. Some estimate that the majority of online gamblers, in fact, reside and play from their computers in the United States. Potential plaintiffs will look for deep pockets among all of the money being traded.

The economics of the industry are amazing and are particularly enticing in a down sector of the economy. While it may cost $300 million or more to build a new resort casino, a virtual casino can be developed for $1.5 million and operate with as few as 17 employees. Profit margins can run as high as 24 percent versus 8 to 16 percent for a land-based casino. An estimated 20 million people are currently online, with a projected 160 million online by the year 2020.

While most online gaming companies are located outside of the U.S., in an effort to avoid government prosecution, it is common for a U.S. company to be in the gaming network chain. Payment processors set up methods to send cash through companies offering secure payment systems for the Internet, others set up the means to open an offshore account, and ISPs provide networking, transport, caching, you name it.

What happens to the ISP who is not engaged in gambling but whose services are used as a conduit between the individual gambler and the online casino? What happens to the payment processor who facilitates the money transfer? What about the content providers who aren't necessarily affiliated with the offshore gambling company?

Each has to keep up with current legal trends. Knowing what is legal and where liability falls is an edge that often only one side of a bargain enjoys. Until now, with somewhat good reason, most online service providers thought they were immune from gambling-related liability. Under certain laws, service providers enjoy broad immunity for their content in most situations. But the law is changing.

Two recent events have occurred that warrant some concern if you are a service provider in the chain of questionable content. First, a recent case focusing on User Agreements between an ISP and its end users illustrates how knowing the law can cost an ISP money, if not up-to-date with current trends, or make money by avoiding liability for the company. Second, the industry in general should note a new policy announced by eBay's subsidiary payment processor, PayPal, which imposes fines for violations of its user policy, including using its service for online gambling debts.

The new, more restrictive view of ISP immunity arises from Grace v. eBay Inc., California Second Appellate District, Div. Three, B168765 (7/22/04). It has long been thought that ISPs are immune from most, if not all, liability associated with the content on their networks. In this case, a California court took a new approach - there is no statutory immunity against liability for a distributor of information who knew, or had reason to know, that the information was defamatory. In other words, if you know, or have reason to know what is on your network, you may be liable for the content. This represents a narrowing of immunity for ISPs. Despite this holding, however, eBay escaped liability.

Why should an ISP care, legally? eBay avoided liability because its User Agreement (the agreement used with online end users) was written in a way to relieve it of liability. That means that online service providers operating in California must evaluate their User Agreements. Time for a tune-up. The law is not completely on the side of ISPs any longer (at least in California).

Why should an ISP care, as a technologist? Technologies that block and filter access to objectionable material help, as do technologies that enable clear click-throughs and other methods which inform consumers about what they are buying or using. Make the terms of the relationship clear at the forefront of the User Agreement and the ISP will more likely be cleared later, as eBay was.

Why should an ISP's wallet care, or, what's the bottom line? ISPs which do not take Grace v. eBay into account will be at a disadvantage when negotiating with content providers, and could wind up with unnecessary liability. Content providers blind to this case will take on unnecessary liability. ISPs should negotiate their agreements with an eye against accepting liability for the customer's content. Be sure that whoever interfaces with the end user has an up-to-date User Agreement.

The other new development is that PayPal is not legal tender for all debts, public and private. PayPal's new policy, which takes effect September 24th and applies to both buyers and sellers, will soon fine users up to $500 for uses related to online gambling, adult content or services, and buying or selling prescription drugs from non-certified sellers. It marks the first time PayPal has imposed fines for violations of its use policy.

PayPal processes transactions on the Net and is potentially giving up a substantial amount of money. It has been reported that, at one time, PayPal received almost ten percent of its revenue from online gambling. eBay denies that it was pressured by the government to make the change. Whatever the reason, if the reported numbers are correct, eBay is willing to lose a significant amount of money and must have a good reason for the policy change.

Why should an ISP care, legally? Two reasons: (1) the User Agreement, and (2) learning how the government works. First, if a company wants its User Policies to be worth a pixel, they should adhere to them. It's not impossible, but much more difficult, to raise a User Agreement as a shield from liability if the company never abides by it. Second, PayPal might only be making this move because of its conscience. But considering it is in the business of making money, there is good reason to guess that it too is making this move to avoid liability. It has previously been reported that the government was displeased with certain links in the online gambling chain. Some argue that they are merely providing a network service and are immune. But regardless of whether the prosecutors are right or wrong, it is expensive to defend in court. An ISP should have its business model reviewed for potential liability, just as eBay has here with its PayPal service. It was the smart thing to do.

Why should an ISP care, as a technologist? PayPal's announcement opens the door for other payment method opportunities. Online gambling is still a huge and legal business in many countries. A technology that could securely avoid the U.S. and U.S. end users (and in that manner avoid U.S. prosecutors) may find an opportunity.

Why should an ISP's wallet care, or, what's the bottom line? ISPs know that the mother of innovation is need and the father of innovation is money. Without money to fund them, many of these online elements will dissipate. That might be a good thing - no judgments here. An ISP could consider what the content replacement will be and fill the void.

The Bottom Line

Congress is also in the mix. Recent legislative efforts that may affect how ISPs provide service in the online gaming market, combined with prosecutorial efforts marked by recent judicial precedent, indicate that federal and state authorities are more inclined now than in previous years to prosecute a service provider that supports an online gaming enterprise. Potential liability increases when elements of the service operate within the United States. Even when the entire service is located outside the United States, a foreign company providing support services to online gaming enterprises may affect a domestic affiliate.

Although there are strong defenses to the types of prosecution experienced by online gaming operators, there is no guarantee of immunity. Companies can, however, engage in a course of action to decrease the potential for claims of illegality. In addition to fine-tuning User Agreements, first, the service provider could avoid jurisdictional issues by keeping all elements of the service in locations where the activities are legal and outside of the United States, and similarly restricting its advertising target markets. Second, the proposed service will appear less like a service promoting or aiding an unlawful gambling enterprise if it does not directly assist online gambling operators located in the U.S., or target the U.S. from offshore. Although taking these two steps will decrease the potential for prosecution, uncertainty in this area of law makes it very difficult to gauge the likelihood of prosecution.

In short, there are simply no legal "bright lines" to follow in assessing legality or illegality in the provision of support services for online gaming. It is clear, on the one hand, that online gaming is unlawful in the U.S., and that, on the other hand, the unknowing provision of support services (e.g., credit card processing) is not unlawful. The law between these two examples - knowing provision of specially-tailored services intended for use by gaming companies and the unknowing provision of services - is still evolving and remains murky. One step forward that the service provider should take is to learn from the two eBay examples and to stay aware of what is happening in the sector.

Danny E. Adams is a Partner in the Tysons Corner office of Kelley Drye & Warren LLP, where his practice focuses on technology and telecommunications policy, related specialized litigation and transactional matters. W. Joseph Price is an Associate in the Tysons Corner office who focuses on gaming and entertainment technology, telecommunications policy, related specialized litigation and transactional matters. They may be reached at 703-918-2300.

Please email the authors at dadams@kelleydrey.com or jprice@kelleydrye.com with questions about this article.