Timegame Studios, developer of the Section 8 first person shooter, has just won an interesting lawsuit against publisher SouthPeak Interactive (via Houston Press and Courthouse News). The case is a useful reminder of both the strength and weaknesses of arbitration, as well giving us some useful practical tips for drafting good publishing agreements (skip to the end of the post for that). I’ve written a summary of the case below.
The facts: developing Section 8.
Timegate entered into a publishing deal with Gamecock (then an independent company), under which Gamecock would advance $7.5m (apparently this turned into $8.29m at some point) for Timegate to develop Section 8. Timegame would put in $2.5m of its own money. As with most publishing deals, the Gamecock development advance was non-refundable but recoupable and had priority: i.e. Gamecock would be paid first from any Section 8 sales revenue until it got its development advance back, after which (presumably) there’d be a revenue split between them. There was an express contract term that Timegate would own the Section 8 IP (this is always important but turned out to be absolutely crucial to Timegate’s eventual victory – more on that later).
The release of Section – stormclouds gather… Fast forward to Section 8’s release date: it didn’t do very well [I thought it was a good game, though]. At roughly around the same time, Gamecock was acquired by Southpeak, meaning that Southpeak stepped into Gamecock’s contractual shoes effectively. From this point on, things seem to have got increasingly nasty on both sides. Southpeak argued that:
- It was Timegate’s fault that the game was a “flop”: it lacked quality and had been released against Halo (said to be a fairly similar game).
- Timegate had failed to contribute its $2.5m share of the funding and had not used the $7.5 Southpeak funding for the purpose of developing the game.
- Timegate had published a PC sequel and PS3 version of Section 8 without paying revenue to Southpeak.
- Timegate had made false representations to induce Southpeak into the contract and had acted fraudulently.
Timegate argued that:
- Southpeak was in breach of the agreement because Gamecock had actually gone insolvent at the time it was bought up by Southpeak (typically, if a contract has been properly drafted then the entry by one party into insolvency gives the other party an immediate termination right).
- Southpeak had been manipulating revenue reports so as to withhold payments to Timegate and keep the money itself [a very serious allegation].
Timegate therefore decided to terminate the contract. Southpeak commenced legal action in Texas, which was referred to arbitration (since there was a binding arbitration clause in the publishing agreement). [Quick arbitration 1.01: arbitration is basically an alternative form of dispute resolution to court action, which is meant to be just as binding but allows parties to have much more influence on who adjudicates their dispute, where, under what law and on what terms and conditions – it’s quite popular in medium-high value cross-border deals.]
Now this is where it gets interesting. The arbitrator found in favour of Southpeak and ruled that:
- Timegate had wrongfully terminated the contract and therefore were in breach of contract itself.
- Timegate had fraudulently induced Southpeak into the contract in the first place.
- Southpeak should be awarded $7.3m in damages from Timegate.
- The publishing agreement would be amended to give Southpeak a permanent licence over the Section 8 IP, including the right to make sequels.
Timegate, understandably, were unhappy. They therefore challenged the arbitrator’s award in court [in the US, like in the UK under the Arbitration Act 1996, you can challenge an arbitrator’s decision under certain very limited circumstances]. So, the whole matter and the arbitrator’s decision ended up before a Texas district judge.
The judge’s decision
The judge has ordered that the arbitrator’s decision be “vacated” – i.e. declared invalid. This almost certainly means that Southpeak doesn’t get any damages and doesn’t get the permanent licence rights over the Section 8 IP. Without getting into the detail too much, the judge’s reasons for this decision were:
(1) Arbitrators under Texas law have the power to void and effectively rewrite contracts in the right circumstances provided that they don’t act contrary to express contractual provisions.
When it came to testing whether the arbitrator’s decision actually fits with what the contract says, the judge didn’t seem too impressed: he found arbitrator’s decision in some respects was quite clearly contrary to the actual contract terms. In particular, the arbitrator awarded a permanent and very wide licence to Southpeak when the contract was clear that Timegate retained all the IP. On that point, the judge found that “It is beyond question that this portion of the arbitration award is in conflict with at least …two provisions of the parties’ contract.”
The judge also found that the arbitrator acted contrary to the contract’s express provisions by awarding damages to Southpeak that included the $8.29m in development advances it gave to Timegate because Southpeak couldn’t actually claim that $8.29m back under the contract (because it was non-refundable and recoupable only under specific circumstances, which hadn’t been met).
(2) BUT, arbitrators also have the power to void and effectively rewrite a contract provided that it is “rationally inferable from the parties’ central purpose in drafting the agreement.”
Very basically, Southpeak argued that it didn’t matter whether the arbitrator’s decision contradicted what the contract actually says, because he has the power to rewrite the contract anyway. This seems to have been quite an uncertain issue under Texas law [I can understand why – it would give arbitrators a very wide power], but essentially the judge found that an arbitrator DOES have that power provided that it is used in a way that is “rationally inferable from the parties’ central purpose in drafting the agreement.” In other words, the arbitrator can’t just make up any old thing and shove it in the contract – he or she has to have regard to what the parties were actually trying to do with the contract.
(3) The arbitrator’s decision had to be voided because in some respects he had failed to have regard to “the parties’ central purpose in drafting the agreement”
Having decided that the arbitrator could void and rewrite the contract as long as he had regard to the parties’ “central purpose”, the judge had to decide whether that had actually happened.
On this key issue, the judge decided that: (i) the arbitrator hadn’t acted wrongly by awarding the $8.29m in developer funding back to Southpeak and (ii) hadn’t acted wrongly by awarding it consequential damages either.
BUT, the judge said that the arbitrator HAD acted wrongly by giving a permanent and wide IP licence to Southpeak, which he found could not be “rationally inferable from the parties’ central purpose in drafting the agreement”. This is what he said on that point:
“The arbitrator’s creation of a perpetual license is another matter. The Court cannot conceive of a way in which a perpetual license, which violates at least two provisions of the parties’ contract, and is inconsistent with the fundamental purpose of the contract, is rationally inferable from the contract itself. The provision takes what was a temporary licensing agreement, which required collaboration and coordination between the parties, and expands it into a permanent contract under which the parties are able to develop competing products. The contract is turned on its head by expanding the rights of Defendants to allow them to actually create sequels, ports, and add-ons related to the Game, without any obligation to pay the Game’s developer, TGS, royalties. Ultimately, the Award gives Defendants rights far beyond what even they requested, and awards those rights in perpetuity.”
So, by this stage the judge has decided that the arbitrator’s decision was defective due to the IP licence he awarded to Southpeak. In those circumstances, under Texas law the judge could vacate (i.e. void) the arbitrator’s decision or modify it. The judge decided to void it:
“The Fifth Circuit has explained that, where an arbitrator exceeds his contractual authority, vacatur or modification of the award is an appropriate remedy. Delta Queen Steamboat Co. v. Dist. 2 Marine Engineers Beneficial Ass’n, AFL-CIO, 889 F.2d 599, 602 (5th Cir. 1989). The Court concludes that it cannot modify the award while still preserving its intent, and acting consistently with the essence of the parties’ contract. The award therefore must be VACATED.”
What this means for Timegate and Southpeak
Although it was not spelt out in the judgment, the implication of that decision is that Southpeak would receive no damages, no IP licence and no further rights in the Section 8 IP – all of which Timegate would keep. Normally this would need to be spelt out in a further court order/filing, but I’ve not seen it yet. It’s of course possible that this isn’t the end of the story though, as Southpeak may file an appeal.
Practical tips from this case:
- Make sure your publishing/development agreements are well-drafted and thought out. A key component in Timegate’s victory here was having a good contract. Clauses that Timegate included in its contract (and so should you):
(1) exactly how funding is to be paid and when it is recoverable
(2) limitations on liability
(3) exclusions of certain kind of liability
(4) some kind of clause about dispute resolution (including arbitration if you want – but see below)
(5) give yourself the right to terminate if the other party goes insolvent
(6) OWNERSHIP OF IP – it’s absolutely critical you are 100% clear about that before you sign up to any contrac
- Monitoring actual revenue flow is key. Having a good revenue clause in a contract is one thing, but making it work is another. In this case, Timegate alleged that Southpeak was manipulating the revenue clause so as to keep revenue for itself. Whether that was right or wrong, it shows that watching what happens to the revenue and the revenue clause is the key to getting paid.
- Arbitration is good but not perfect. As I said earlier, there a number of advantages to arbitrating disputes instead of litigating them – but remember that, even if you win an arbitration, the other guy might still challenge you in court (which is what Timegate did).
- Arbitrators have very wide powers: the judge was prepared to agree here that the arbitrator could, if acting properly, basically rewrite the parties’ contract. That’s a very wide power indeed – so it pays to keep your eyes open about what could actually happen at an arbitration before you include arbitration clauses in your contracts or propose an arbitration to the other side in a dispute.
- Stick to your guns: sometimes you have to keep spending to win a lawsuit. Timegate must have been pretty disappointed when they received the arbitrator’s decision originally, but they decided to fund a court challenge, which turns out to have delivered them a sizeable win.