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A Wake-Up Call for Video Game Developers

By Sean Kane| May 7, 2013

On April 9, the U.S. Court of Appeals for the Fifth Circuit issued an order upholding an arbitration award against a video game developer and granting a publisher a perpetual license in the developer’s game due to the developer’s fraudulent conduct and egregious breach of a video game development agreement. The appellate ruling issued in New Orleans came in the case of TimeGate Studios Inc. v. Southpeak Interactive LLC, which originated in the U.S. District Court for the Southern District of Texas.

In June 2007, video game publisher Gone Off Deep LLC d/b/a Gamecock Media Group (later acquired by Southpeak Interactive LLC) entered into a contract with developer TimeGate Studios Inc. to produce and market a futuristic military‐style product, titled “Section 8.” TimeGate was obligated to design and develop a “high quality” video game, and Gamecock was to provide most of the investment funding for the game’s development and responsible for manufacturing, marketing, distributing, and selling the game after its release. The agreement stated that TimeGate will remain the “exclusive owner” of the intellectual property in the video game, but granted Gamecock a worldwide license for a term of eight years following the game’s first release or five years following the release of an add‐on or sequel, whichever is later. Soon after the release of “Section 8” in September 2009, the parties’ relationship began to deteriorate as sales of “Section 8” failed to meet expectations.

TimeGate originally filed suit against Gamecock for breach of the development agreement in December 2009, and Gamecock filed counterclaims. Additionally, following Gamecock’s request, the district court stayed the suit due to the existence of an arbitration provision in the underlying development aAgreement. Such arbitration took place in April and July of 2011. Following an eight-day hearing, the arbitrator found that TimeGate had engaged in a litany of fraudulent misrepresentations and contractual breaches.

The arbitrator found that TimeGate had fraudulently induced Gamecock into entering into the development agreement and then breached the agreement in so many ways that the collaborative relationship presupposed by the agreement was no longer possible. Due to its finding, the arbitrator awarded Gamecock and Southpeak Interactive $7.35 million, plus attorney’s fees, in monetary compensation and a perpetual license in the intellectual property of “Section 8.” TimeGate then requested that the district court vacate the arbitrator’s award on the basis that the perpetual license was not consistent with the “essence” of the underlying development agreement. The district court initially found in TimeGate’s favor on the basis that the arbitrator had exceeded its powers.

However, after looking at the issue on appeal, the Fifth Circuit’s recent order reversed the district court and ordered it to reinstate the arbitrator’s award. The Fifth Circuit found that “[w]e will sustain an arbitration award as long as the arbitrator’s decision ‘draws its essence’ from the contract — even if we disagree with the arbitrator’s interpretation of the contract.” In the instant matter, the Fifth Circuit observed that the development agreement’s arbitration clause was “quite broad” and contained no relevant limitations.

Moreover, the Fifth Circuit felt that the arbitrator’s grant of a perpetual license furthered the general aims of the development agreement. Specifically, the Fifth Circuit stated that the “Section 8 perpetual license is rationally rooted in the Agreement’s essence. Timegate committed an extraordinary breach of the Agreement, and an equally extraordinary realignment of the parties’ original rights is necessary to preserve the essence of the Agreement. Because the Agreement bestowed broad remedial powers upon the arbitrator and because it was fraudulently induced and irreversibly violated by Timegate, the perpetual license is a rational and permissible attempt to compensate Gamecock and maintain the Agreement’s essence.”

While not the first case where an arbitrator changed the terms of an “agreement-gone-bad,” TimeGate Studios Inc. v. Southpeak Interactive LLC should be somewhat of a wake-up call to both the developers and publishers in the video game industry. The agreement that Gamecock and TimeGate entered into is indicative of many deals in the industry. It comprised approximately 35 pages of terms and conditions which covered basically all of the rights and responsibilities of the parties under all of the likely outcomes of the “Section 8” relationship. While many of these terms were significantly negotiated, the arbitration clause seems to be fairly broad, generic and off the shelf.

Many large companies in the video game industry avoid the insertion of an arbitration provision. I have negotiated many development agreements where publishers will not even consider them. There is a fear that an arbitrator is just too unpredictable and may just split the baby to avoid any challenge by a potentially unhappy party, while a court is more apt to hear the matter and decide it for one party or another based on the specific terms of the agreement at issue.

However, there are other benefits and pitfalls to arbitration. In terms of a benefit, arbitration can be quick. That said, depending on a party’s position the quick nature of arbitration could also be a negative if their defense strategy is based on delay. Arbitration decisions are confidential, for the most part. Unless they are challenged in a court the specifics are not generally known to the general public. This can be a boon to a company who might have been found engaging in untoward conduct as their reputation may not be damaged in the same way that a publicly issued court decision might.

Moreover, the parties can define what background and experience an arbitrator must have which may avoid the problem of trying to explain a complex video game issue to a judge with no particular experience in the field.
It is my belief that these “purported” fears result from boiler plate arbitration clauses being the norm for most contracts. Most companies do not give much thought to actually changing the language of a standard arbitration clause. However, they do this to their detriment.

Arbitration is a powerful remedy but also a very adaptable one as TimeGate Studios Inc. v. Southpeak Interactive LLC demonstrates. Many of the concerns about the pitfalls of arbitration can be avoided by clear and thoughtful drafting. Left unchecked, the powers of an arbitrator in most boiler plate provisions are very broad so long as the decision does not change the “essence” of an underlying agreement. The Fifth Circuit relied on this concept in determining that the arbitrator has not exceeded its authority in granting the perpetual license to “Section 8.”

The Fifth Circuit found that the arbitrator’s determination that the parties would be unable to work together in the future led to the need for Gamecock/Southpeak to be able to benefit from the “Section 8” game in some other way. As no readily available or better option existed the perpetual license was necessary to fulfill the essence of the agreement which was to allow Gamecock to publish “Section 8.” However, had the parties included an arbitration provision in the development agreement which limited the arbitrator’s authority to make changes to certain terms, like the “Section 8” license rights, the Fifth Circuit’s decision would likely have been much different.

Agreements in the video game industry generally fall into two categories, agreements where the parties have negotiated the terms and conditions with significant forethought and agreements where one party basically just signed whatever the other party put in front of them. Regardless of how they were negotiated, it is a common theme that once an agreement has been executed, it is tossed in a file and ignored. Publisher and developer course of dealing during a video game development cycle is often much different than what is actually required by the terms of the agreement purporting to govern the relationship. In fact, in certain instances following execution, the agreement is only looked at again later if some issue or problem has arisen. This is not a policy that, as a video game attorney, I would recommend.

The extraordinary relief granted in this matter demonstrates that developers and publishers should seriously consider what terms and conditions they will agree to and must do their best to ultimately comply with the language in a development agreement. This is a great example of why boiler plate language and form documents do not always serve all of the parties well. Here, the broad nature of the arbitration provision benefited the publisher but it could just have easily gone the other way. Therefore, publishers and developers should be more vigilant in their ongoing relationships during the development cycle.

While hindsight is always 20/20, a publisher could have done certain things to mitigate and/or avoid the problems which occurred to Gamecock/Southpeak in relation to “Section 8.” Many development agreements have provisions that since the publisher is funding the development it ultimately owns and controls the rights to the intellectual property embodied and surrounding the video game. Had this provision existed in the development agreement, the arbitrator’s finding that Gamecock/Southpeak was due monetary damages for TimeGate’s questionable conduct (as opposed to the perpetual license to “Section 8” rights specifically reserved in the agreement by TimeGate) would likely not have been challenged. It is also common for a publisher to retain rights to audit the developer’s spending on the game and/or to mandate the amount of the publisher’s payments which must be actually spent on game development.

However, these rights are not usually invoked until something has seriously gone wrong with the relationship which is usually too late. In the instant matter, had Gamecock/Southpeak invoked its audit rights to routinely confirm the spending on “Section 8,” it would have likely been apparent that TimeGate was not complying with its contractual obligations, i.e., retaining more than $500,000 of Gamecock’s payments and not investing its own promised 2.5 million into game development. This may have led to less damage to Gamecock/Southpeak and an earlier resolution of the matter.

Only time will tell if the decision in TimeGate Studios Inc. v. Southpeak Interactive LLC will lead to other grants of licenses to underlying game rights as a means to compensate a publisher for developer misconduct. However, what it does demonstrate to the industry now is that parties to a development agreement should strongly consider whether or not to include an arbitration provision. Moreover, if an arbitration provision is being included, it is important to craft clear language in determining the proposed extent of an arbitrator’s authority.

While the “essence” of an agreement is subjective, specific language limiting an arbitrator’s authority is not. Had the language in the development agreement at issue not been broadly written, the perpetual “Section 8” license would likely not have been upheld. Therefore, whether a party is looking to benefit from a holding similar to the one in this case or avoid finding itself in TimeGate’s position, having an attorney well versed in drafting agreement for the video game industry is a must.

–By Sean F. Kane, Pillsbury Winthrop Shaw Pittman LLP

Sean Kane is an attorney with Pillsbury in New York.

The opinions expressed are those of the author and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.