V-Gaming Turns Two in Illinois

On the verge of turning two, it is time to give the video gaming terminal (VGT) industry that has developed in Illinois its own proper name; I vote for “V-Gaming.” Having heard it referenced as VGT gaming (repetitive), video gaming (too confusing), terminal gaming (morbid), route gaming (seedy), VLT or video lottery terminal gaming (misleading) and distributed gaming (too general), the industry deserves a rebrand for having survived its tumultuous infancy. I even called it wide area gaming for a while, which no one enjoyed and I regret.

With the hopeful assumption that V-Gaming has much better appeal than wide area gaming, it is the reference embraced in this article as some of the unique regulatory and legal trouble spots of the early V-Gaming industry are explored. A number of state legislatures, often with encouragement from the industry, have maintained an interest in the returns from Illinois’ V-Gaming expansion as well as the impact it has had on communities and the existing riverboat gaming industry there. It makes sense that other states would take an interest in the cost-sensitive manner in which the Illinois General Assembly chose to deploy VGTs throughout the state.

Unlike a VLT structure in which a lottery or similar government commission controls and funds electronic gaming device expansion, the V-Gaming structure through which the Illinois General Assembly chose to add new gaming positions throughout the state, capitalized on some concepts from master franchise systems. By using a central system under which various levels of licenses were obligated to operate, the state was able to control its costs, minimize its risks and ensure that the creativity and drive to get the new gaming product dispersed throughout the state was put to private industry, rather than left to a government agency.

The Video Gaming Act (the “Act”) created this structure on July 13, 2009, and legalized the operation of up to five VGTs in potentially 15,000 locations throughout the state under supervision of the Illinois Gaming Board (the “IGB”).1 The Act was adopted to generate additional gaming revenue and stop the large network of illegal gaming that had been conducted on an estimated 30,000 gray video gaming machines throughout Illinois for years. The IGB has since adopted and amended various rules to further refine the framework for the gaming expansion authorized under the Act.

This V-Gaming structure has two key components. First, each VGT is linked to a central communications system that is designed, implemented and administered by a third party vendor to provide the ability to constantly monitor and audit gaming activity. The compensation provided to the third party vendor is based on expected net VGT revenue and is, therefore, largely self-funding. In Illinois, the IGB selected Scientific Games International Inc. to run the central system. Second, there are certain key entities and individuals that must obtain privileged licenses to handle the work of linking the VGTs to the central system and maintaining that link while marketing and delivering the gaming product to patrons.

The levels of licensure include manufacture, distributor, terminal operator, licensed establishment, licensed technician and licensed terminal handler. While manufacturers and distributors are certainly critical in providing the VGTs themselves, often with much needed purchase money financing, terminal operators and licensed establishments are the heart of the system. Terminal operators are licensed by the IGB to own, place and maintain VGTs at licensed establishments, acting like mini-casino operators across a region of various locations, in some cases more than 1,000 sites, each with up to five VGTs. Unlike other states that allow VGTs or VLTs, such as West Virginia, Oregon, Montana, Louisiana and South Dakota, Illinois required the terminal operator to bear all costs associated with the machines including an automated payout device that lessens the state’s cash flow auditing burden and patron problems in general.

Even though the Illinois General Assembly adopted this V-Gaming structure in 2009, it was not until September 2012 that the first VGTs were linked to the central system and net terminal income (NTI) was generated from V-Gaming patrons. Both before and during its first two years of operations, the V-Gaming implementation encountered various hurdles that slowed down progress towards the 40,000 to 50,000 VGTs originally predicted for the state and annual incremental tax revenue estimates of $375 million to $500 million. A legal challenge to the Act put the entire industry in question until the Illinois Supreme Court upheld the law in late 2011. With that ongoing uncertainty, the IGB had to create a workable framework through which to regulate and control V-Gaming operations with no clear roadmap and limited resources that were already focused on the active riverboat gambling industry.

During the pendency of this framework, the V-Gaming industry in Illinois began nonetheless. Without a finalized regulatory structure or even license application forms available, various entities and individuals assumed terminal operator status and began to aggressively secure locations at which VGTs could be placed. Akin to a nice gold rush, potential licensed establishments became coveted by these hopeful terminal operators who would go to extremes to get long-term contracts, or “Use Agreements,” granting the exclusive rights to place VGTs at a location.

There was virtually no regulatory oversight in these early arrangements. With unlicensed entities and individuals contracting with unlicensed locations for V-Gaming operations, a new gray gaming market was created with the use agreements themselves as the commodity. Existing illegal game route operators and gray machine maintenance workers began to lock bars and truck stops into the new legal V-Gaming industry with often poorly drafted and ambiguous use agreements. In addition, terminal operator hopefuls sent forth teams of unvetted sales agents to secure use agreements for either a lump sum payment or some “rev share.” Even if they were willing, none of these opportunists could tell the locations what they were signing up for because the full regulatory structure, policies and internal controls were still being created and modified. Moreover, they could provide no clarity concerning from whom the unwitting locations would eventually receive terminal operator services; it was not uncommon for the use agreements to be assigned two or more times before they eventually were held by a licensed terminal operator able to place machines. A great deal of misinformation was provided to both locations and communities as this early frenzy for locations continued.

This early network of brokers for use agreements frequently included no compliance features at all. For instance, despite the prohibitions in the Act on inducing establishments to enter use agreements by providing anything of value in connection with the contract,2 locations were being given relatively large amounts and elaborate gifts to sign the use agreements with premium locations generating bidding wars between brokers. These brokers desperately searching for signatures did not feel the jurisdiction of the IGB or concern themselves with statutory violations because they were going to turn around and sell the use agreements themselves, sometimes for more than $100,000 per contract. The brokers and sometimes the terminal operators would convince municipalities that had opted out of the Act to opt in without any substantial oversight on the tactics used to do so.

The IGB did an exemplary job of dealing with the vast increase in applications and suitability investigations that accompanied the V-Gaming push but, consequently, was left with no resources early on for enforcement under this novel and vast new industry. In the end, bars, restaurants, fraternal organizations, truck stops and veterans’ associations were very often left with preposterous expectations, multiple use agreements executed with different brokers/terminal operators and enough complaints to excite any Illinois business litigator. Terminal operators were chronically upset as well. As each round of locations were licensed by the IGB or went “live,” a new round of disputes would arise regarding which terminal operator was going to serve various locations with multiple use agreements. There is and will continue to be a great deal of litigation in this regard. With hindsight, any state that is considering V-Gaming should also consider a restriction on use agreements with anyone other than a licensed terminal operator and perhaps some restriction on the assignment of those use agreements as well; this should help keep the use agreements from becoming a gaming commodity.

While some unintended consequences resulted from the early V-Gaming industry, other features worked as intended. While still just a fragile two, V-Gaming has all but completely vanquished illegal video gaming in Illinois. This is a practical result of the structure that both ensures that illegal gray operators will be motivated to cease such activity to be part of legal gaming and that as legal gaming competition increases, it will force out the grays. It works like this: A community gets its first V-Gaming establishment and that establishment owner pushes the IGB or liquor control commission to shut down illegal gaming in the community to limit competition.

Despite the unending complaints regarding the lengthy suitability process for mere establishment licensees, the IGB has made some significant progress in getting VGTs live. As of the end of September 2012, there were only 61 VGTs on the central system available for patron play. As of Sept. 1, 2014, there are 18,118 machines, each generating an average of approximately $3,000 in NTI per month. With respect to state returns, V-Gaming has generated $155,000,000 in state and local direct incremental tax revenue over the last trailing 12 months. Additional state tax revenue is provided from income tax on the amounts collected by the terminal operators and licensed establishments for their part in V-Gaming.

Even though these returns are a little under half way to the projected scope and returns of the V-Gaming industry in Illinois, a few trends should continue to help narrow that gap. The IGB continues to license new establishments each month and the number of municipalities that have opted out of the Act is now around 175, down from more than 500. The IGB has just recently adopted standards for player tracking systems and promotions that will allow for the kind of targeted marketing by terminal operators that can dramatically increase NTI.

These trends are not pleasing everyone. The Illinois Casino Gaming Association is claiming significant negative impact on the historical riverboat gaming operations there with a 5.3 percent drop in revenue in 2013. However, there are a number of other issues facing the riverboat gaming industry at large that could account for the drop and the amount of NTI generated off VGTs during the same period, in hard dollars, was over triple that drop.

There has been no outcry regarding local negative impact caused by the V-Gaming industry up to this point, likely because of the existing gray gaming it simply replaced. It appears that, having fumbled through its first two years, adding stability along the way, the V-Gaming industry in Illinois may eventually deliver on some of its great expectations.

1 230 ILCS 40/78
2 230 ILCS 40/2five(c)