Fifth Circuit Reinstates Arbitral Award in Video Game Dispute

The United States Fifth Circuit Court of Appeals has reversed a district court’s order vacating an arbitral award in a dispute between a video game publisher and developer.  In Timegate Studios, Inc. v. Southpeak Interactive, L.L.C., No. 12-20256 (5th Cir. Apr. 9, 2013), a video game developer, Timegate Studios, Inc. (“Timegate”), entered into an agreement with a video game publisher, Gamecock Media Group (“Gamecock”) to create a high quality, futuristic military game named “Section 8.”  As part of the contract, Timegate was obligated to meet certain development milestones while Gamecock provided the bulk of the investment funding.  The parties’ agreement contained an arbitration provision.

Under the terms of the parties’ agreement, Gamecock had the exclusive right to license, manufacture, market, and distribute the video game product.  The company was also provided with a limited but exclusive right to market and sell any game add-ons or sequels.  In addition, the agreement granted Gamecock an eight-year worldwide license following the initial release and a five-year worldwide license following the release of any sequels.  Finally, the parties’ contract stated Timegate was the exclusive owner of the game’s intellectual property (“IP”) and provided Gamecock with a right to use the IP only in connection with reasonable game publishing, marketing, and distribution efforts.

By the time the game was released, Gamecock was acquired by Southpeak Interactive, L.L.C. (“Southpeak”).  After the video game failed to sell according to the parties’ expectations, the relationship between the two companies reportedly began to deteriorate.  As a result, Timegate filed a lawsuit against Gamecock alleging breach of contract.  Southpeak responded by filing a motion to compel the dispute to arbitration.

An arbitrator found that Timegate materially breached the parties’ agreement and issued a final award in favor of Gamecock.  In addition to awarding Gamecock more than $7 million, the arbitrator provided Gamecock with a perpetual, royalty-free license to the IP related to the video game.  In effect, the arbitral award provided both parties with the right to create and distribute derivative video game merchandise and other items independently and without paying one another royalties.

After Gamecock filed a motion to confirm the arbitral award in district court, Timegate argued the arbitrator exceeded his authority in crafting the perpetual license portion of the award.  The district court ruled in favor of Timegate and vacated the entire award.  Gamecock then filed an appeal with the Fifth Circuit.

Initially, the appellate court addressed the appropriate standard of review and stated the arbitrator’s award must be sustained so long as his decision “draws its essence” from the parties’ agreement.  Next, the court examined Gamecock’s argument that the arbitrator’s award of a perpetual license was permissible and was a rational means of furthering the parties’ intent when the contract was formed.

The Appeals Court held,

We conclude that the arbitrator could have reasonably found that only by severing the parties’ obligations to work with each other to develop, publish, and sell Section 8 could each party achieve the object of the Agreement: access to the financial benefits of their agreed-upon contributions. In fact, one provision in the contract actually provides that in the event of certain (inapplicable) breaches of the Agreement by Timegate, Timegate “shall deliver to [Gamecock] all Work Product and other materials requested or required by [Gamecock] . . . including, but not limited to, the Intellectual Property.” Indeed, when questioned at oral argument, Timegate’s counsel could offer no alternative remedy to permanently and fairly compensate Gamecock for Timegate’s contractual breaches, given the findings of the arbitrator. This supports our conclusion that the Award was permissible exercise of the arbitrator’s creative remedial powers.

After that, the Fifth Circuit dismissed Timegate’s argument that the contract was construed too broadly by stating,

…we conclude 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.

Because the court found a perpetual license was a remedy that furthered the essence of the parties’ contract, the Fifth Circuit Court of Appeals reversed the lower court’s order and remanded the case with instructions to reinstate the arbitrator’s award.