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Lessons from Timegate's Section 8 Appeal and Suit
by Will Lewis on 04/17/13 10:23:00 pm   Expert Blogs   Featured Blogs

The following blog post, unless otherwise noted, was written by a member of Gamasutra’s community.
The thoughts and opinions expressed are those of the writer and not Gamasutra or its parent company.

 

Section 8

On April 9, 2013, the Fifth Circuit United States Court of Appeals reversed the Federal District Court and granted publisher Southpeak Interactive a perpetual license in the Timegate Studios developed video game, Section 8. This post aims to explain the background behind the suit, why the court likely arrived at the decision it arrived at, and how developers can try to avoid the same situation.

In June 2007, Timegate Studios and Gamecock Media Group entered into a video game publishing agreement under which Timegate would develop a video game entitled Section 8 and Gamecock would publish the game. Under the agreement, Gamecock was granted an exclusive right and license to reproduce, manufacture, package, advertise, publish, market, sell to end-users, wholesalers, and retailers, and to distribute and display Section 8 and any other iterations of the game on other platforms. Gamecock was also granted a limited exclusive right and license to manufacture, market, publish, and sell DLC associated with Section 8. Gamecock was also granted the option to publish one sequel to Section 8. Finally, the agreement stated that Timegate would remain the exclusive owner of the game's intellectual property and that Gamecock's use of the property was limited to marketing, publishing, and distribution efforts; Gamecock was specifically prohibited from preparing derivative works or sequels.

Before Section 8 was published, Gamecock was acquired by Southpeak. Southpeak assumed all of Gamecock's rights and responsibilities under the Section 8 publishing agreement. This is why Southpeak ultimately published the game and defended against the lawsuit.

In September 2009, Southpeak published Section 8 on the Xbox 360 and the PC. The game opened to average reviews, and it's strongest feature, multiplayer, was never populated enough for the game to fully reach its potential. In December 2009, Timegate filed suit against Southpeak, alleging multiple breaches of the publishing agreement, including that Southpeak had misreported sales figures to Timegate thereby withholding royalty payments from Timegate. Southpeak counter-sued for breach of contract and fraud.

What Timegate Did Wrong

The suit ended up in binding arbitration. The arbitrator found that Timegate had actively engaged in several fraudulent misrepresentations and contractual breaches. Specifically, the arbitrator found that Timegate committed the following offenses:

  • Timegate spent only $6.76 million of the $7.5 million Gamecock had provided to it to develop Section 8. The arbitrator found that Timegate "pocketed" approximately $750,000. This likely means that they paid it out to themselves in bonuses or spent it on office perks unrelated to the development of Section 8.

  • Timegate had promised Gamecock that it would spend $2.5 million of its own money on Section 8 development. But Timegate failed to spend any of the $2.5 million that it was obligated to spend on Section 8's development.

  • Timegate failed to use its best efforts to develop a high quality game as required by the agreement.

  • Timegate fraudulently induced Gamecock to enter into the publishing agreement.

  • Timegate self-published a PlayStation 3 port of Section 8.

  • Timegate unilaterally developed a sequel, Section 8: Prejudice.

  • Timegate failed to provide fully functioning Section 8 DLC.

  • Timegate failed to provide a Russian translation.

  • Timegate failed to allow Southpeak to distribute the game through certain third-party websites. Presumably, Steam, etc.

Based on federal law, the courts are bound to follow an arbitrator's factual findings. What this means is that everything that the arbitrator found above is deemed to be true in the courts.

The Decision Against Timegate and What is Meant by a Perpetual License

The arbitrator awarded Gamecock $7.35 million in damages, about $830,000 in attorneys fees, and amended the original publishing agreement to grant Gamecock, and therefore Southpeak, a perpetual license in Section 8's intellectual property. The effect of the perpetual license was not to grant Gamecock and Southpeak an exclusive license in Section 8. Rather, the effect of the perpetual license was to allow both Timegate and Southpeak to develop and publish Section 8 sequels independently. But really, although Prejudice received better reviews, what's the value in an average property?

Why the Court Upheld the Remedy Against Timegate

The heart of the appeal by Timegate was that the arbitrator had exceeded the scope of his powers in amending the agreement to grant Southpeak a perpetual license. Under the law of contract intepretation, the Fifth Circuit was thus tasked with determining the essence of the publishing agreement. The court determined that the essence of the agreement was that a developer who could make a game was partnering with a publisher who could market the video game with the goal of profit for both. The court held that the only way for Southpeak to benefit from Section 8 as envisioned under the agreement was to allow Southpeak to independently produce its own Section 8 titles. The court reasoned that this would allow both Timegate and Southpeak to financially benefit from Section 8, the property to which which they both contributed.

Curiously, the court seemed to justify its holding by reference to what were standard video game publication agreements in 2006. In contrast to the Section 8 agreement, in which the developer retained all intellectual property rights, standard video game publication agreements in 2006 assigned intellectual property rights, such as the game's name, characters, storyline, and logos, to the publisher.

What Lessons Does This Provide for Developers

This case provides three main lessons for developers. First, choose your publisher carefully. This is a tough one to get right. For example, in this case the game was in development for two years. A Gamecock that was solvent in 2007 was allegedly insolvent in 2008, and acquired by a new publisher. Southpeak's lack of interest in or different commitment to Section 8, or inexperience in marketing multiplayer FPS's could have contributed to the slow sales of Section 8, which resulted in a multiplayer experience that was less satisfying than the game would have provided had there been more players.

Which leads to the second lesson, make sure the other side is actually at fault for a game's poor performance before you launch a lawsuit. I don't think that Section 8 will find many diehard supporters, and it wasn't necessarily a bad game, but it might not have been worthy of a large sales volume. This second lesson primarily applies to developers' attorneys, but an objective look at the quality of Section 8 could have been a good indicator of why the royalties were so low. The consequences of filing this suit were fairly high, and Timegate's attorneys might face a lawsuit from Timegate.

Lastly, and at the risk of sounding like a patronizing attorney, it is imperative that developers understand and follow the publication agreements that they sign. And if they're not going to follow the agreement, then developers need to consider the economics of their actions. Timegate likely did not do too bad in this regard.

Timegate pocketed approximately $750,000 of Gamecock's funding and did not invest $2.5 million of its own money, for a gross economic benefit of $3.25 million. Following arbitration, Timegate was ordered to pay Southpeak $7.3 million in damages which represented the arbitrator's estimate of what Southpeak would have earned under the publication agreement on the PlayStation 3 port of Section 8 and the sequel. In other words, this $7.3 million represents what Southpeak would have earned if the agreement was followed and it published the port and sequel, and Timegate likely earned this $7.3 million plus what it would have earned under the agreement if it had only acted as the developer. Timegate also had to pay $800,000 in attorney's fees for Southpeak, and likely spent at least $800,000 on its own attorneys. Therefore, it looks like Timegate spent approximately $1.6 million in attorneys fees in exchange for saving $2.5 million in costs and paying out $750,000 in bonuses during development resulting in a net economic benefit of about $1.65 million. Not bad.

Thoughts? 

Will Lewis is a tax and business attorney based in the Silicon Valley. He advises domestic and foreign clients on a range of business, tax, and estate planning matters. You can reach him at lewistaxlaw@gmail.com.


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Comments


Ryan Creighton
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"Timegate spent only $6.76 million of the $7.5 million Gamecock had provided to it to develop Section 8."

This is the only bit i don't quite understand. Isn't a company allowed to profit on a project? If they were paid $7.5 million to develop the game, and through ingenuity and/or time travel they were somehow able to fulfil their contractual obligations by only spending seven dollars and thirty-nine cents, pocketing the difference as profit, isn't that ... you know ... okay?

Walter Verburg
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I think the problem was that they were contractually obligated to put all of that into development, which would have profited the personally(Salaries). I would assume that they were also due some cut of the revenue of the game, which is where the company itself might have built up capital.
That said, I am by no means an expert on that topic.

Thomas Happ
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I agree . . . also if they used the rest as bonuses and perks, doesn't that serve to retain better employees and thus make a better game?

Although from what I've heard, Timegate is not so nice to its employees, so this might not be what they did.

Will Lewis
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Walter is pretty spot on with his analysis. Timegate was contractually obligated to put it all into development. There was likely some amount built into the $7.5 million to pay for salary expense in development, but the arbitrator must have seen evidence that Timegate did not use all of the money for the exclusive development of Section 8. However, the profit from the deal was supposed to come from sales royalties.

Typically, with video game publication agreements, the agreement says that all of the development funding from the publisher must be spent on development of the game that is the subject of the agreement. In practice, however, the developer often uses less than the full amount on developing the contracted game and uses the remainder of the funds to begin developing their next title. This is still wrong and a violation of the contract, absent some exception. Timegate could have presented evidence to the arbitrator that this is customary practice in the industry; if Timegate did present such evidence, then the arbitrator was not persuaded by the evidence, or the arbitrator decided that it was an integrated contract (this essentially means that the contract contains all of the terms of the agreement and there are no implied terms) and the contract was not designed to abide by any custom.

Damian Connolly
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"Therefore, it looks like Timegate spent approximately $1.6 million in attorneys fees in exchange for saving $2.5 million in costs and paying out $750,000 in bonuses during development resulting in a net economic benefit of about $1.65 million. Not bad."

? Timegate had to pay out $7.3m + lawyers fees - how does that equal a net economic benefit? Perhaps I'm not understanding something

Christopher Wright
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$7.3 million is the court's estimate of how much Gamecock would have gotten from the deal if Timegate had followed contract. That isn't all the profits from the contract violations. Compared to following contract, they paid an additional $1.6 million in lawyer fees, but they avoided paying $2.5 million out of pocket and also misappropriated $750,000 that they didn't have to pay back.

The wording in the article was not so clear, I grant.

Will Lewis
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Damian, I totally understand where you're coming from. I hope that I can make this a little more clear.

The arbitrator punished Timegate for bad behavior by forcing it to pay for Southpeak's $830k in attorney's fees. It likely paid $800k on its attorneys.

The arbitrator did not punish Timegate by making it pay $7.3 million in damages to Southpeak. Instead, the arbitrator was attempting to give each party what it should have expected to receive if Timegate had followed the terms of the agreement.

I don't know what all of the terms of the agreement were, but, for the sake of simplicity, let's assume that there were no development costs and Southpeak and Timegate agreed to split the net profit 50:50. Let's assume that the net profit on the PS3 port and sequel was $14.6 million. Therefore, under the agreement, Southpeak and Timegate should have each received $7.3 million from the sales of the PS3 port and the sequel. However, Timegate kept the entire $14.6 million, and Southpeak received nothing. To make the parties whole, the arbitrator ordered that Timegate must pay Southpeak what it should have earned under the agreement which is $7.3 million.

This type of recovery is called "expectation damages" because it is what the parties expected to receive under the contract. Therefore: Timegate pocketed about $750k in cash from development and saved $2.5 million of its own money in development costs; the $7.3 million it paid to Southpeak was money that should have gone to Southpeak if the agreement was followed and is therefore a wash economically because Timegate was never entitled to the money; and the lawyer's fees were probably about $1.6 million. Then we're just looking at the original equation of $3.25-$1.6 million = $1.65 million net economic benefit.

There are additional time value of money, interest, and ROI questions here, but they all weigh in favor of Timegate probably coming out even better than $1.65 million.

Please let me know if you have more questions or if I could clear anything up.

Will Lewis
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Christopher, Fair point :p I should have given a clearer explanation of the damages earlier in the article.

Anytime you have a question, please ask. Unasked questions or misunderstood advice (or, ahem, unclear writing) is much, much worse than being afraid to ask.

West Short
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I was counsel for the publisher in this case, and wanted to clarify that the "damages" portion of the award ($7.349 million) was not an "expectancy" or "benefit of the bargain" recovery of what the publisher expected to get out of the deal - these were the hard costs incurred by the publisher in reliance upon TimeGate's promises in the contract, so these were actually what are called "out of pocket" damages. In other words, when TimeGate pays these damages to the publisher, the publisher will have only been repaid its out of pocket expenses, and will have made no profit on the game. Also, the arbitrator didn't "punish" TimeGate by ordering it to pay the publisher's attorney's fees - the contract itself specified that in the event of a dispute the prevailing party recovered its attorney's fees. So, had TimeGate prevailed, it would have recovered its attorney's fees from the publisher.

Although I agree with you that developers should realistically assess who is at fault for a game's poor performance before launching a lawsuit against the publisher, I don't think blame was the primary motivator behind this case. In my opinion, TimeGate saw that the game was not going to make a profit, and decided to try to use litigation to try to break its ties with the publisher so that it could publish the PS3 version of the game, a sequel, and add-on products, and keep the profits from those ventures itself. Litigation as a business tool can be effective if timed and handled properly.

In this regard, you are probably right about the financial benefits of TimeGate's litigation strategy in the short run -- particularly once you factor in the benefits that TimeGate may have received from self-publishing the PS3 version of the game, the sequel to the game (Prejudice), and other add-on products. In the long run, however, paying a judgment of this size could prove a far more expensive endeavor for TimeGate than honoring its agreements with the publisher.

Will Lewis
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Thank you for the clarification, Mr. Short. I stand by my analysis based on the Circuit Court's opinion, but there are always a lot of details, material and not, that aren't covered in an opinion. I read this as the expectations damages because of how the court interpreted the contract and its use of the vague term "cash loss suffered to date" and the undefined term "milestone payments."

I think that we could get into a semantic argument about blame as far as the attorney's fees go, but my goal with the comment I made was to simplify why the fees were awarded. In the end, fees were awarded because one party was wrong.

Congratulations on the win! And, again, thank you for filling us all in on the details.


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