"Famous Last Words"

Risk is the Hinge of Any Deal (February 2008)

Dear Jim:

If you were to analyze any deal and try to get to the single unifying principal, where would you end up?

In a Philosophical Mood

Dear Philo:

Once we get beyond negotiation of milestone schedules, payment terms, approval conditions, ownership of IP elements, and all the other issues that make game development deals contentious, it becomes increasingly apparent that the courtship and mating dance we call contract negotiation is all about risk allocation.

Development costs of a first-class game for two or more console systems regularly run into the $15-$20 million range. Development can take two years requiring a staff of over 100 people!

When a publisher signs up a developer, it is putting cash on the line. If the game is completed, if it is wonderful, if it is accepted by the public, if Jupiter aligns with Mars, the opportunity is there for massive profit (witness the generally reported opening week for Halo 3 of $300 million!).

But if any one of a long line of things fall apart, that game dev deal can be a financial sinkhole for the publisher.

And potential loses are not limited to the investment in development. Claims of IP infringement in the patent, copyright, trademark, and trade secret areas, the specter of “hot coffee” claims, and lurking litigators who view our industry as a treasure trove of potential damages awards, all create the risk that development agreements parcel out among the parties.

Negotiating who has that risk, and how it is balanced in the deal, is a critical part of any contract agreement.

Let's look at a few examples for illustration:

1. Many agreements provide that late delivery of milestones is material breach. A material breach results in a greater range of remedies for the non-breaching party (see Contract Walk-Through article) up to and including termination. Some agreements provide that if there is termination for material breach, all development advances or fees are refundable. Of course, we fight that in our negotiations. But even if the agreement does not provide for refund, a wounded or vengeful publisher can always sue for its damages arising from the default. Those damages may include all amounts paid to the developer up to the time of termination.
2. Development agreements routinely require the developer to represent (promise) that the game does not infringe upon any IP or personal rights of any third party. At their broadest, representations like this shift all responsibility for claims arising out of content of the game to developer. But is developer the source of all content? Are there elements provided by third parties (licensors, middleware providers, even the publisher)? Can the developer truly know whether there may be infringements under foreign laws in distant parts of the world where the game may be sold? A cautious developer should limit any IP and personal rights reps to portions of the game written by developer, and further try to limit them to infringements under U.S. law. I also caution developers about making any patent reps whatsoever (as the recent industry-wide American Video Graphics patent suit showed). Many publishers will accept a rep that no US patents known to developer will be infringed.
3. Reps grouped in the IP section frequently go further than IP issues. Whenever you see developer being asked to represent that the game does not infringe the rights of privacy or publicity of any third party, or that the game is not “slanderous, defamatory, obscene, pornographic, lewd, indecent, or blasphemous,” we are heading into territory far removed from IP. Such reps are a further example of attempts to shift liability for content to developer. Presuming that these can not be removed altogether (as I believe they should -- after all, the publisher frequently specifies, oversees, and has absolute approval rights over all aspects of game content!), it is extremely important to try and limit these reps to U.S. law. All of these concepts of illegality differ country to country. Standards of defamation, for example, differ significantly even between the United States and Britain . Suits for libel arising out of books published in both countries are known to have been brought in England rather than the United States because the standards make it more likely that a plaintiff can recover. Standards for what constitutes lewd or indecent depictions of characters differ widely around the world. Blasphemy is not illegal in the United States , but may result in death sentences elsewhere. And rights of publicity (the right to control the use of one's name and likeness for commercial purposes – even after one's death) differ, even among the 50 states!

As a general rule, developers should try to limit their liability to game assets produced and provided by developer. The standard for determining whether developer has defaulted in its reps (promises) should be U.S. law. Anything that is provided by a third party, or included in the game because it is specified and required by publisher, should be outside the area of risk for developer. If publisher decides to market its game outside the U.S., it should take the risk for compliance with local laws.

Each agreement has an indemnification clause in which developer agrees to hold publisher and various affiliated publisher entities harmless if any reps (promises) of developer are challenged by a third party. Publisher should also indemnify developer for any similar type third party claims arising from licensor material, material provided by publisher, or other non-developer material that is required for use in the game. Publisher should also indemnify developer against claims arising from marketing, sale, and distribution of the game – functions that are totally beyond the control of developer.