"Famous Last Words"

Duck and Cover (July 2003)

Dear Jim,

Every time I see an article about the games industry, it talks about how big the business has become, and how much money is being spent on games.

But I know that BAM and 3DO, and maybe other publishers, have had serious financial problems that have left developers unpaid for milestones and games they have worked on. 3DO has even gone into chapter 11 bankruptcy!

How can we protect ourselves from being hung out to dry by our publisher?

Scared Developer

Dear Scared:

BAM and 3DO have left a path of developers unpaid and severely crippled, or in some cases perhaps, even out of business.

While overall the business keeps growing, that growth is more and more focused in fewer and fewer companies. That’s a trend that could lead to further financial difficulty for certain publishers. Publisher’s financial difficulty invariably ripples across to the developers who have created their games.

Developers can be proactive in protecting their positions.

It starts before a contract is signed.

Every publisher has a credit manager who evaluates the financial stability of every customer to whom the publisher ships games. Developers must make their own objective credit evaluations of publishers. This leads to the fundamental questions: “Should we be doing business with X?” Or, “How much business should we be doing with X as an overall percentage of our portfolio?”

If the publisher is a public company, check the most recent SEC filings (available on FreeEDGAR). Read the notes that are part of the filings. Review the financial statements. Does the publisher have sufficient cash reserves? Are its receivables too large; or, are a large proportion overdue (past 60-90 days)? This may indicate it is having difficulty getting paid by its customers.

How do its accounts payable look? What percentage of its cash on hand is represented in accounts payable? This could indicate a liquidity problem. Maybe the publisher is not paying its bills in order to conserve cash. Remember that the only problem for which a company cannot recover is to run out of money.

If your publisher is a private company, ask your friends and colleages. Contact developers who are doing work for them. What are their own experiences? Do they get paid? On time? Do they have concerns about the stability of the company? My experience is that developers are generally willing to share this information.

Once you have signed that contract, keep following your publisher’s financial statements. Know where you stand.

When you negotiate your contract, pay particular attention to the review, approval, and payment dates for each milestone. Make sure you proactively work to get those approvals (in writing if necessary) and that milestone invoices are promptly submitted.

If you are not paid on time, don’t let it slide. Make an issue of it. It is a big deal. Be persistent; know who makes the decisions; who approves the checks.

Each contract provides for certain occurrences that are known as “material breach.” For example, failure to deliver code on time may be called out as a material breach.

When an occurrence is a material breach, after a short “cure period,” the non-breaching party may be able to terminate the agreement.

A good contract strategy is to provide that non-payment when due constitutes a material breach on the part of the publisher. This, coupled with negotiated language that preserves ownership of all code until the final payment is made, can give the developer a strong tool to encourage payment on time by the publisher.

Publishers will strongly resist all of the above in contract negotiations. Typical publisher forms of agreement provide that nearly all affirmative obligations fall to the developer; publishers generally do not want to be required to meet performance dates.

Finally, when planning milestones and milestone payments, make sure that every milestone covers your development costs and includes some profit. Signing back-loaded contracts puts developers at significant risk of financial loss; not only if the publisher finds itself in financial difficulty, but also if the project is cancelled for any reason.

Because game development is a very low margin business, developers are particularly at risk when their publishers do not pay (or pay late).

But if developers implement strategies such as those discussed above, these risks may be reduced.

(***Note -- All of the above deals with ways a developer can begin to protect itself during the development process. However, if a publisher goes into bankruptcy, none of these strategies will result in continuation of royalty payments for sales of games under previous development agreements. That’s a much more complicated issue best left to your individual attorney.)