The New Virginia Skill Game Machine Bond – Opportunity or Peril?

Author: David Gonsalves

7-10-2020

Governments across the country have responded vigorously both in an attempt to slow the spread of the new coronavirus as well as to combat the economic effects of those efforts to slow the spread. In a strange new twist, the commonwealth of Virginia has enacted a new order to combat the effects of combatting effects of efforts to contain the virus. In other words, COVID-19 relief efforts have blown a hole in the budget and because states, unlike the federal government, are required to balance their books, Governor Ralph Northam had to go looking for money – enter skill game machines, the revenue they generate and the bonds that secure that revenue.

While gambling remains illegal in Virginia, so-called skill game machines started popping up in 2017 when a company named Queen of Virginia petitioned the Virginia Alcohol Beverage Control Board (ABC Board) to review their legality under ABC Board regulations. The Board deemed certain machines as games of skill and allowed retail establishments under their jurisdiction to operate the machines. While the revenue generated by skill game machines should have been covered under Virginia’s 6% corporate income tax, the Commonwealth was concerned about reporting of the large amount of cash flowing through such machines. The government was further concerned about early evidence of skill game machines diverting tax revenue from the Virginia Lottery.

On May 18, 2020, Governor Northam issued Executive Directive Eleven requiring retail stores and truck stops operating skill machines (defined below) to register and report income, pay a monthly $1,200 tax for each machine, and to post a bond in amounts between $50,000 to $1,000,000 based on the number of machines in operation to guarantee proper reporting and tax remittance. The directive is temporary and expires on June 30, 2021; however, given the ongoing need for government revenue, we expect Virginia lawmakers will extend or make permanent the tax and therefore the bond requirement.

Businesses are scrambling to meet the deadline for registration on July 10, 2020 (extended from July 7, 2020). The surety requirement has proven difficult to fulfill for many businesses due to the large penal sums and adverse language in the bond form, especially given the similarities to other hard to place surety classes, such as Lottery bonds. This article serves as a guide to the new Virginia Skill Game Machine Bond for insurance agents, surety underwriters and representatives to help their customers navigate this new bond requirement.

What are the Imminent Deadlines on the New Skill Game Bonds?

The regulations require operators to file an initial registration statement and surety bond by July 10, 2020. The registration statement must contain the applicant’s information, number of machines at each location, and the prior month’s total wagers and prizes awarded for each machine. The first installment of taxes are due August 20, 2020 based on the initial registration statement. Going forward, operators must file a monthly report on the 20th calendar day and remit the prior month’s tax due.

What is a Skill Game and What Types of Businesses Need the Bond?

To paraphrase Virginia legislation, a ‘skill game’ is similar to a traditional gambling slot or electronic machine for which someone can wager and win a prize, but “the outcome of which is determined by any element of skill of the player”. The full definition can be found in HB-881. 

Both operators and distributors of any machine that meets the definition of a skill game must file a bond with Virginia ABC. Coin-operated amusement games (i.e.,arcade games) are exempt if they do not offer prizes including cash, cash equivalents, or vouchers that can be exchanged for cash. 

How Do Surety Companies Underwrite the Bond?

Our review of the statutes, bond form, and experience writing this new bond indicate that surety companies will carefully review the applicant including personal credit and business financials and will likely require collateral for the larger bond amounts. There are three primary issues that make this bond difficult to obtain – (1) large bond amounts, (2) adverse bond form language, and (3) guarantee of financial obligations.

The bond amounts are determined by the number of skill game machines in operation as shown in the table below:

For the $50,000 bond amount, surety underwriters will review an application, personal credit report for all owners, and potentially a business and personal financial statement. Many carriers are not even considering the strongest applicants due to the many issues related to the Skill Game Machine bond. For the larger bond amounts, collateral will most likely be required.

The bond form contains two provisions that make most surety companies quite skittish and unlikely to write this bond – (1) a demand clause, and (2) a forfeiture clause. The demand clause can be found in Section 1 of the bond form and the language essentially removes the surety company’s right to investigate and determine the validity of a claim. Instead, the ABC Board may demand claim payments regardless of the surety company’s determination of validity. Here is the clause in question:

The forfeiture provision is found in Section 5 of the bond form and the language allows the ABC Board the right to submit a claim for the full bond amount for any violation of the regulations and regardless of the size of the actual loss. Below is the forfeiture language:

The last nail in the coffin for most carriers is the fact that the bond guarantees payment of tax obligations. On its own, financial guarantees of this nature typically require strict underwriting and carry larger premium rates for most carriers. Paired with the large bond amounts and ugly bond form provisions, most markets will run and hide from this bond. We suggest contacting a national surety bond broker who can shop your customer’s application to multiple surety companies.

What Do Surety Companies Charge for The Skill Game Bond?

Applicants can expect to pay a premium amounting to 5 -10% of the bond amount along with furnishing collateral of 50% of the penal sum for bond amounts over $50,000. The high premiums and presence of collateral reflect the above average risk presented to surety companies by Skill Game Machine Bonds in Virginia. Below is a chart of typical rates and collateral we are currently seeing for these bonds.

Collateral is typically required in the form of a cashier’s check or irrevocable letter of credit. Assuming no claims have been paid on the bond, collateral will be returned to the principal following a waiting period, anywhere from six months to two years after the bond has been cancelled, depending on the carrier. A good broker with a deep knowledge of the surety market can help you navigate the difference amongst carriers with respect to collateral and other terms.

What Events Could Trigger a Claim?

Any violation of the regulations as determined by the ABC Board could be cause for a bond payout. Although historical data does not yet exist, we believe claim payments will occur most frequently due to failure to remit taxes when they are due and/or failure to provide timely monthly tax reporting. Tax records must remain on file for a one year period after the emergency executive order expires, so even if the bond is cancelled, surety companies may remain liable if the principal is audited and has not kept record of all tax payments. In order to determine whether the business owner has violated the statutes pertaining to the bond, the VA ABC Board conducts a hearing after providing 10-days written notice to the principal. Results of the hearing are final and violations can result in a full penalty bond payout.

Does Virginia Offer Any Alternatives to the Skill Game Bond?

The  ABC Board is accepting US Treasury Bonds, Commonwealth of Virginia bonds, or municipal bonds issued by cities or counties in the Commonwealth in lieu of the surety bond requirement. We were unable to identify how long the ABC Board will hold such deposits or the minimum time to maturity for eligible securities, but we expect that both would be at least through September 1, 2021.

How Is the Skill Game Bond Filed?

The ABC Board accepts electronic copies of this bond. Applicants can file the bond by emailing a copy to [email protected]. The original should be retained by the applicant.

Can the Skill Game Bond be Cancelled?

Yes, this bond may be cancelled by giving 30 days written notice to the VA ABC Board. However, we do not expect cancellation to be prevalent, especially during this initial temporary period, as the bond is hard to place and most surety carriers we have worked with on this bond are treating the premium as fully earned upon issuance and therefore will not return premium upon cancellation.

What Happens When the Emergency Legislation Expires?

The Virginia Skill Game Machine Bond is initially required for a minimum of 14 months. The executive directive expires on June 30, 2021 but requires the bond to remain effective through September 1, 2021 to protect the ABC Board from non-payment of any outstanding tax liabilities that are reported in arrears. We expect some form of permanent legislation to take place prior to the expiration of the order or an extension of the executive order. After all, governments rarely scale back on tax generating revenue!