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BALANCING LIABILITIES IN AUTONOMOUS VEHICLE ACCIDENTS: DO NOT JUST BLAME THE GHOST INSIDE

By: Sean Kim*

I. Introduction

Despite its reemergence in the last five years, the concept of autonomous vehicles existed as early as the 1920s.[1]  While the early concept largely focused on speed and collision prevention systems provided by automated highway systems, or “smart roads,”[2] the advent of computers and artificial intelligence has shifted the focus from “smart roads” to “smart cars.”[3]  This shift has led to the continued development of vision-based systems of vehicle guidance.[4]  By 2007, all entrants in the United States Defense Advanced Research Projects Administration (DARPA) competition were successful in operating their autonomous vehicles in an urban setting that mimicked a city environment.[5]  As technology becomes more sophisticated, more automobile manufacturers and leading tech companies, such as Google and Apple, are cooperating to develop autonomous vehicles.[6]

As the number of autonomous vehicles on the road increases, ­a new genre of tort law is introduced: determining and balancing liability between drivers and manufacturers in autonomous vehicle accidents.[7]  While the general public expects autonomous vehicles to offer safer, hands-free driving experiences and to completely replace human interaction with motor vehicles, the need for consumer—or driver— education or behind-the-wheel training still exists.[8]

Section II provides an overview of negligence and strict liability under products liability law, as well as an overview of the types of automobile defects relevant to the analysis.  For the sake of this Note, breach of warranty will not be addressed.  Section III discusses recent developments of autonomous vehicle news and different state laws regulating autonomous vehicles.  Section IV recommends increased federal regulation for autonomous vehicles and heightened standards for vehicle manufacturers and drivers alike.

II. Background

A. Introduction to Products Liability

1. Negligence

Negligence is generally defined as “the failure to exercise reasonable care” under the circumstances.[9]  There are five elements required to establish a prima facie case for negligence: duty, breach of duty, “but-for” causation, proximate causation, and physical harm.[10]

Duty provides a maximum threshold to which people may be held accountable for their actions that cause harm to others.[11]  Without duty, one cannot be found liable for negligence.[12]  Breach of duty is often described as an “act or omission” that unreasonably affects the rights of others.[13]  While breach of duty implies a standard of reasonable care that people ought to follow to prevent undue harm to others,[14] the standard varies in different situations.[15]

The third and fourth elements of negligence are “but-for” and proximate causation.[16]  A causal relationship—both “but-for” and proximate—between a defendant’s breach of duty and the plaintiff’s harm must be established for liability to attach.[17]  “But-for” causation asks whether harm to the plaintiff would have happened were it not for defendant’s negligence,[18] while proximate causation relates to the closeness or remoteness of the defendant’s breach of duty to the plaintiff’s harm.[19]  The more remote a defendant’s action from a plaintiff’s harm, the less likely a court will find the defendant’s action a proximate cause of the plaintiff’s harm.[20]  The last element of negligence is actual harm.[21]  Without actual harm, no liability can be assigned to the defendant.[22]

2. Strict Liability

The doctrine of strict liability “[e]nsure[s] that the costs of injuries resulting from defective products are borne by the manufacturers that put such products on the market rather than by the injured persons who are powerless to protect themselves.”[23]  Strict liability attaches to a seller of defective or unreasonably dangerous products if the product causes harm to the user or consumer, or to his property, and if (a) the seller is engaged in the business of selling such a product, and (b) the product is expected to and does reach the consumer without substantial change in its condition.[24]  Although state courts apply different interpretations for the scope of strict liability,[25] almost all states have adopted the language of Section 402A of the Restatement in their rules.[26]

B. Types of Defects in Automobile Vehicles

1. Manufacture Defects

A manufacturing defect is a mistake in the process of building a product that would be safe if it were built as designed.[27]  A manufacturer may be held strictly liable for dangerous manufacturing defects, even if it has exercised “all possible care” in manufacturing the product.[28]  A plaintiff must establish that “the product does not conform to the specifications, regardless of whether there was negligence in the manufacturing process” to prevail in a products liability litigation.[29]  However, some courts hesitate to attach strict liability to software under the manufacturing defect doctrine.[30]

Another method available to consumers is the malfunction doctrine, a variation of the manufacturing defect doctrine.[31]  The malfunction doctrine allows a plaintiff to show a manufacturing defect by inferring product defect from “circumstantial evidence that (1) the product malfunctioned, (2) the malfunction occurred during proper use, and (3) the product had not been altered or misused in a manner that probably caused the malfunction.”[32]

2. Design Defects

A design defect is a defect in intended product design that makes a product harmful or dangerous.[33]  Many states assign strict liability to manufacturers for manufacturing design defects.[34]  The State of California uses two tests—the consumer expectation test and the risk/benefit test—to establish design defects­­[35] and to hold sellers and manufacturers strictly liable.[36]  Under the consumer expectation test, a plaintiff must prove that a defendant’s defective product did not perform as safely as an ordinary consumer would have expected it to perform when used or misused in an intended or reasonably foreseeable way, and that the product’s failure to perform safely was a substantial factor in causing the plaintiff’s harm.[37]  As for the risk/benefit test, strict liability attaches to a manufacturer when two conditions are satisfied: (1) the manufacturer’s product design was a substantial factor in causing harm to the plaintiff and (2) the manufacturer fails to prove that the benefits of the product’s challenged design outweigh the risks of such design.[38]

3. Failure to Warn

Manufactures may be held liable for injuries that are attributable to the relevant risks of their products.[39]  They are required to disclose and warn consumers of the foreseeable risks of using their products, and they can be liable for any injury or damage attributable to the lack of information disclosed.[40]  In California, for example, failure to warn (or inadequate warning) is a sufficient ground to hold manufacturers and sellers strictly liable.[41]  In order to minimize potential liability stemming from failure to warn, manufacturers err on the safe side by providing copious disclaimers and warnings.[42]

For example, Tesla’s new autonomous vehicle technology manual may have a disclaimer asking drivers to pay close attention to the traffic when using its autonomous vehicle technology.  Without a disclaimer warning drivers to pay close attention to the traffic while using the autonomous technology, Tesla could be held liable for any accident that may be attributable to this lack of disclaimer.[43]  In addition to providing adequate warning at the time of sale, manufacturers have post-sale responsibilities to provide warnings for newly discovered facts pertinent to the safety of their products.[44]  Although this post-sale responsibility is widely recognized by manufacturers, the “common law legal framework for addressing liability when manufacturers fail to do so is less well established.”[45]

III. Analysis

A. State Regulations for Autonomous Vehicle Drivers

As autonomous vehicle technology becomes more available to the public, a new standard may be required for drivers that utilize this technology.  Negligence is based on a standard that asks what a reasonably prudent person would do in a given, particular situation.[46]  In light of the perceived benefit of autonomous vehicle technology, however, the reasonable driver standard may shift, placing a higher burden on the vehicle and software manufacturers.

Basic reasonableness standards for autonomous vehicle drivers can be found in different state statutes.  For example, Nevada statute Sections 482A.070, outlining requirements for a human operator for highway testing of an autonomous vehicle,[47] and 482A.080, outlining equipment requirements for autonomous vehicles,[48] provide a basic requirement for autonomous vehicle drivers.  California, Florida, and the District of Columbia outline similar requirements for drivers and autonomous vehicles.[49]

These statutes generally include the following requirements: First, drivers must be seated in a position to allow them to immediately take control of the vehicle, i.e., being able to access the means to engage or disengage the technology.  Second, drivers must be able to safely monitor the autonomous vehicle operation.  Monitoring vehicle operation consists of monitoring the dashboard and hearing or seeing an alert indicating a failure of the autonomous system, or any other malfunction affecting the autonomous vehicle technology.  Third, drivers must be capable of taking control of the vehicle when necessary.  This requires that drivers not be in various physical or mental states—falling asleep behind the wheel or driving under the influence—that renders them incapable of manually driving the vehicle legally.

B. State Regulations for Autonomous Vehicles
1. Autonomous Vehicle Requirements

In Nevada, autonomous vehicles are required to provide a visual indication to its drivers when the autonomous technology has been engaged/disengaged, and be equipped with a means to alert the driver that the autonomous technology is unable to operate the vehicle safely.[50]  Moreover, Nevada statute requires that a driver of an autonomous vehicle be actively engaged while driving.[51]  For autonomous vehicle equipment and functionality, California, Nevada, Michigan, and the District of Columbia all require the vehicles to meet federal standards and regulations for motor vehicles and comply with applicable state traffic and motor vehicle laws.[52]  Furthermore, they require the vehicles to have safety mechanisms for engaging/disengaging the technology, visual indicators inside the vehicle that show when the vehicle is in autonomous mode, and a means of alerting the operator of a technology failure.[53]

2. Data Collecting and Reporting Requirements

One noticeable discrepancy between the aforementioned states is the requirement of reporting all disengagements of autonomous mode, near misses, and crashes.[54]  While California requires manufacturers to collect and report data related to accidents[55] or disengagement from autonomous mode by the test driver resulting from a failure of the autonomous technology,[56] Nevada only requires manufacturers to report accidents or traffic violations occurring during autonomous vehicle testing.[57]  Neither Florida nor the District of Columbia, on the other hand, has data collecting and reporting requirements for autonomous vehicle testing or operation.

3. Manufacturers’ Liability and Its Scope

For manufacturers, Nevada limits a manufacturer’s liability to accidents or injuries caused by defects that were present in the vehicle as originally manufactured.[58]  It thus shields manufacturers from potential liabilities from accidents or injuries caused by defects originating from any conversion or installation necessary to convert a regular vehicle into an autonomous vehicle.[59]  Michigan and the District of Columbia followed suit with Nevada’s approach.[60]  This approach to manufacturers’ liability seems fair and reasonable, and it closely follows the Restatement’s approach that if there were substantial changes in a product’s original condition, the manufacturer of the product would not be held liable.[61]

However, some jurisdictions have adopted a different approach.[62]  In 1996, an Illinois court wrote that “[w]here an unreasonably dangerous condition is caused by a modification to the product after it leaves the manufacturer’s control, the manufacturer is not liable unless the modification was reasonably foreseeable.”[63]  The “reasonably foreseeable” approach broadens the scope of potential liability of the automobile manufacturers because they could be held liable for damages or injuries caused by third-party modifications if these modifications were reasonably foreseeable to the manufacturer.[64]  On the other hand, California code does not even mention manufacturers’ liability, failing to address and balance liabilities between vehicle manufacturers and third­ parties that make modifications to manufactured vehicles.[65]

C. Determining a Standard for Manufacturers Liability

Further development and public use of autonomous vehicle technology may challenge the adequacy of current product liability law.  It has been suggested that the advent of autonomous vehicles will result in an imbalance of liability between autonomous vehicle manufacturers and consumers.[66]  After a much-publicized fatal accident that involved a driver with his Tesla Model S electric sedan in autonomous driving mode, federal regulators opened a formal investigation into the accident.[67]  Although Tesla, with possible recall of its vehicles looming (depending on U.S. National Highway Traffic Safety Administration (NHTSA) findings), escaped from the aforementioned accident unscathed, the accident nevertheless highlighted the need for manufacturers to eliminate any software and/or hardware defects and to provide all required information to drivers and vehicle owners.[68]

The Restatement (Third) of Torts recognized that the seller’s duty to warn of product-related defects after the point of sale is “often daunting.”[69]  Continued technological developments, such as on-board sensors and driver assistance systems—adaptive cruise control, automated emergency braking, and pedestrian detection[70]—make automakers more vulnerable to negligence and strict liability.[71]  This increase in liability, so-called “proximity-driven liability,” resulting from increased proximity between drivers and automobiles, may run against the spirit of the doctrine of strict liability, which is to safeguard the general public from defective products by increasing liability of the manufacturer—the only party able to rectify the defect and prevent public loss.[72]

The purpose of autonomous vehicle technology is to make the vehicle safe for consumers.[73]  Knowing that software is never perfect, however, it is unfair to place a higher burden of liability on manufacturers that aim to make driving easier and safer for the general public.  Barring specific instances in which software failure or malfunction is the sole cause of an accident, autonomous vehicle operators should also shoulder the responsibility of being safe operators.  Nevertheless, vehicle manufacturers should shoulder any liability stemming from defects of its hardware and/or software, regardless of whether it was negligent.

IV. Recommendation

A. Standards for Manufacturers and Drivers

Courts have generally refused to apply the doctrine of strict liability to software failures because of the notion that software cannot be perfect and error-free.[74]  While understandable, strict liability should be applied to lessen the burden borne by the public—the burden of potential dangers and both the economic and social costs associated with automotive accidents.

Manufacturers and developers are in a far better position to prevent and mitigate software failures or defects.  Furthermore, increasingly sophisticated marketing of autonomous vehicles and the autonomous vehicle technology makes it more difficult for the consumers to see the risk behind the technology.[75]  Moreover, complicated chains of supply of parts and distribution of autonomous vehicles make it that much more difficult for consumers to pinpoint the origin of the defect in a manufacturer’s product.[76]  Some autonomous vehicle manufacturers such as Google and Mercedes-Benz have indicated that they will take full responsibility of any accidents caused by failures of their autonomous vehicle software.[77]

Moreover, courts should apply the objective reasonable-person standard to autonomous vehicle software, which should consider the following, non-exhaustive factors in determining whether a software was defective: (1) total utility, or benefit, to the drivers and others, (2) total amount of risk, or harm, to the driver and others, (3) the likelihood of the risk actually causing harm to others, and (4) any existing, reasonable alternatives of lesser risk and the costs of those alternatives.[78]  This standard should allow courts to determine whether the software made a reasonable—as opposed to correct—decision, eliminating potential ethical dilemmas from the liability calculus. [79]  Although the reasonable-person standard lacks certainty,[80] courts, nevertheless, have been successfully applying it to many tort cases, and thus should be able to determine whether autonomous vehicle software has acted reasonably according to the standard.

As autonomous vehicle technology becomes more advanced and ready for public use, autonomous vehicle drivers may become less responsible on the road, creating a potential imbalance of liability between manufacturers and consumers.[81]  Courts should apply a higher standard to autonomous vehicle drivers involved in an automobile accident while using autonomous vehicle technology.  This will require the courts to determine whether drivers of autonomous vehicles were driving, or monitoring their autonomous vehicles in a reasonable way.  Despite possible concerns about uncertainty and the unpredictable nature of the reasonable-person standard, its application would not be difficult for the courts since they have been more than capable of determining whether one has acted reasonably or not in a given situation.

B. Federal Regulation for Autonomous Vehicle Technology

Congress should enact a law regulating autonomous vehicle operations, especially to require sensors and software functionality, including parameters that govern and influence autonomous vehicle software’s decision making.  The United States Department of Transportation (USDOT) already has extensive safety standards and regulations provided by NHTSA for regular vehicles.[82]  As evidenced in numerous state laws, bills, and regulations on autonomous vehicles, regulations and requirements for the operation of autonomous vehicles are scant and general at best.[83]  On the other hand, for aircrafts, the Code of Federal Regulations (CFR) and the Federal Aviation Administration (FAA) have extensive requirements and regulations for flight guidance systems.[84]

An example of a possible federal regulation on autonomous vehicles may be monitoring and recording autonomous vehicle and driver activities for a specified time period before an accident.  The recorded vehicle and driver activities would greatly help courts determine whether the driver was monitoring his or her autonomous vehicle operation in a reasonable manner.  Furthermore, the government should regulate technical parameters such as sensor sensitivity, radar range, and software processing speed, and delineate what constitutes a substantial change, or material modification, to autonomous vehicles and autonomous vehicle software.  Unified quality standards for autonomous vehicle parts and sensors would provide clarity and information to consumers and greater control and guidance on autonomous vehicle performance, safety, installation, modification, and testing standards.

V. Conclusion

Autonomous vehicle technology is no longer a product of science fiction.  Google’s self-driving vehicles have driven over two million miles so far,[85] and many Tesla drivers are already taking advantage of Tesla’s autonomous vehicle software.[86]  However, the technology is far from perfect, and there are scenarios that are beyond technology’s current capabilities to handle.[87]  In order to protect the public from accidents caused by autonomous vehicle software defects or malfunctions, standards for autonomous vehicle manufacturers should be heightened.  Likewise, in order to protect the public from accidents caused by negligent drivers using this technology, reasonableness standards for these drivers should likewise be heightened.[88]

In addition, a federal department such as the Department of Transportation, or an agency such as NHTSA, should regulate autonomous vehicle operation, including sensor and radar operations, software controls and parameters, vehicle inspection guidelines for manufacturers and third parties, and operation manuals for autonomous vehicle drivers.  Centralized federal regulation would provide concrete guidelines not only for the states but also for the vehicle manufacturers and the public alike.  The technology is already vastly ahead of the regulation, and there is some serious work to do for our state and federal legislatures.

* Juris Doctor, University of Illinois College of Law, 2017. Thanks to the editors and staff of the Journal of Law, Technology & Policy for their efforts. I would also like to thank my wife, Catherine, for her continuous support. This work would not have been possible without her. Finally, many thanks are owed to my parents, family, and friends for their unwavering support.

[1] Marc Weber, Where to? A History of Autonomous Vehicles, Computer History Museum, http://www.computerhistory.org/atchm/where-to-a-history-of-autonomous-vehicles (last visited Apr. 8, 2017).

[2] Id.  This was because much of the danger from driving during that time period was from ill-marked roads rather than the automobiles themselves.

[3] Id.

[4] Id.

[5] Id.

[6] 33 Corporations Working on Autonomous Vehicles, CB Insights (Aug. 11, 2016), https://www.cbinsights.com/blog/autonomous-driverless-vehicles-corporations-list.

[7] John Villasenor, Products Liability and Driverless Cars: Issues and Guiding Principles for Legislation, Brookings (Apr. 24, 2014), http://www.brookings.edu/research/papers/2014/04/products-liability-driverless-cars-villasenor.

[8] Sherry Baxter, Reasonable Doubt: The Road to Regulation for Self-Driving Vehicles, Ga. Straight (Jan. 22, 2016, 2:17 PM), http://www.straight.com/news/622601/reasonable-doubt-road-regulation-self-driving-vehicles.

[9] See, e.g., Bodin v. City of Stanwood, 927 P.2d 240, 249 (Wash. 1996) (stating basis for negligence action).

[10] David G. Owen, The Five Elements of Negligence, 35 Hofstra L. Rev. 1671, 1674 (2007).

[11] Id. at 1675.

[12] Palsgraf v. Long Island R. Co., 162 N.E. 99, 99 (N.Y. 1928).

[13] Id.

[14] Id.

[15] While adults are held to a reasonable person standard, children and disabled people are held to a standard of reasonableness for a person with similar characteristics.  Restatement (Third) of Torts § 10 (2010); see also Stevens v. Veenstra, 573 N.W.2d 341 (Mich. Ct. App. 1997) (holding that a fourteen-year-old driver education student is not held to a reasonable person standard for adults, but instead to a standard reasonable for fellow fourteen-year-olds).  However, people with greater levels of skills, such as doctors and other medical professionals, are required to exercise a greater amount of care they reasonably possess.  See Helling v. Carey, 519 P.2d 981, 983 (Wash. 1974) (finding that defendant was negligent in failing to conduct a simple pressure test that other optometrists would reasonably have done).

[16] Id.

[17] Id.

[18] Id.

[19] Id.

[20] Id.

[21] Id.

[22] Id.

[23] Greenman v. Yuba Power Products, Inc., 377 P.2d 897, 901 (Cal. 1963).

[24] Restatement (Second) of Torts § 402A (1965).

[25] Villasenor, supra note 7.

[26] Derek H. Swanson & Lin Wei, McGuireWoods, United States Automotive Products Liability Law (Oct. 2009), https://www.mcguirewoods.com/news-resources/publications/us-automotive-products-liability.pdf.

[27] Restatement (Third) of Torts: Prod. Liab. § 2(a) (1998).

[28] Id.

[29] Jeffrey K. Gurney, Sue My Car Not Me: Products Liability and Accidents Involving Autonomous Vehicles, 2013 U. Ill. J.L. Tech. & Pol’y 247, 258 (2013).

[30] See 68 Am. Jur. 3d Proof of Facts § 8, at 333 (2002) (“[N]o cases have been found applying [manufacturing defects] to software.”).

[31] David G. Owen, Manufacturing Defects, 53 S.C. L. Rev. 851, 873 (2002).

[32] Id.

[33] Restatement (Third) of Torts: Prod. Liab. § 2(b) (1998).

[34]Dennis W. Stearns, An Introduction to Product Liability Law, Marler Clark L.L.P., http://www.marlerclark.com/pdfs/intro-product-liability-law.pdf (last visited Apr. 8, 2017).

[35] Barker v. Lull Eng’g Co., 573 P.2d 443, 457–58 (Cal. 1978).  The California Supreme Court in Barker set out two tests to establish defect in the product design: the consumer expectation test and the risk/benefit test.  Id.  For the consumer expectation test, a plaintiff must prove that the defendant’s defective product did not perform as safely as an ordinary consumer would have expected it to perform when used or misused in an intended or reasonably foreseeable way, and that the product’s failure to perform safely was a substantial factor in causing plaintiff’s harm.  Id.  The consumer expectation test is reserved for cases where plaintiff’s everyday experience permits a conclusion that the product design is defective and not safe.  Pruitt v. General Motors Corp. 72 Cal. App. 4th 1480, 1484 (1999).  For the risk/benefit test, the plaintiff has to prove that the defendant’s product design was a substantial factor in causing harm to the plaintiff, and the defendant must fail to prove that the benefits of the product’s challenged design outweigh the risks of the design.  Barker, 573 P.2d at 457–58.

[36] David H. Canter et al., California Products Liability Law: A Primer (Jan. 2012), http://trialattorneysofamerica.com/documents/Primer2012.pdf; see also Anderson v. Owens-Corning Fiberglas Corp., 810 P.2d 549, 553 (Cal. 1991) (holding that strict liability has been invoked for three different types of defects: manufacturing, design, and inadequate warnings).

[37] Barker, 573 P.2d at 457–58.

[38] Id.

[39] Restatements (Third) of Torts § 2(c) (1998); see also Villasenor, supra note 7.

[40] Villasenor, supra note 7.

[41] In Livingston v. Marie Callenders, Inc., the court found Marie Callenders liable to a plaintiff who suffered an allergic reaction to a Marie Callenders product on a strict liability failure to warn theory.  72 Cal. App. 4th 830 (1999).  The product contained an ingredient (MSG) to which a substantial number of the population is allergic.  Id. at 832–33.  Also, the ingredient was one whose danger was not generally known, or if known was one which the consumer would reasonably not expect to find in the product, and where the defendant knew, or by the application of reasonable developed human skill and foresight should have known, of the presence of the ingredient and the danger.  Id.

[42] Villasenor, supra note 7.

[43] A product is defective because of inadequate warnings if the foreseeable risks of harm posed by the product could have been reduced by reasonable warnings by the seller or other distributor, and the lack of warnings renders the product not reasonably safe.  Restatement (Third) of Torts: Prod. Liab. § 2(c) (1998).

[44] Id. § 10.  The Supreme Court of Michigan ruled in Comstock v. General Motors Corp. that a manufacturer of an automobile (GM), the brakes of which were defective, had a duty to warn of the vehicle’s inherent danger, not only at the time of sale but any time shortly after the product entered the stream of commerce if a defect became known to the manufacturer and if a failure to give prompt warning of the known, latent defect imperiled life and limb.  99 N.W.2d 627, 636 (Mich. 1959).  In Hasson v. Ford Motor Co., the Supreme Court of California stated in its dicta that the manufacturer was negligent in failing to take into account (in designing its braking systems and advising on their maintenance) foreseeable brake abuse by drivers resulting in overheating of brakes.  564 P.2d 857, 870 (Cal. 1977).

[45] Villasenor, supra note 7.

[46] Owen, supra note 10, at 1677.

[47] Nev. Rev. Stat. § 482A.070 (2013).

[48] Id. § 482A.080.

[49] See Cal. Code Regs. tit. 13, § 227.44 (2014); Fla. Stat. §319.145 (2012); D.C. Code §50-2352 (2012) (outlining some vehicle and driver requirements for testing and/or operating autonomous vehicles).

[50] Nev. Rev. Stat. § 482A.080 (2013).

[51] Id. § 482A.070.  Autonomous vehicle drivers are required to be (a) seated in a position so that he can take immediate control of his vehicle, (b) able to monitor safe operation of the vehicle, and (c) capable of taking control over the autonomous vehicle in case of emergency.

[52] James M. Anderson et al., RAND Corp., Autonomous Vehicle Technology: A Guide for Policymakers 44–47 (2016), http://www.rand.org/content/dam/rand/pubs/research_reports/RR400/RR443-1/RAND_RR443-1.pdf.

[53] Nev. Rev. Stat. § 482A.080 (2013); D.C. Code §50-2352 (2012); Cal. Veh. Code § 38750(c) (2013); Fla. Stat. §319.145 (2012).

[54] Technology Law & Policy Clinic Autonomous Vehicles Team, Autonomous Vehicle Law Report and Recommendations to the ULC, U. Wash. Sch. L., https://www.law.washington.edu/Clinics/Technology/Reports/AutonomousVehicle.pdf, at 5 (last visited Apr. 8, 2017).

[55] Cal. Code Regs. tit. 13, § 227.44 (2014).

[56] Id. § 227.46.

[57] Nev. Admin. Code §482A.130 (2012).

[58] Id. § 482A.090.

[59] Id.

[60] “A manufacturer of automated technology is immune from civil liability for damages that arise out of any modification made by another person to a motor vehicle or an automated motor vehicle, or to any automated technology . . . .”  Mich. Admin. Code r. 257.817 (2013).  “The original manufacturer of a vehicle converted by a third party into an autonomous vehicle shall not be liable in any action resulting from a vehicle defect caused by the conversion of the vehicle, or by equipment installed by the converter, unless the alleged defect was present in the vehicle as originally manufactured.”  D.C. Code §50-2353 (2013).

[61] “One who sells any product in a defective condition unreasonably dangerous to the user or consumer or to his property is subject to liability for physical harm thereby caused to the ultimate user or consumer, or to his property, if (a) the seller is engaged in the business of selling such a product, and (b) it is expected to and does reach the user or consumer without substantial change in the condition in which it is sold.”  Restatement (Second) of Torts § 402A(1) (1965) (emphasis added).  However, a question remains: what constitutes a substantial change?  The Restatement leaves that question to the courts to decide.  See id. § 402A(1) cmt. p (commenting on varying degree of changes that can be made to a product without shifting the liability from the seller or manufacturer of the product to the party that made the changes).

[62] Villasenor, supra note 7.

[63] Davis v. Pak-Mor Mfg. Co. 672 N.E.2d 771, 775 (Ill. Ct. App. 1996); see also Woods v. Graham Eng’g Corp., 539 N.E.2d 316, 318  (Ill. Ct. App. 1989) (ruling that when a change or modification by a third party is foreseeable, liability will still be imposed on the original manufacturer); Hoyt v. Wood/Chuck Chipper Corp., 651 So.2d 1344, 1351 (La. Ct. App. 1995) (holding engine manufacturer not liable since it could not have anticipated plaintiff’s material alteration of the power unit).

[64] See Lavoie v. Power Auto, Inc., 312 P.3d 601, 608 (Or. Ct. App. 2013) (holding that changing a floor mat of a vehicle was a reasonably foreseeable modification/alteration that was a substantial contributing factor to the personal injury).  So in some states, automobile manufacturers will have to consider changing floor mats as one of the foreseeable “substantial” modifications that can cause automobile accidents.

[65] Cal. Veh. Code § 38750 (2015); see also Anderson et al., supra note 52, at 47.

[66] Gary E. Marchant & Rachel A. Lindor, The Coming Collision Between Autonomous Vehicles and the Liability System, 52 Santa Clara L. Rev. 1321, 1339 (2012).

[67] Bill Vlasic & Neil E. Boudette, Self-Driving Tesla Was Involved in Fatal Crash, U.S. Says, N.Y. Times (June 30, 2016), https://www.nytimes.com/2016/07/01/business/self-driving-tesla-fatal-crash-investigation.html.

[68] Id.

[69] Restatement (Third) of Torts § 10 cmt. a (1998).

[70] Sven A. Beiker, Legal Aspects of Autonomous Driving, 52 Santa Clara L. Rev. 1145, 1147–48 (2012).

[71] Bryant Walker Smith, Proximity-Driven Liability, 102 Geo. L.J. 1777, 1794 (2014).

[72] Id. at 1778.

[73] FAQ, Waymo, https://waymo.com/faq/ (last visited Apr. 8, 2017).

[74] 68 Am. Jur. 3d Proof of Facts § 8, at 333 (2002).

[75] Frances E. Zollers et al., No More Soft Landings for Software: Liability for Defects in an Industry that Has Come of Age, 21 Santa Clara Computer & High Tech. L.J. 745, 746 (2005).

[76] Id.

[77] Michael Ballaban, Mercedes, Google, Volvo to Accept Liability when Their Autonomous Cars Screw Up, Jalopnik (Oct. 7, 2015, 11:47 AM), http://jalopnik.com/mercedes-google-volvo-to-accept-liability-when-their-1735170893.

[78] The factors closely mimic that of the reasonable-person standard that reflects a cost-benefit approach supported by principles of utility and efficiency.  Owen, supra note 10, at 1677.  It also resembles the “Hand Formula” that uses a risk-calculating approach of judging one’s decision making.  United States v. Carroll Towing Co., 159 F.2d 169, 173 (2d Cir. 1947).

[79] John Gardner, The Many Faces of the Reasonable Person, N.Y.U. Sch. L., at 7­–8, http://www.law.nyu.edu/sites/default/files/upload_documents/The%20Many%20Faces%20of%20the%20Reasonable%20Person.pdf.

[80] Id.

[81] See Alex Davies, Obviously Drivers Are Already Abusing Tesla’s Autopilot, WIRED (Oct. 22, 2015, 7:00 AM), http://www.wired.com/2015/10/obviously-drivers-are-already-abusing-teslas-autopilot/ (noting that some drivers of autonomous vehicles are driving recklessly by pushing the limit of the autonomous vehicle technology).

[82] Federal Motor Vehicle Safety Standards and Regulations, Nat’l Highway Traffic Safety Admin., http://www.nhtsa.gov/cars/rules/import/FMVSS (last visited Apr. 8, 2017).

[83] The Hawaii House of Representatives’ bill for autonomous vehicle operation only includes safety requirements, minimum insurance coverage, and necessary equipment and performance standards that ensure safe operation.  H.R.B. No. 1458, 28th Leg. (Haw. 2015).  In addition, Nevada’s statute has not set forth autonomous vehicle requirements for operations, insurance, and minimum safety standards.  Nev. Rev. Stat. § 482A.100 (2013).

[84] 14 C.F.R. § 25.1329 (2016).

[85] Waymo, supra note 73.

[86] Your Autopilot Has Arrived, Tesla (Oct. 14, 2015), https://www.teslamotors.com/blog/your-autopilot-has-arrived.

[87] Neal E. Boudette, Tesla’s Self-Driving System Cleared in Deadly Crash, N.Y. Times (Jan. 19, 2017), https://www.nytimes.com/2017/01/19/business/tesla-model-s-autopilot-fatal-crash.html.

[88] See Sam Levin & Nicky Woolf, Tesla Driver Killed While Using Autopilot Was Watching Harry Potter, Witness Says, Guardian (July 1, 2016, 1:43 PM), https://www.theguardian.com/technology/2016/jul/01/tesla-driver-killed-autopilot-self-driving-car-harry-potter (noting that driver negligence may have contributed to the first fatal Tesla crash).

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Better to be Good than Lucky: Using Fantasy Sports Strategy to Defend the Legal Status of America’s Newest Pastime

By Erica Buerger

I. Introduction

When Indianapolis Colts’ future Hall of Fame quarterback Peyton Manning announced that he would not start the 2011 NFL season, his streak of 227 consecutive starts ended and fantasy team owners panicked.  In 2011, there were approximately $650 million of fantasy football prizes on the line.[1]  It is estimated that Manning’s absence shifted $65 million away from people who would have won their fantasy football leagues had he not been injured.

There are currently over 32 million fantasy sports players in the United States and Canada, and the industry generates more than $3 billion in revenue.[2]  Fantasy sports have become as much of an American pastime as the games upon which they are based.  But this popularity may be disguising the fact that fantasy sports are just another form of illegal gambling.  In most states, the legality of a betting game depends upon the amount of skill versus chance required to play the game.  In general, the more skill that is involved, the more likely the game is legal.

The problem is that as fantasy sports evolve to meet the needs of an ever-expanding fan base, many leagues have added features that allow less-knowledgeable players to participate.  By lowering the amount of skill needed to play, the outcome is more chance-based.  If this trend continues and current gambling law prevails, fantasy sports could become so dependent on chance that they will become illegal.

II. Gambling Law

A. Federal Law

The purpose of federal gambling law is to “aid the states in controlling gambling.”[3]  Specifically, to assist the states in the “enforcement of their [gambling] laws.”[4]  Federal gambling laws do not attempt to create uniformity between the states.  Rather, they exist simply to supplement each state’s own laws.

B. State Law

Gambling regulation is mostly a function of state law and can vary considerably.  The dictionary defines gambling as “play[ing] a game for money or property” or “bet[ting] on an uncertain outcome.”[5]  However, most states allow activities that seem to fall into this category, such as state lotteries.  In fact, in most states, an activity is legal unless a plaintiff makes an affirmative showing that a particular activity involves three elements: consideration, reward, and chance.[6]

1. Consideration

Consideration is often loosely defined as something given in exchange for something else.  In the context of gambling, most courts construe this term narrowly holding that consideration exists only when a “participant provided money or a valuable item of property in exchange for the chance of greater winnings.”[7]  However, some courts adopt a broader definition finding that consideration exists when any legal detriment is given in exchange for the chance to win a prize.[8]

2. Reward

In gambling, the reward is the prize that one receives after winning a game of chance.  To meet this requirement, courts have held only that the reward must be tangible.[9]

3. Chance

Chance is the most controversial element.  To constitute a game of chance, courts have held that the outcome of the game must depend upon factors that are out of a player’s control, as opposed to a player’s “judgment, practice, skill, or adroitness.”[10]  To make this determination, courts have applied three tests: (1) the “dominant factor test,” (2) the “any chance test,” and (3) the “gambler’s instinct test.”

Most states use the dominant factor test.[11]  In Johnson v. Collins Entertainment, the South Carolina court explained that a game is chance-based when “the dominant factor in a participant’s success . . . is beyond his control . . . even though the participant exercises some degree of skill.”[12]  The threshold of the dominant fact test is the point at which either skill or chance affects the outcome by more than 50%.

Some states use the any chance test.  In these states, an activity is a game of chance if it incorporates any element of chance, regardless of whether the game also incorporates skill.[13]  Because almost every game involves some chance, most games will not survive scrutiny in these states.

Finally, a few states use the gambler’s instinct test.  This test defines a game of chance as one that appeals to the “gambling spirit,” without regard to whether skill or chance dictates the outcome.[14]  Because of the highly subjective nature of this test, a court’s decision can vary considerably.

III. The Legality of Fantasy Sports Under the Majority View

Most states adopt a narrow definition of consideration and use the dominant factor test.  In these states, the structure and features of a particular fantasy game is of utmost importance.  Legal fantasy games generally fall into three categories: (1) leagues that do not charge an entry fee; (2) leagues that do not award prizes; and (3) leagues that are predominately skill-based.  The first two categories are relatively straightforward.  Leagues that are free are legal because there is no consideration.  Alternatively, leagues that do not award prizes are legal because there is no reward.

The third category is more complex.  In this category, fantasy games are legal if the outcome is more than 50% based on skill.  Fantasy leagues are generally considered skill-based if they allocate players through a traditional auction and span at least one entire season.[15]  This is because fantasy players have the opportunity to offset chance occurrences, such as player injuries or adverse weather conditions, with efficient team management, lineup changes, and trade negotiation.  It is this category of fantasy games that is most at risk as the popularity of fantasy sports increases.

IV. The Future of Fantasy Sports: How New Features Affect the Dominant Factor Test

A. Auto-Draft

Auto-draft is a feature used during a fantasy draft that ensures a fantasy team owner automatically drafts the highest-rated player available.  Automatic drafting algorithms are designed to create competitive leagues.  Beginners typically use auto-draft because they lack enough knowledge to fill their teams.  Some argue that auto-draft is unfair because there is no guarantee that the owner using auto-draft would have actually selected the highest ranked player.[16]

B. Point Projections

Point projections are similar to a cheat sheet in that they predict how many points a player will earn during a game.  To set a lineup, an owner starts the players on his team with the highest number of projected points.  Point projections place a passive team owner in the same position as an owner who has done extensive research on his players’ current matchups, injury reports, or other conditions affecting a player’s potential performance.

C. Short Season Leagues

Fantasy games that stretch over longer time spans allow an owner’s managerial skills regarding drafting a team, setting lineups, and making trades to counteract the effects of chance.  Fantasy leagues that span multiple seasons allow owners to employ strategies that may take several years.  These leagues require a considerable level of commitment, knowledge, and skill.  Conversely, some leagueslast only a day or a week.  In these games, the outcome is more chance-based because it is closely tied to a single, real-world event.

D. The Effect

The intent of auto-draft, point projections, and short season games is to increase fantasy sports participation.  These features accomplish this task by reducing the need to spend time analyzing statistics and setting lineups.  But because the legality of a fantasy sports game is based on the level of skill required to play the game, these features, while increasing participation, are simultaneously pushing a multi-billion dollar industry to the brink of extinction.  To avoid this outcome, current gambling laws should not be used to regulate fantasy sports.

V. How Fantasy Sports Differ From Other Gambling Games

Fantasy sports cannot be regulated effectively under current gambling law because they are different from other casino-type games.  Fantasy sports are different because strategy can be used to overcome the chance elements involved in the game.  To understand the impact of strategy in fantasy sports games, it is important to understand the differences between strategy and skill.

Skill is “the ability to use one’s knowledge effectively.”[17]  Skill can be obtained through study, repetition, drill or practice. Often, exercising skill becomes an automatic response that occurs independently of any cognitive process.  Strategy, on the other hand, is a deliberate, planned, and conscious activity.   Strategy involves the application of skill but it also implies an understanding of the interaction between underlying concepts.

Managing a fantasy sports team takes skill and strategy.  Drafting players, for example, is partly skilled-based because players’ statistics can be learned through study.  Drafting players is also strategy-based because an owner must prioritize his selections by anticipating other owners’ choices.  Trade negotiation, however, is primarily strategy-based.  Skill-based trades would involve analyzing statistics to make mutually beneficial trades.  But most trades are not mutually beneficial.  Instead, trades typically involve psychological warfare, feeding off other owner’s impulsive natures, or exploiting other teams’ weaknesses.  In fact, many fantasy experts insist that trade negotiation is an art.

By utilizing strategy, owners can prevent chance from determining the outcome of the game.  All fantasy sports involve chance due to adverse weather conditions and possible player injuries.  However, a skillful owner circumvents these elements by drafting backup players, checking game day weather and injury reports, and adjusting his lineup as necessary.  Conversely, a poker player cannot eliminate the chance that he will be dealt an unfavorable hand, a craps player cannot anticipate the roll of the dice, and a roulette player cannot predict the number on which the ball will fall.  Therefore, the ability to use strategy to “beat chance” distinguishes fantasy sports games from other illegal gambling.

VI. Resolving Fantasy Sports’ Differences Under the Law

A. Ambiguity

Not only are fantasy sports different from other gambling activities, they are also different from each other.  Because of this, attempts to regulate fantasy sports under existing gambling laws have produced ambiguous guidelines.  For example, in Humphrey v. Viacom, a New Jersey court held that the fantasy sports game at issue was legal because it would be “patently absurd” to conclude that the combination of an entry fee and a prize constituted gambling.[18]  The court reasoned that such a holding would mean that spelling bees, beauty contests, and golf tournaments would also be considered gambling.  Although this holding appears to give fantasy sports a “clean bill of health,” it has been severely limited to its facts.[19]  Therefore, fantasy sports games continue to be arbitrarily analyzed depending on the rules of each particular game.  A better approach is for states to pass specific fantasy sports legislation.

B. Fantasy Sports Specific Law

Montana is currently the only state with specific statutory authorization for fantasy sports.[20]  While the Montana Code is a good starting point, new legislation should expand the law by first defining a fantasy sports game and then requiring the game to meet a two-part test.  First, like in Montana’s Code, a fantasy sports game could be defined as an activity in which “a limited number of persons . . . pay an entry fee for membership in the league” and create “a fictitious team composed of athletes from a given professional sport.”  If the game meets the basic definition, its legal status could be determined based on (1) whether the game involves strategy; and (2) whether strategic decisions lessen the effect of chance on the game.

Part one of the test would require a court to consider whether the game involves strategy.  This inquiry looks only at whether participants’ strategic decisions ultimately affect the outcome of the game.  Part two asks whether a participant can use strategy to effectively “beat chance.”  This requires a court to identify chance elements, such as player injuries or adverse weather conditions, and ask whether a strategic player could reduce the effect of those elements.

When the two-part test is met, the game should be deemed legal.  Alternatively, if chance elements, such as those dependent on random number generators, dice throws, or card shuffles, cannot be controlled, the game should be illegal.  The new law recognizes fantasy sports games as a game of strategy.  By distinguishing them in this way, the law protects the legal status of true fantasy sports games.

VI. Conclusion

Fantasy sports emerged as an American pastime as participation skyrocketed over recent years.  New features, designed to further increase participation, arguably lower the amount of skill involved in the game thereby threatening the legality of fantasy sports. To fix this problem, state legislatures must pass fantasy sports specific laws.  By doing so, states can protect the multi-billion dollar industry.

[1] Darren Rovell, Peyton Manning Injury Could Shift $65 Million in Fantasy Winnings, CNBC (Sept. 6, 2011, 6:57 PM), http://www.cnbc.com/id/44414737/Peyton_Manning_Injury_Could_Shift_65_Million_in_Fantasy_Winnings.

[2] Michael Stein, The Verdict: Yahoo Is Endangering Fantasy Sports, THT Fantasy (Feb. 1, 2011, 5:11 AM), http://www.hardballtimes.com/main/fantasy/article/the-verdict-yahoo-is-endangering-fantasy-sports/.

[3] New York v. World Interactive Gaming Corp., 714 N.Y.S.2d 844, 852 (App. Div. 1999).

[4]Id. at 851 (emphasis added).

[5] Gamble Definition, Merriam-Webster, http://www.merriam-webster.com/dictionary/gamble (last visited Feb. 6, 2013).

[6] E.g., New York v. Hunt, 616 N.Y.S.2d 168, 169 (Crim. Ct. 1994); Valentin v. el Diario la Prensa, 427 N.Y.S.2d 185, 186 (Civ. Ct. 1980); McKee v. Foster, 347 P.2d 585, 590 (Or. 1959); Geis v. Cont’l Oil Co., 511 P.2d 725, 727 (Utah 1973).

[7] Marc Edelman, A Short Treatise on Fantasy Sports and the Law: How America Regulates its New National Pastime, 3 Harv. J. Sports & Ent. L. 1, 27 (2012).

[8] E.g., Affiliated Enter. v. Waller, 5 A.2d 257, 262 (Del. Super. Ct. 1939); State ex rel. Schillberg v. Safeway Stores, Inc., 450 P.2d 949, 955 (Wash. 1969).

[9] Arkansas v. 26 Gaming Machs., 145 S.W.3d 368, 374 (Ark. 2004).

[10] Edelman, supra note 9, at 28

[11] Anthony N. Cabot et al., Alex Rodriguez, a Monkey, and the Game of Scrabble: The Hazard of Using Illogic to Define the Legality of Games of Mixed Skill and Chance, 57 Drake L. Rev. 383, 390 (2009).

[12] Johnson v. Collins Entm’t Co., Inc., 508 S.E.2d 575, 584 (S.C. 1998).

[13] Texas v. Gambling Device, 859 S.W.2d 519, 523 (Tex. App. 1993).

[14] Milwaukee v. Burns, 274 N.W. 273, 276 (Wis. 1937).

[15] See Joker Club L.L.C. v. Hardin, 643 S.E.2d 626, 629 (N.C. Ct. App. 2007); (“[S]kill will prevail over luck over a long period of time”).

[16] Derek Ambrosino, Is Autodraft a Necessary Evil?, THT Fantasy (Jan. 4, 2012, 5:44 AM), http://www.hardballtimes.com/main/fantasy/article/is-autodraft-a-necessary-evil/.

[17] Skill Definition, Merriam-Webster, http://www.merriam-webster.com/dictionary/skill (last visited Feb. 6, 2013).

[18] See generally Humphrey v. Viacom, Inc., No. 06-2768 (DMC), 2007 WL 1797648, at *7 (D.N.J. June 20, 2007)

[19] Eric Sinrod, Fantasy Sports Leagues Participation is not Illegal Gambling, Judge Rules, Find L. (July 3, 2007), http://articles.technology.findlaw.com/2007/Jul/03/10896.html.

[20] Mont. Code Ann. § 23-5-802 (2011).

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The California Money Transmission Act: Boon to Consumers or Bane to Innovation?

By James Mariani*

I. Introduction

Recently California passed the Money Transmission Act (CA MTA), which some believe to be a threat to innovation in Silicon Valley and the death knell for certain types of startups.[1]  The CA MTA “prohibits a person from engaging in the business of money transmission in California or advertising, soliciting, or holding itself out as providing money transmission unless licensed [] or exempt from licensure,”[2] thus expanding California’s previous money transmission regulations and licensure requirements in broad terms while assigning regulation and licensing authority to the California Department of Financial Institutions (DFI).[3]  The Act now applies to domestic money transmitters and includes stored value device issuers, as well as other businesses that offer new types of alternative payment and mobile applications.

II. Background

Money transmission laws date back to 1936 in California after money transmitter businesses were created to take advantage of a new market of immigrants wishing to send money back to their native land.[4]  Regulations were originally designed to prevent money laundering, fraud, and other financial crimes, however after the events of September 11, 2001, the financing of terrorist activities jumped to the forefront prompting many states to pass money transmission laws. Congress responded with its own legislation, passing the USA PATRIOT Act, which among other things, amended 18 U.S.C. § 1960 criminalization of acting as an unlicensed money transmitting business in a state that requires such a license, by making the mens rea requirement one of general intent. The District of Columbia and 48 states have similar money transmitter laws, however none seem to be experiencing the uproar and criticism experienced in California.[5]  This can most likely be attributed to two issues: the CA MTA is broader and has more expensive licensing requirements than what is typical among the states and California has an environment of unique, highly entrepreneurial channels and a large startup volume.

III. The California Money Transmission Act

The CA MTA provides that “a person shall not engage in the business of money transmission in this state, or advertise, solicit, or hold itself out as providing money transmission in this state, unless the person is licensed or exempt from licensure . . . .”[6]  Based on findings that the failure of money transmission businesses to fulfill their obligations would cause harm to consumers and the state while undermining public confidence and general welfare, the legislature designed the act with the purported purpose of protecting the interest of persons in the state who use money transmission services, of providing for the safe and sound conduct of the business of licensees, and to maintain public confidence in licensees.

“Money Transmission” is defined broadly to mean selling or issuing payment instruments, selling or issuing stored value, or receiving money for transmission.[7]  A “payment instrument” is defined as an instrument for the transmission or payment of money or monetary value, whether or not negotiable, excluding issuers who also redeem the instrument for goods or services provided by the issuer.[8]  “Stored value” means monetary value representing a claim against the issuer that is stored on a digital or electronic medium and accepted as means of redemption for money or as payment for goods or services excluding cards issued by businesses that also redeem the card for goods or services provided by the issuer.[9]  Finally, “receiving money for transmission” broadly includes any transaction where money or monetary value is received for transmission within or outside the United States by electronic or other means—thus possibly including certain novel mobile payment applications and emerging payment platforms that are not offered by banks or other regulated depository institutions.[10]

These broad terms change existing regulations in several ways.  First of all, the Act combines three existing license regimes—traveler check issuers, money order sellers, and foreign money transmitters—into one. Secondly, it newly subjects domestic money transmitters and stored value, or open loop, issuers to licenses. Finally, it criminalizes engaging in money transmission in California without a license. It is important to note that this law applies to anyone who engages in its prohibitions in California or for California residents.

1. Licensure Requirements

Just as the CA MTA’s defining prohibition is seemingly broad and open-ended, likewise are its license requirements, which are more demanding than what is typical among the states.[11]  A license is only attainable by a corporation or limited liability company and is issued by the Commissioner of the California Department of Financial Institutions (Commissioner).[12]  An application requires a nonrefundable $5,000 fee along with a multitude of specified information provided “in a form and in a medium prescribed by the [C]ommissioner.”[13]  This section also includes a catchall provision entitling the Commissioner to “any other information the [C]ommissioner requires with respect to the applicant” as well as the ability to waive or replace specified information requirements.[14]  The Commissioner is authorized to conduct an examination of an applicant, at the applicant’s expense, and then approve its application if certain specific findings are made including that “the financial condition of the applicant is otherwise such that it will be safe and sound for the applicant to engage in the business of money transmission,” the applicant and its agents are of good character and sound financial standing, it is competent, its plan affords reasonable promise of successful operation, and it is reasonable to believe the applicant will be compliant once licensed.[15]  In addition to the broad terms of authorizing a license, § 2036 provides a supplementary and powerful catchall phrase entitling the Commissioner to “impose on any authorization, approval, license, or order issued pursuant to this chapter any conditions that he or she deems reasonable or necessary to the public interest,” including exemptions from the license requirement.[16]

          a.     The Net Worth or “Sound Financial Standing” Requirements

When designing the CA MTA, the California legislature found that “the failure of money transmission businesses to fulfill their obligations would cause loss to consumers, disrupt the payments mechanism in this state, undermine public confidence in financial institutions doing business in this state, and adversely affect the health, safety, and general welfare of persons in this state.”[17]  Based on this concern, the legislature added large security deposit requirements in order to ensure that licensees were of sound financial standing in order to prevent the failure of money transmission businesses and weed out “fly-by-night” company applicants.[18]  The security requirement however is ambiguous and broad—as is the trend throughout the Act—providing that as a security, a licensee will deposit cash, securities, or a surety bond in “such amount as the [C]ommissioner may find and order from time to time as necessary to secure the faithful performance of the obligations of the licensee . . . .” If a licensee sells or issues payment instruments or stored value, then it must maintain securities or a surety bond of at least $500,000 or 50 percent of the California average daily outstanding payment instrument and stored value obligations up to $2,000,000. A licensee that engages in receiving money for transmission must maintain a security or surety bond in an amount greater than the average daily outstanding obligations for money received for transmission in California ranging from $250,000 to $7,000,000. The security, money, bonds, and their proceeds are deposited with the State Treasurer and “shall constitute a trust fund for the benefit of persons in California” who were customers of the licensee in the event of its failure.[19]

          b.     Other Post-license Compliance Requirements

In addition to the security deposit requirements, the CA MTA also includes several regulatory compliance provisions such as paying an annual $2,500 fee (among other conditional licensee fees);[20] filing audit reports and specific informational reports—including total volume of activities, transactions, obligations, etc.;[21] and providing consumers with certain disclosures, notices, and records.[22]

2.    Noncompliance Penalties

The Commission has yet to exercise its enforcement capabilities, but they are broad and powerful as presented in the statute. The CA MTA authorizes the Commissioner to suspend or revoke a license if “the Commissioner finds that a licensee or agent of a licensee has, among other things, violated the provisions of the CA MTA or engaged in fraud or unsound practices . . . .”[23]  If a money transmitting business fails to attain a license and conducts business regardless, it could be faced with heavy civil penalties, criminal penalties, or both. Also frightening is the possibility that the CA MTA may, in conjunction with § 1960 of the USA PATRIOT Act, result in an unknowingly unlicensed money transmitting business being guilty of committing a federal general intent crime.  This fact is exceptionally worrisome, as many companies may not realize that they require a license due to the Act’s ambiguity.  Also, the expensive licensing requirements can be crippling to some startups that are unable to afford the license requirements.  As this Act only recently went into effect, it is difficult to predict the scope of the possible enforcement actions, the weight of their ensuing penalties, or how such actions will play out.

3.     Who Requires a License?

The breadth of the CA MTA has stirred sizeable criticism and prompted many to ask who exactly requires a license. “A spokewoman from the DFI advised companies to ask themselves simple questions:”

Do you take funds/value from A and agree to pay them to B on behalf of A; and/or Do you take funds/value from A, and store it so that A can make purchases from third parties or take cash out at a later date.[24]

This answer however, is no less broad than the language of the statute.  It could potentially cover a wide array of companies from Airbnb, for renting hosts’ rooms to travelers; to Apple, for taking money from customers and paying it to App developers; and to Zynga, for selling virtual currency. There has already been confusion between DFI and a company on the Act’s application; Airbnb believes the licensing requirements do not apply to them, and DFI believes the opposite. DFI has shown that it is willing to work with companies, like Square who didn’t even apply for a license until a year after the Act went into effect. This leniency though, might be temporary as the Act is relatively new and possesses penalties that are potentially crippling.  When interpretations between a company and DFI differ on the law’s application, litigation might be required.  In such cases, criminal enforcement and civil penalties may be at stake.  If a money transmitting business does fail, the security bond requirements of the Act are supposed to make consumers whole, which may or may not justify the high compliance cost.

FaceCash is a startup that stopped doing business in California because it couldn’t afford the security deposit requirements. The company was unable to receive an exemption from the state and embarked upon litigation against California. The CA MTA cannot be enforced against FaceCash because it discontinued its business in California, but what if it had not?  Companies that can’t afford the security deposits and aren’t sure whether the Act applies to them may be faced with asking themselves whether they should risk the potential penalties rather than try and comply with the Act’s high licensing requirements.

IV. Conclusion

The DFI publishes a list of the companies that currently are licensed under the CA MTA as a money transmitting business.[25]  The best strategy for a company presently is to look at this list and determine if its business model is similar to those companies that require and have attained a license. If its business model is innovative, using the plain English test passed down by the DFI is the next best choice. However, until the scope of the Act’s enforcement and penalties are clearer, many startup companies will be dissuaded from conducting possible money transmission business and risking high penalties and possible criminal prosecution. In this sense, the CA MTA is detrimental to innovation, and a new, expensive burden for the many startups that make their home in California.

*J.D., College of Law, University of Illinois, expected 2013

[1] Money Transmission Act, Cal. Fin. Code § 2000 (West 2012); see Chris Hinyub, The Money Transmission Act: A Boon to Banks, a Bane of Small Businesses, IVN.us (May 25, 2011), http://ivn.us/2011/05/25/money-transmission-act-boon-banks-bane-small-businesses/ (“[T]he Money Transmission Act is designed to kill innovation.”); Owen Thomas, This Innovation-Killing California Law Could Get A Host of Startups in Money Trouble, Business Insider (July 11, 2012, 6:21 PM), http://www.businessinsider.com/california-money-transmitter-act-startups-2012-7 (“[Startups’] entrepreneurial impulse could be stifled by a surprisingly broad statute governing money transmission in California . . . .”).

[2] Marie Hogan, California’s New Money Transmission Law Sweeps Up, Joseph & Cohen (May 19, 2011), http://josephandcohen.com/2011/05/californias-new-money-transmission-law-sweeps-up/.

[3]Jonathan Pompan, California Enacts Sweeping New Law Targeting Money Transmitters, Venable LLP (Oct. 2010), http://www.venable.com/california-enacts-sweeping-new-law-targeting-money-transmitters-10-05-2010/.

[4] Andrea Lee Negroni, Risky Business: State Regulation of Money Transmitters, CLEAR News (Goodwin Proctor LLP, Bos., Mass.) Spring 2003, at 1–2, available at http://www.goodwinprocter.com/~/media/Files/Publications/Attorney%20Articles/2003/Risky_Business_State_Regulation_of_Money_Transmitters.ashx.

[5] Jonathan L. Pompan, Understanding the Relationship Between Money Transmitter Laws and Regulations and Debt Management Plans, Venable LLP (Jan. 20, 2012, 9:30 AM), http://www.aiccca.org/images/AICCCA%20Presentation%20-%20Understanding%20the%20Relationship%20between%20Money%20Transmitter%20Laws%20and%20Regulations%20and%20Debt%20Management%20Plans%20(January%2020%202012).pdf.

[6] Money Transmission Act, Cal. Fin. Code § 2030 (West 2012).

[7] Id. § 2003(o).

[8] Id. § 2003(q); see Hogan, supra note 2 (listing as examples: a check, draft, or money order).

[9] Fin § 2003(v); see Hogan, supra note 2 (distinguishing Visa gift cards, which are included; from cards issued by leading coffee chains, which are excluded).

[10] Fin § 2003(s); Hogan, supra note 2.

[11] See Pompan, supra note 9 (explaining that typical requirements for state licensing include “good moral character”, “sufficient financial responsibility”, “business experience”, “confidence of the public”, “a minimum net worth of [e.g.] $150,000”, and “3 years experience in money transmission or other related financial services”).

[12] Money Transmission Act, Cal. Fin. Code § 2031 (West 2012); Pompan, supra note 2.

[13] See Fin. § 2032 (listing specified information requirements from § 2032(c)(1)–(22)).

[14] Id.

[15] See id. § 2033 (listing specific findings from  § 2033(b)(1)–(5)).

[16] See id. § 2036.

[17] Id. § 2001(c).

[18] Id. §§ 2033, 2037; Danielle Rodabaugh, California Money Transmitter Company Closes, Possibly to Avoid $750,000 Surety Bond, Suretybonds.com (July 8, 2011), http://www.suretybonds.com/blog/california-money-transmitter-company-closes-possibly-to-avoid-750000-surety-bond/1411 (“The state established the high surety bond requirement to keep fly-by-night companies out of the market.”).

[19] Fin. § 2037; Pompan, supra note 2.

[20] Fin. § 2038. See § 2038(e)–(h) for additional conditional fees.

[21] Id. § 2039 (listing specific requirements for respective required reports); Pompan, supra note 2.

[22] Fin. §§ 2100–2106; Pompan, supra note 2.

[23] Fin. § 2035; Pompan, supra note 2.

[24] Id.

[25] Directory of Money Transmitters, CA.gov, http://www.dfi.ca.gov/directory/mt.asp (last updated Sept. 5, 2012, 9:31:16 AM).