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.
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 email@example.com.