(If you find any mistake in my English, please let me know via a PM)
(Really, I speak terrible English, so please, tell me if I make mistakes. I'd like to improve it a bit )
This way you can wars in a prison, the winner is allowed free. I think it's a good idea. Either that or they can earn their freedom by doing time the traditional way.
Tortured, having them fight wars in the jail system to get out would only promote PVP-whorish behavior, and alot of the people who will be sent there are going to be there for that behavior. However, I do like the 'time' aspect. The problem is, though it could be good (put them there rather than ban for 3-15 days. This way they can still talk to players they want to talk to), these people could also just make brand new chars to get around their ban.
Or maybe do labor?
You know, as in "Get so manny nomad brains" from a nomad that often passes by.... Or mine a huge amount of something in a astroid field with verry limited dropping thingy's.
The previous server I played on had a pretty decent prison system, and if they found some one cheating or breaking the law, all his/her ships would be sent to the prison colony. I suggest not only a prison sentence but may be also a hefty fine that keeps them from cheating in the future.