On April 9, the U.S. Court of Appeals for the 5th 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 Agreement. 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 5th Circuit’s recent order reversed the district court and ordered it to reinstate the arbitrator’s award. The 5th 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 5th Circuit observed that the Development Agreement’s arbitration clause was “quite broad” and contained no relevant limitations. Moreover, the 5th Circuit felt that the arbitrator’s grant of a perpetual license furthered the general aims of the Development Agreement. Specifically, the 5th 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.”

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 form documents do not always serve all of the parties well without significant revisions. Additionally, parties to a development agreement should strongly consider whether or not to include an arbitration provision. If arbitration is being included, it is equally important to craft clear language in determining the proposed extent of an arbitrator’s authority. 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 development agreements is a must.