Penny auctions, sometimes referred to as “entertainment shopping” or “bidding fee auctions,” are a relatively new addition to the online auction sphere, and have the potential to take the igaming industry by storm. This business model mixes the fun of shopping with the excitement of winning prizes, in a way that arguably skirts traditional legal restrictions on gambling, due to the absence of any “wager” or risk of loss.
Unlike traditional auction sites, such as eBay, where a customer with the highest bid wins an auction after a set period of time expires, penny auction bidders attempt to become the last bidder in an auction when a countdown timer reaches zero. That’s not the full story, however – in most auctions, each bid adds more time to the countdown time. Theoretically, a penny auction could be never-ending – as bidders continue to bid, more time is added to the clock which can result in an indefinitely on-going auction.685
Penny auctions offer the excitement of “winning” a retail item at a substantial discount, while removing the activity from traditional gambling regulations. They exist in a niche space on the Internet, at the perfect intersection of shopping and entertainment; similar to traditional auction websites but with an added twist.
A key distinction between traditional online auctions and penny auctions is the manner in which bids are acquired. Most penny auction sites sell “bid packs” to users. Users are typically required to purchase bids in order to participate (although not all penny auctions operate in the same manner). Each time a bid is placed, not only does the auction’s countdown timer increase, but the cost of the retail item (i.e., the amount which the winning bidder will pay in order to receive the prize) typically increases by one penny in value. Bids or bid packs may also expire. Notably, to encourage continued participation, many penny auction sites offer auctions where the prize is… more bids.
The attraction for the operator is obvious; hundreds or thousands of bidders spending countless dollars on bids for the chance to win a retail item at a huge discount. However, it is likely also easy to recognize that this business model has some inherent legal risks for the operator; among them, consumer protection issues and potential gambling violations.
Consumer Protection Issues
The most prevalent legal risks tend to be in the realm of consumer protection. One of the largest complaints from users is that they spent much more money trying to obtain a product at a reduced rate than if they had purchased the product from traditional sources. Additionally, penny auction bids are most often non-refundable. In an effort to soften the blow to losing bidders, many penny auction sites will allow bidders to apply the value of their tendered bids to the retail purchase price of an item and still purchase it after the auction ends – as a form of consolation prize. Some penny auctions also offer extensive FAQs regarding bidding strategy and how to succeed at winning an auction, primarily to educate consumers and to mitigate legal concerns. Despite these good faith efforts to educate consumers and prevent them from over-spending on bids, complaints are still common, as evidenced by the large amount of cautionary advice which may be found online.
The large amount of consumer complaints generated in connection with penny auctions has forced governmental authorities to confront this unique intersection of purchasing and entertainment – often for the first time. The law is just beginning to develop in this field, which provides both risks and opportunities, as with any cutting edge business model.
Some guidance on the consumer protection issues may be found in the FTC’s Dot Com Disclosure Guide, at least as far as adequate consumer disclosure requirements and unfair business practices. But penny auction operators are still treading in mostly uncharted territory. Many of the consumer protection cases against penny auction websites which made their way to court in the past several years have been settled and/or voluntarily dismissed, never allowing a court to assess the merits of the claims or generate clear law. At least one penny auction operator was fined substantially by state authorities for using deceptive code to defraud bidders. Given the potential consumer protection concerns, penny auction operators are best advised to carefully avoid any unfair business practices, and publish adequate, conspicuous disclosures – avoiding reliance on boilerplate legal terms of fine print user agreements.
Another important consideration for penny auction site operators is the argument from critics that penny auctions facilitate gambling because the auctions allegedly contain the three elements typically associated with gambling: prize, chance, and consideration.
In order to steer clear of the “prize/chance/consideration” trifecta, and thus remove the activity from the realm of “gambling,” penny auction companies often try to eliminate one of those elements; typically “chance” or “consideration.” For example, if it is entirely free to play a game of chance that offers an opportunity to win a prize, then the consideration element has been removed. Of course, more often than not, that would make for very low profitability. Instead, many sites, including QuiBids and BidCactus, argue that bidding on a penny auction is not an exercise in chance; rather, it is a skill-based activity. Another argument that has been advanced is that the bids do not constitute “bet” since no money is wagered is subject to being lost – particularly where the amount of the expended bids can be applied to purchase the product.
Unfortunately, the few cases involving penny auctions thus far have failed to clarify some of these thorny legal issues. In Mendelsohn v BidCactus, although eventually settled, the court seemed to lean toward a judgment for the plaintiff in the early stages, ruling that the plaintiff may be able to demonstrate that BidCactus is engaged in gambling “by showing that chance predominates over a consumer’s use of bidding skills.” QuiBids also raised a similar argument – that its auctions involve skill rather than chance – in the Locke v. QuiBids case, which was similarly settled, although there the court dismissed a claim which would have necessitated a finding of gambling on the part of QuiBids, unfortunately with no explanation.
As noted above, in addition to the skill/chance distinction and the prize/chance/consideration analysis, whether or not bidders “bet” or “wager” bids is extremely important, especially in states which prohibit both gambling and skill gaming. Moreover, even in the most restrictive jurisdictions, wagering on the outcome of a game of skill or chance is prohibited, but participating in such a game may not be.
Such nuanced legal arguments have been raised with respect to penny auctions before, but as noted above, never fully adjudicated. In Locke v. Quibids, QuiBids explained that a user does not “wager” or “bet” on the auctions because the user does not risk losing the cost of his bids. Rather, the user knowingly pays QuiBids a fee that it will never get back, even if the user wins the auction. However, the lack of substantive rulings on this issue results in a legal grey area. The determination of whether bids are bets, and whether skill predominates over chance in penny auction bidding, are issues that must be addressed in future cases.
The Future of Penny Auctions
Although specific data on the penny auction industry may be difficult to ascertain, due to the closure of some industry powerhouses (such as Bidcactus) and the opening of others, the market is beginning to open its doors to some new ventures close to the penny auction mold. For example, uBIDUP permits lowest unique bidding auctions for Bitcoin-only transactions. Integration of alternative currency bidding generates its own set of legal challenges and operational considerations. Despite the unsettled legal status of penny auctions, the industry appears to be flourishing.
However, until the relevant legal issues have been adjudicated, entrants into the penny auction market must rely on a patchwork of outdated, traditional gambling cases coupled with a common-sense approach to consumer protection. Even then, each case is unique given the myriad ways that penny auctions can be configured. With the steep increase in popularity of the penny auction business model, these legal issues are likely to take center stage in the development of this novel business model. As states struggle with the concept of legalization of pure online gambling, however, penny auction websites can help fill the void with a potentially legal business model, which combines increasingly popular online shopping with the thrill of “winning” a discounted item.
Lawrence G. Walters heads up Walters Law Group, www.GameAttorneys.com, and has practiced law for over 25 years. He represents clients involved in all facets of the online gaming industry, and has developed a unique expertise in advising penny auction operators.Available at: http://www.ftc.gov/sites/default/files/attachments/press-releases/ftc-staff-revises-online-advertising-disclosure-guidelines/130312dotcomdisclosures.pdf See e.g., Brock et al., v. QuiBids LLC et al., No. 8:12-CV-01216 (C.D. Cal. July 26, 2012) (voluntarily dismissed); Hertzog et al. v. QuiBids LLC et al., No. 5:12-CV-00786 (W.D. Ok. July 6, 2012) (voluntarily dismissed on appeal); Locke et al., v. QuiBids, LLC, No. 5:10-CV-01277 (W.D. Ok. Nov. 30, 2010) (voluntarily dismissed) See; Florida Attorney General Press release, available at: http://www.myfloridalegal.com/newsrel.nsf/newsreleases/752BFB28C46B554185257CF2006559AF Mendelson v. BidCactus, Case No. 3:11-cv-01500 (D. Conn. 2012) citing State v. Parker, 222 A.2d 582, 584 (Conn. Cir. Ct. 1966). See, n. 2, supra