NBC, FOX Broadcasting and other defendants reached a multi-million dollar settlement with plaintiffs in multiple California class action lawsuits alleging that American Idol and Deal or No Deal SMS sweepstakes were illegal lotteries.  The settlement—which was approved by a California federal district court on December 20, 2011—marks the end of over four years of litigation and highlights the significant financial liability that sponsors and related companies could face if their promotions (contests and sweepstakes) are not carefully structured to avoid potentially violating lottery and gambling laws.

Premium SMS Sweepstakes Litigation

It is illegal under state and federal lottery laws to require someone to provide consideration (e.g., pay money or expend significant effort) to enter a promotion in which he or she may win a prize if the award is based on a sufficient degree of chance (e.g., a random drawing).  In other words, a promotion typically will be considered an illegal lottery if it includes three elements—prize, chance and consideration—so it must be structured to eliminate at least one of these elements.  A properly structured sweepstakes attempts to eliminate the consideration element, often by offering a free (no consideration) alternative entry method.  The class actions discussed below, however, demonstrate that even when a free alternative method of entry is offered, there are potential meaningful risks involved if any portion of the participants pay to enter the sweepstakes without receiving reasonably equivalent value for their payment in addition to the entry itself.

In 2007, plaintiffs brought class actions on behalf of all participants who paid a 49¢ or 99¢ premium SMS fee, but did not win a prize, against the sponsors and others associated with sweepstakes offered in connection with the popular reality shows American Idol and Deal or No Deal.  As noted in a prior Perkins Coie sweepstakes update, these cases were significant because the defendants offered a free alternative entry method but were still sued for lottery law violations because some participants allegedly paid merely for a chance to win.  Defendants moved to dismiss the class actions on the basis that the consideration element of an illegal lottery was missing because the sweepstakes offered a free alternative method of entry via the Internet.  Siding with plaintiffs, the district court denied the motion, explaining that "Defendants' offers of free alternative methods of entry do not alter the basic fact that viewers who sent in text messages paid only for the privilege of entering the Games.  They received nothing of equivalent economic value in return."  In 2008, defendants appealed to the Ninth Circuit Court of Appeals, which dismissed the appeal in mid-2010.

Settlement

In late 2010, after more than three years of litigation at the district and appellate levels, the parties agreed to voluntary mediation to resolve the cases.  The district court granted final approval of the settlement on December 20, 2011. The settlement requires certain defendants to:

• refund all premium text message charges paid by the class (a potential recovery of over $51 million);
  
  
• pay plaintiffs' attorneys over $5 million in fees and costs; and
  
  
• agree to a five-year injunction against creating, sponsoring or operating any contest or sweepstakes that does not give participants entering via premium SMS something of comparable value to the premium SMS charge beyond mere entry into the promotions.

The Takeaway

Sweepstakes are an effective vehicle for promoting products and services and engaging consumers.  But sponsors face potential lawsuits and regulatory action if their promotions are not carefully structured.  Before launching a promotion, businesses should consider state and federal laws regarding illegal lotteries and gambling.  Sponsors offering paid-entry sweepstakes, for example, should not only offer a free alternative entry method, but should also ensure that paying entrants get fair value for their payment in addition to a sweepstakes entry.  Sponsors should also think about how best to allocate the risk for failing to comply with state and federal lottery and gambling laws before entering into contracts with promoters and administrators.

© 2012 Perkins Coie LLP