With just three sentences, a local business seeking leads for new customers illustrates how a seemingly simple promotion can generate legal and public relations complications when not structured properly. In this malformed promotion, a gym seeking new members described its lead-generating promotion to potential participants with the following three sentences:

For every member you refer, you’ll receive one ticket for a drawing. For every referral that joins, you’ll receive two additional tickets. Once we hit 20 members, we will draw two prizes, one for the member that has brought in the most members, and the other will be drawn randomly from all tickets.

So what’s wrong with this promotion? Wow, where do I start?

THE BASICS

For this discussion, you need to know that valid contests and sweepstakes may not combine the elements of prize, chance, and consideration. A promotion offered by a business may have one or two of these elements but it may not have all three:

  • prize + chance = legal sweepstakes
  • prize + consideration = legal contest (in most jurisdictions)
  • prize + consideration + chance = illegal lottery or gambling

THIS PROMOTION IS NOT A CONTEST OR A SWEEPSTAKES

This business is actually offering two separate promotions – and each is poorly formed. The first promotion offers a prize to the person who brings in the most members. The second promotion selects a winner randomly from the people providing referrals.

Promotion One. The first promotion offers a prize for the “member that has brought in the most members”. This aspect of the promotion is trying to be a contest but it potentially fails due to the existence of prize, chance, and consideration. Some of the elements are easier to identify than others.

Prize. Easily identifiable. The business offers a prize for the promotion participant whose referrals generate the most new memberships.

Consideration. In this promotion, individuals receive a ticket in exchange for generating referrals and new memberships. Consideration is not limited to currency. Hence, some states might interpret this exchange as the individual providing payment (or consideration) for the ticket. While most states allow contests to charge an entry fee, the sponsor of the contest-with-an-entry-fee must select the winner based on a skill demonstrated by the winner. As discussed in the next paragraph, Promotion One arguably does not select the winner based on skill.

Chance. When a promotion charges consideration (which can be money or something else of value), the contest winner must be selected based on skill; not based on chance. The “chance or skill” issue is ambiguous in a promotion where the prize is awarded to “the member that has brought in the most members”. Is it a skill to generate new memberships? The answer depends on state law with some states likely to conclude that generating new memberships is NOT a valid skill for the selection of a contest winner.

Prognosis for Promotion One. The ultimate prognosis for Promotion One depends on the interpretation of law in the relevant state. For Promotion One to be legal, the applicable state must accept one or both of the following

  1. Receiving an entry into a contest in return for generating referrals and/or memberships for the business sponsoring the contest does not constitute paying consideration (or an entry fee) for
  2. Offering referrals that result in new memberships is a valid skill for a contest.

In states accepting one or both of these propositions, Promotion One is a valid contest since it does not have all three elements of prize, chance, and consideration. In states rejecting both propositions, Promotion One combines the three elements of a prize, chance, and consideration, and is, therefore, an illegal lottery.

Promotion Two. By awarding a prize to an individual drawn randomly from all tickets, Promotion Two is attempting to be a sweepstakes. Sweepstakes may have the elements of prize and chance but not consideration. The existence of prize and chance are clear in Promotion Two. The sponsor bestows a prize to a winner. The random drawing constitutes chance.

The existence of consideration is questionable. As discussed above, some jurisdictions might regard the exchange of promotion tickets for referrals as payment of consideration for the ticket. In such jurisdictions, Promotion Two is an illegal lottery as it combines prize, chance, and consideration.

PROMOTION DOES NOT EXPLAIN HOW TO MAKE A REFERRAL

The promotion offers a ticket in exchange for a referral. But what qualifies as a referral?

Suppose Michael is staffing the welcome desk and, as he checks me in, I mention that my co-worker Jen Smith is looking for a new exercise routine and might be interested in the gym. Is that a referral?

Can I just email the gym my Outlook contact list as an email attachment (NOT something I would do) and have each of the 430 people listed count as a referral that gets me a promotion ticket?

Does my friend need to come into the gym and take a tour to qualify as a referral? Can my friend come by himself and just mention my name, or do I need to bring my friend and physically make the introduction.

PROMOTION DOES NOT IDENTIFY THE PRIZE

What is the prize! Is it three extra towels lying around the locker room? A nice bracelet that’s been in the lost and found bin for a few weeks?

At a minimum, the business should tell participants the value of the prize. After ten of my friends join the gym adding a combined $10,000 to the gym’s annual revenue, I might not be satisfied finding out after-the-fact that my “prize” is a free tropical smoothie from the gym juice bar (even if that smoothie does retail for an outrageous $9.50).

IS THERE REALLY ANY RISK?

Do these missteps really generate any risk for a simple promotion targeted to local customers of a small business, you might ask.

There are federal and state laws regulating contests, sweepstakes, and other promotions. I advocate compliance with all those laws and regulations. Nevertheless, for a promotion in which the dollar amounts, number of participants, geographic region, and publicity outreach remain limited, it is possible that a poorly structured promotion will not generate much attention from federal and state regulators.

A more palpable risk comes from the promotion’s participants. If participants believe that the undisclosed prize is not commensurate with their efforts, do not have their recommendations count as referrals, or otherwise feel the business has not treated them fairly, those promotion participants become dissatisfied patrons.

Dissatisfied patrons might stop doing business with the company, give the company bad online reviews, and warn their friends to avoid the business – the opposite effect of what the business hoped to achieve with its promotion. A huge step in preventing a business promotion from generating such dissatisfaction is having adequate rules, and making promotion participants aware of those rules.

In a worst case scenario (where the administration of the promotion incorporates some “unfair business practices” – albeit inadvertently) – those customers might report the business to the better business bureau, the state attorney general office, or consumer protection bureau - or, less likely but by no means impossible, even file a lawsuit against the business. At that point, federal and state regulators just might become more interested in the simple promotion targeted to local customers of a small business.

IN PART TWO OF THIS BLOG POSTING, I WILL DISCUSS HOW TO FIX THIS MALFORMED REFERRAL CONTEST PROMOTION