DraftKings, FanDuel lawsuits take daily fantasy battle into critical phase

FanDuel and Draftkings delivered their biggest legal blow on Friday in New York. Here’s what to keep in mind as both sides dig in.

Three days after New York attorney general Eric Schneiderman took on DraftKings and FanDuel, the two leading daily fantasy sports operators struck back with a vengeance. Both operators on Friday filed lawsuits in New York state court arguing that Schneiderman’s attempt to shut down DraftKings and FanDuel in New York violates the law and is “irresponsible” and “irrational.” The suits also demand an expedited court order that would declare daily fantasy sports games as lawful entertainment under New York law and seek jury trial that could lead to the State of New York paying DraftKings and FanDuel and their attorneys. Later on Friday, Schneiderman responded by announcing that his office would take action in bringing both companies to court in order to get them to cease business activities in the state. The lawsuits set the table for a lengthy court battle that could determine the fate of daily fantasy sports.

Key arguments from the lawsuits

Both operators’ lawsuits categorically reject the cease-and-desist letters sent to them by Schneiderman on Tuesday. Those letters, as explained in a separate SI.com article, conclude that DraftKings and FanDuel are engaged in illegal sports betting under New York law. The letters also demand that DraftKings and FanDuel stop accepting payments from New York customers. In his letters, Schneiderman highlighted how DraftKings and FanDuel games run afoul of New York Penal Law Section 225.00. This law bars gaming contests where chance is a “material” element. How one defines “material”—which is synonymous with “meaningful” and “substantial” but doesn’t match up with a fixed percentage, such as “40%”—is crucial in determining the lawfulness of DFS games. These games clearly involve some combination of skill and chance, but how much of each element is highly debatable. Under New York law, the operators have until Monday to respond directly to Schneiderman; their lawsuits on Friday make clear how they would respond.

A core argument in the lawsuit filed by DraftKings is its contention that Scheniderman denied it sufficient due process under the U.S. and New York Constitutions. According to DraftKings' account, neither Schneiderman nor his staff afforded it any opportunity to be heard prior to Schneiderman making his very public demand earlier this week. DraftKings’ complaint portrays Schneiderman as engaging in a “draconian rush to judgment” that was concealed from the operators until they received cease and desist letters. In DraftKings’ view, Schneiderman made a “mockery of due process” that not only is unbecoming of a state attorney general but also unlawful under New York law.

The operators—especially DraftKings—also illuminate arguably the most vulnerable aspect of Schneiderman’s reasoning. Schneiderman’s cease and desist letters highlight two seemingly contradictory criticisms of DraftKings and FanDuel. On one hand, Schneiderman contends that DFS games are mostly about chance and luck, but on the other, he criticizes these games for being consistently won by only a small percentage of players. The ability of a relatively small group of DFS players to consistently win suggests that skill plays an important role; if chance were determinative, then different DFS players would be inclined to win each game.

Further, the operators charge that Schneiderman has tortiously interfered with their business contracts. Schneiderman allegedly contacted PayPal and other money-transfer operators that work with DFS operators and threatened that they would violate New York criminal law if they processed payments with DraftKings and FanDuel’s customers. Tortious interference is often a difficult claim to prove, but if Schneiderman lacked the authority—as the two operators contend—to punish them, then his alleged contact with money-transfer operators could be problematic.

FanDuel and DraftKings face a significant challenge in convincing a court that it should not only intervene but also effectively overrule Schneiderman. A court is poised to give considerable deference to Schneiderman in his interpretation of New York laws that he is charged with enforcing. In order to obtain injunctive relief, DraftKings and FanDuel would also need to persuade a court that they have a high likelihood of winning on the merits. On the other hand, the two operators have a fairly compelling argument that they would suffer irreparable harm if Schneiderman’s order is carried out. Losing the New York market would be devastating to these two companies: not only would they lose customers and consumer trust, but they would lose the confidence of companies with which they have partnered and make it more likely that other states would ban DFS.

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Extending the clock for DraftKings and FanDuel in New York

Litigation will likely take months, if not years, to play out, particularly when considering the near-certainty of appeals. Delay, of course, isn’t necessarily the worst thing for FanDuel and DraftKings: the longer it takes to resolve the legal status of DFS under New York law, the longer these operators will likely be able to operate in New York.

Also significant to the timing is Schneiderman’s demand, which asks that the two operators stop DFS activities in New York. This demand is styled as a request, rather than as a command. Along those lines, it does not appear Schneiderman’s demand is self-enforcing, meaning it would likely require a court order for the demand to become an obligation. Obtaining such an order could take time, thus further extending the clock.

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The lawsuits filed by DraftKings and FanDuel are likely not a surprise to Schneiderman or to the attorneys on his staff. They surely realize that DraftKings and FanDuel have hired high-profile attorneys in recent days to signal an obvious attempt to “lawyer-up” and prepare to fight. Schneiderman, who is not up for reelection until 2018, is arguably staking his national reputation on his high-stakes pursuit of DraftKings and FanDuel. His investigation into these operators began in earnest about a month ago in the wake of a DraftKings employee’s accidental leak of sensitive information. The incident drew attention to the fact that employees of DFS operators were allowed to play DFS for money, and prompted many of the initial calls to regulate what is still a nascent industry.

Schneiderman’s actions come at a particularly pivotal time for DFS operators in New York. This weekend is the first of the 2015 season to feature DFS contests on football and basketball at both the professional and collegiate levels, potentially making it one of the most lucrative weekends for operators. Fantasy sports website Rotogrinders is sponsoring one of the largest DFS conventions in midtown Manhattan, which began Thursday and runs through the weekend. And New York Assistant Assembly Speaker, Rep. Felix Ortiz, introduced legislation on Oct. 30 that would have given the state’s gambling commission broad regulatory power over DFS games in the state.

Taken together, the developments raise substantial questions about how all parties will pursue a path forward. Here are seven of those questions—and the answers we have so far—about the future of DFS in New York.

1) How else will DraftKings and FanDuel take on Schneiderman?

DraftKings and FanDuel are likely to wage a battle against Schneiderman on multiple levels. Their first strategy was through public relations. Within hours of Schneiderman’s letter, both operators asked New York customers to sign petitions decrying the depiction of DFS games as unlawful. The public relations effort hasn’t subsided. Indeed, a daily fantasy sports rally outside the A.G.’s office in New York on Friday morning helped document and establish a vocal base of support for the industry. 

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Legally, the response to Schneiderman’s actions will likely be more complex. As discussed above, DraftKings and FanDuel have already filed lawsuits. Under New York law, both operators also have five business days to formally respond to his demand. Both will likely avail themselves of this right because in law, parties can lose cases if they failed to exhaust their administrative remedies. In other words, if DraftKings and FanDuel decline to respond to Schneiderman, a court could later tell them that they should have attempted to resolve the matter out of court. If the operators respond to Schneiderman, they will of course categorically reject Schneiderman’s depiction of their business practices as unlawful under New York law. They will stress, among other points, that DFS mostly involves skill and that “luck” is both an insignificant and “non-material” (to address the specific language in New York’s law) element in the games.

In the meantime, the two operators have stressed they’re remaining in the Empire State and will continue to operate there, however as of Saturday morning FanDuel was not accepting account deposits, and players in New York state who attempted to access FanDuel via its mobile app were greeted with a screen prompting them to sign the company’s petition against Schneiderman’s decision. Technically, if Schneiderman’s demand becomes enforced, DraftKings and FanDuel would not be barred from operating in New York. They would be barred from accepting “wagers.” Consequently, they could theoretically offer DFS games for no money, although this is highly unlikely.

2) How will Schneiderman’s letter impact DFS sites’ user metrics?

According to ESPN, citing figures provided by FanDuel CEO Nigel Eccles, 10 percent of FanDuel’s customer base is in the state of New York, which is the state with the most DFS customers. The number of FanDuel’s New York customers is believed to be in the hundreds of thousands. For the immediate future, those users can still use the site and play in DFS games.

These numbers could change soon depending on how aggressively DraftKings and FanDuel wage a legal fight. Posing a greater potential risk is how consumer confidence would be impacted by an ongoing legal battle with a state attorney general. Furthermore, it appears likely that as both operators ramp up a legal fight, less money will be spent on advertising. For example, no DFS ads were run during CBS’s Thursday Night Football broadcast, almost unprecedented for an NFL telecast in 2015.

As we wrote earlier this week, DFS user total tournament entries and tournament entry fees are already plateauing and in some instances declining. This decline in growth started prior to the attorney general’s announcement, which indicates some consumer fatigue existed before Scheiderman entered the debate.

Don’t be surprised if the uncertainty from Schneiderman’s announcement alone significantly accelerates the decline of tournament entries and entry fees and causes the largest week-over-week drop off of 2015 after this weekend.

3) Why ask only FanDuel and DraftKings to cease and desist, and not the other fantasy sports operators in the state?

Schneiderman’s rationale for limiting his request to the two main DFS operators is unclear. Most likely, however, it relates to the substantial amount of entry fee revenues generated by FanDuel and DraftKings and to these operators’ overplayed and—Schneiderman would contend—deceptive advertisements during the first half of the NFL season.

A more sweeping principle of not allowing anyone to offer DFS, though, is not reflected in Schneiderman’s opinion. Fantasy operators like Fantasy Aces, DraftPot and Yahoo are still operating in New York and did not receive notices. While these other DFS operators can continue to operate without disruption in New York, they are nonetheless vulnerable to any interpretation of state law dictating that DFS is itself a form of gambling. These operators thus have a stake in seeing FanDuel and DraftKings prevail in their legal efforts against Schneiderman.

Other operators, such as DailyMVP and DraftOps have taken a different course and ceased operations in the state in the wake of Schneiderman’s letter. These moves reflect a “better safe than sorry” approach that stands in stark contrast with the two biggest operators’ stance against Schneiderman. A DraftOps spokesperson told Fortune.com, “Until New York passes legislation that clearly declares daily fantasy sports legal or DraftKings/FanDuel receive some declaratory ruling from a court of law that makes it safe to operate, we think it is wise not to operate within the state.” 

4) Will other attorneys general follow suit?

Only one other state body has recently taken action to define DFS as gambling, and that was the edict of Nevada’s Gaming Commission, not its attorney general, Adam Paul Laxalt. Other states’ attorneys general, such as Maura Healey of Massachusetts and Lisa Madigan of Illinois, are carefully studying DFS. A report Saturday from the Dallas Morning News indicated that Texas attorney general Ken Paxton is considering investigating the legality of DFS in the wake of a formal request from a state representative. 

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DraftKings is based in Boston and has wisely hired former state A.G. Martha Coakley, who only left office this past January and was the boss of many of the attorneys who still work at the Massachusetts A.G.’s office. Coakley urged leaders on Wednesday not to “over-regulate” when it comes to DFS and noted that some political leaders still required significant education on the issue. (As recently as 2013, Coakley and Schneiderman were public allies, co-leading a nine-state coalition calling for a change in leadership within the Federal Housing and Finance Agency.)

Healey, on the other hand, has intimated that DFS needs to be regulated and even told Boston Magazine that DFS games constitute “gambling.” She seems unconvinced that DFS is unlawful in Massachusetts, however, and appears to be taking a less combative approach toward major operators that’s more aimed at specific regulatory goals, such as protecting young players from becoming addicted and ensuring fair advertising disclosures, MassLive.com reported.

Other states could take similarly aggressive approaches in different forms. In Florida, where representatives have introduced legislation widely seen as industry-friendly, a federal grand jury was convened by the U.S. Attorney’s office to investigate whether DFS operators are in violation of the Illegal Gambling Business Act. The Florida-based Fantasy Sports Trade Association was subpoenaed for its records as part of the investigation.

5) How will investors in DFS operators react?

The two sites have raised hundreds of millions of dollars in capital from notable public and private operators. Those investors could be compelled to withdraw their investment, and new investment could be stanched, amid worries about the ramifications of backing a company that is accused of engaging in unlawful conduct.

This is particularly important in the event that DraftKings and FanDuel engage in a long, drawn-out legal battle—which all signs are pointing to—because venture funding is believed to be one of the major sources of the operators’ legal funding. Each of the major DFS operators have a deep bench when it comes to legal counsel, none of which is cheap. On Thursday, Bloomberg News reported that DraftKings asked its eight NBA partner teams to defer roughly 10% of its committed payments, suggesting that the company could be trying to save money or lower its profile as it comes under increasing scrutiny.

Executives of operators that have invested in DFS are also subject to subpoenas, which would require them to answer questions while under oath about their discussions with DFS and potentially compel them to share emails sent to DFS executives. Robert Kraft and Jerry Jones, meanwhile, are reportedly having discussions “at the highest levels” about their involvement in DFS gaming, according to the New York Post. That same report said that DraftKings was in the middle of its latest funding round, which was valued at approximately $1 billion, when Schneiderman’s letter Tuesday stopped it “dead in its tracks.”

6) Will DFS players in New York be able to withdraw their money?

On Friday,FanDuel announced it would not accept new deposits from New York as of Saturday. ​Empire state players with funded accounts were free to operate those accounts with existing funds. FanDuel told SI.com on Friday night that it was not experiencing a higher-than-usual amount of withdrawals in the wake of its announcement, and assured that players would be able to easily withdraw funds in the event that it was forced to cease operations in the state entirely.

DraftKings’ account withdrawals were being processed normally as of Saturday morning. When asked whether players could fund their accounts through the weekend, CEO Jason Robins maintained at an event in Manhattan Friday evening that his company was given five business days to respond to the attorney general’s letter, and that it was legally within its right to operate its business during that period. “I'm not sure why we would do anything prematurely,” he told SI.com. When asked if the site planned to halt account funding after the five-business-day period, which ends Tuesday, he emphasized DraftKings has never violated, nor would ever violate, any legal requirements when it came to operating in the state.

Schneiderman has made it clear that the state is not seeking to win back money that players have already won and is instead focused on combating DFS operators in the long-term. DraftKings’ lawsuit Friday accused the attorney general of targeting its payment processors, “threatening them with adverse action” if they did not stop immediately performing their contractual obligations to DraftKings in New York. “It's not just contradictory,” Robins told SI.com of Schneiderman’s alleged actions, “it’s illegal.” Bloombergreported Friday that Vantiv, a payment processor, stopped processing payments imminently in the wake of DraftKings’ lawsuit.

Monitoring withdrawals over the coming days and weeks could lend considerable insight into consumer confidence in the major operators. Last month, when Nevada’s Gaming Control Board officially defined DFS as wagering and forced operators to cease operations until they had obtained a wagering license, players were still able to withdraw funds despite not being able to play within state lines, according to Dusti Gouker of LegalSportsReport.com. Smaller operators like DailyMVP and DraftOps that did not receive cease and desist notices could be motivated to stick around New York in order to pick up business fleeing from the Big Two.​

In the event Schneiderman successfully sues DraftKings and FanDuel to permanently enjoin them from operating in New York, the two operators could be forced to refund funds automatically, or pay restitution to customers as well as a hefty fine to the state. But like any other attempt to involve a court, the litigation process in Schneiderman suing DraftKings and FanDuel would likely take months, if not years, to play out.

7) What does the cease-and-desist mean for brick-and-mortar sponsorships in New York?

Both operators have extensive physical advertising throughout New York arenas. DraftKings is a long-term marketing partner of MSG, FanDuel is advertised at NBA games and even lower-tier operator DraftOps has a broad advertising display at the Barclays Center in Brooklyn. Ads also appear on New York public transit and billboards, and in the case of the WNBA’s New York Liberty, on the front of players’ jerseys.

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Then there are television advertisements, which are already being curtailed after a relentless campaign in the first half of the NFL season. Schneiderman has called these advertisements misleading, and Healey has intimated similar ideas. Both these television and physical ads could face either extensive scrutiny or even expulsion from the airwaves.

As part of DraftKings’ request to NBA partners to defer some of its investment, the operator reportedly asked that its signs and banners in arenas show up less often on television, according to Bloomberg.

FanDuel and the NBA have a multi-year partnership in which each promotes the other’s product, one of the first league-wide deals. As part of the agreement, the NBA has an undisclosed equity stake in FanDuel. Both are businesses headquartered in New York City.

FanDuel was hoping for a massive NBA season of revenues as a result of the first year of this deal. But the NBA—which has not pulled support for FanDuel at this time, and has said it expects FanDuel to follow all legal precautions—could be compelled to pull its support if it’s determined FanDuel and DraftKings are illegal in the state. As a result, the partnership between FanDuel and the NBA—which was styled as a long-term engagement—might already be in jeopardy.

Michael McCann is a writer and legal analyst at Sports Illustrated. He is also a Massachusetts attorney and the founding director of the Sports and Entertainment Law Institute at the University of New Hampshire School of Law. This fall he is teaching an undergraduate course at UNH titled “Deflategate.” McCann is also the distinguished visiting Hall of Fame Professor of Law at Mississippi College School of Law and he teaches “Intellectual Property Law in Sports” in the Oregon Law Sports Law Institute. As a disclosure, one of McCann’s family members is represented in a personal matter by an attorney who represents a plaintiff in John Weaver v. FanDuel and DraftKings.

Will Green is a contributing writer and video producer at Sports Illustrated. He covers college basketball, college football, daily fantasy sports and wagering.