I have always viewed the video game development contract to be a little like a pre-nuptial agreement.
There certainly are major aspects of game dev terms and conditions that would never be found in a boy-weds-girl deal; but both are negotiated and signed when there is love in the air, expectations run high for great happiness and success, and the hardball positions taken by each side in the course of negotiating may be the first signs of chill in what has been a blissful but tempestuous courtship (or seduction!) leading to a walk down the aisle.
Like the basic pre-nup, it is the sincerest hope and expectation of both sides that once signed, the game dev contract can be tossed in the drawer and never referenced again (well, at least until royalty checks start to arrive).
However, not every marriage lasts, and not every game development contract leads to a hit—or even a completed project. At those times, the parties need to reexamine their earlier agreements and the rights of each party that may flow accordingly.
In the early pre-historic days of video games, as in 20 years or so ago, a game could be designed and programmed by one to three people in six to eight months at a cost of five or low six figures. Developers and publishers traveled in the same circles, game publishers were making money hand-over-fist in an as-yet “undiscovered” industry, and publishers were still primarily privately held businesses. In such an environment, the risk of investing in development was low. When the game did not materialize in the form or time frame contemplated in the deal, the parties could rationalize and commiserate, share a drink, try to learn from the experience, and move on.
These days, with the capital cost of competing in the games business going through the roof, budgets for anticipated “AAA” franchise Xbox 360 and PlayStation 3 games equaling those for independent feature films, development requiring teams of upwards of 60 people working 18 months or longer on a single title, profits harder to come by in an increasingly competitive market, and game publishers primarily public companies (traded in Japan, Europe, or the United States) with the public markets’ demands for profits and growth, it can be more difficult for a publisher to simply walk away when its developer expectations are not realized.
Just as a pre-nup contains the terms of a settlement in the event the marriage doesn’t work, every game development contract contains termination language for when results do not equal expectations. Termination clauses are hotly negotiated because of financial baggage they carry. For the developer, a favorable termination clause can provide a critical nest egg while it transitions out of an abruptly cancelled project to find new work.
Because of the competitive nature of game development, and the careful screening process of publishers, it is not unusual to take six months or longer, and a substantial investment in demos and preliminary design work, for a developer to find a new project. This dry period has the potential to drain a developer of its cash reserves, or even put the developer out of business.
For the publisher, paying a large settlement for a cancelled project is throwing good money after bad. Settlements paid to developers when games are cancelled directly impact the publisher’s bottom line.
Publishers, as the financing entities of video games, typically issue the development contracts and control the drafting process. So it should not be unexpected to see first draft termination language that is far from generous. The “first draft” terms publishers offer are often far more onerous than those in other segments of the entertainment industry. For instance, unlike the movie business, it is an extreme rarity to find “pay or play” language in a game deal. It becomes the job of developer’s counsel to improve the offer on the table. To do so requires an understanding of the standard termination language alternatives that may be available.
Here’s a publisher-friendly, but not atypical, termination clause taken from a hypothetical development contract. The clause includes six sections, each of which is set forth below, followed by analysis and commentary to assist in understanding the issues at play.
Section 1: Developer’s Right to Terminate
BREACH AND TERMINATION
XX.1 In the event of a material breach of this Agreement by Publisher, Developer may terminate this Agreement by giving sixty (60) days prior written notice. Notwithstanding the foregoing, this Agreement will not terminate at the end of the notice period if Publisher has cured, or taken reasonable steps to cure, the breach about which it has been notified. Developer agrees that its sole remedy for failure by Publisher or its licensees to cure, or attempt to cure, any breach hereof, shall be a legal claim for damages, and Developer hereby waives all rights to seek injunctive and other forms of equitable relief.
Any analysis of a developer’s right to terminate as a result of game publisher’s material breach must start with consideration of the material obligations of the publisher that may be subject to breach. It is generally accepted that a “material breach” is any breach that goes to the heart of the agreement, or that is identified by the parties as being “material.”
The publisher’s obligations that may be breached are limited by the terms of the contract. Publisher’s representations and warranties in the first drafts of these deals are generally limited to publisher having the right and power to enter into the agreement, and to perform its obligations under the deal. These obligations may be as few as providing the intellectual property assets required if the game is based on a licensed character or property; reviewing and approving (or rejecting) developer’s milestone submissions in its sole, unfettered, and subjective discretion; and paying for development milestones as and when they are approved. Once the game is completed, the publisher may be required to account and pay royalties as and when earned, and to provide audit rights as negotiated by the parties.
Default of any of these may or may not rise to the level of material breach. And if a default is not material, Developer’s remedy is limited to an action for damages without the right to terminate the agreement. If I am developer’s counsel, I want the agreement to provide that publisher’s obligations to timely review milestones, give feedback and approvals, and make payment of all amounts owed to developer are material obligations of publisher.
Termination for material breach frequently provides for a cure period before this extreme remedy can be invoked. Section XX.1, above, as it applies to the game publisher, provides for an unusually generous sixty days in which to commence or attempt (but not complete) the cure. Compare that to the cure period provided below for developer default. From the developer’s perspective, a shorter and more definite cure period for publisher material breach is desirable.
Section XX.1 of our pro forma Termination section also provides that developer waives its right to seek injunctive and other forms of equitable relief in connection with any breach by publisher. Readers will recognize this language is common in motion picture industry agreements. It serves as a sort of “insurance policy” to protect the producer from the risk of having distribution or exhibition of the finished project disrupted as a result of a dispute.
While we are sympathetic with the need for producers and game publishers to protect their investments, it is inappropriate for developers to waive their right to seek equitable relief in all circumstances. For example, I have represented a client who completed a game that was accepted by the game publisher and submitted to the hardware manufacturer for approval prior to manufacturing (this is the final step in the process to publish a game for the Nintendo, Sony, or Microsoft game console systems). My client was owed a substantial final payment. Despite repeated invoicing and requests, payment was not forthcoming.
Having waived the right to seek injunctive relief that could stop release of the game, as well as other forms of equitable relief, such as specific performance that could compel the final payment, our only alternative was to threaten litigation in the California Superior Court. Given the backlog, even if an action were to be commenced, it could delay recovery for an extended period of time—perhaps longer than the sales life of the game! Had the client been able to threaten and pursue injunctive relief, the pressure on the publisher may have led to quicker payment.
Another situation in which waiver of the right to pursue equitable remedies puts the game developer at a severe disadvantage may be when limited rights to developer proprietary tools and technology are granted to a publisher in connection with assignment of ownership of the underlying game.
If the publisher were to use these tools and technology in a manner that goes beyond the limited rights granted by the developer—for example, if the publisher were to incorporate the technology without consent into a sequel (a subsequent game using the same underlying property, game world, and/or characters) or a port (a version of the game designed to operate on a different hardware platform than developer’s version)—developer’s best remedy could be to enjoin release of the infringing sequel or port. Without such a right, developer’s only remedy may be to sue for damages. And it may be extremely difficult to quantify developer’s damages with any certainty in connection with such unauthorized expropriation.
Section 2: Publisher’s Right to Terminate
XX.2 In addition to Publisher's other termination rights hereunder, Publisher may upon written notice to Developer terminate this Agreement as a result of a material breach of this Agreement by Developer, provided that Developer may cure such breach in fifteen (15) days from the date said notice is given except for termination by Publisher for material breach in connection with timely delivery of Work Product, in which case termination shall be deemed effective immediately. A material breach may include, but is not limited to, Developer's failure to finish the Game, Developer's ceasing to do business, Developer's failure to have the Work Product approved by Publisher, and/or Developer's failure to finish the Game on time or on budget as per the Milestone schedule. In the event of such termination, Publisher shall have no obligation to pay Developer any additional installments of the Fee, and Publisher shall be entitled to be paid back or to recover any and all payments made to Developer hereunder.
Publisher’s termination rights differ markedly from developer’s. Developer’s cure period is limited to fifteen days rather than sixty, and developer has no right to commence but not complete a cure within that period. There is also a material breach by developer for which there is no cure period; failure of the developer to timely deliver Work Product subjects the developer to immediate termination, presumably with notice but without the opportunity to remedy. The disparity in the publisher’s termination rights is particularly disadvantageous to the developer because the factors constituting breach include elements outside of the developer’s control.
The heart of every game development contract is an exchange of developer’s services and work product for the compensation provided by publisher. Game development is undertaken in increments, called “milestones,” in which pre-determined work product content must be completed on or before designated calendar dates. Each milestone is then objectively compared by the publisher against: (i) the pre-agreed requirements for the applicable milestone and (ii) the publisher’s own subjective standards for quality. If a milestone is found to meet these objective requirements and subjective standards, it is approved and the resulting payment is processed. If it fails, even on publisher’s subjective grounds, it can be rejected and developer must take all steps to remedy the failure to the publisher’s satisfaction.
Game development requires close cooperation and support from many parties. The developer may rely on its publisher to provide certain elements of game content, hardware support, timely review, feedback, approval of milestones, and prompt payment of amounts due. If the game is based on licensed intellectual property, one or more third parties may reserve the right to review and approve material prepared by developer. For example, in a sports game based on a professional league, approvals may be required by the league, the players union, and by the sports celebrity or personality whose name and likeness appears on the package. If the game is being prepared to operate on a Nintendo, Microsoft, or Sony hardware system, it will require the review and approval of the applicable hardware manufacturer. All of the above may be out of the control of developer.
Delay in providing any of these materials or approvals (or payments!) can lead to delay in development of the game. Rejection of materials prepared and submitted in good faith by the developer can upset the development calendar set forth in the milestone schedule. And the publisher’s business or operating considerations that are external to the development effort have been known to delay approval and payment of invoices that provide necessary cash flow to the developer.
But Section XX.2, as submitted, provides for immediate termination without any cure period in the event of any delay in timely delivery of milestones, without regard to the cause of such delay. Section XX.2 goes on to call out certain developer defaults that will be deemed to rise to the level of material breach.
The most significant issue to consider in describing a default as a material breach is that it escalates the potential remedy from an action for damages, and continuation of the agreement, to termination of the agreement.
There may be defaults that truly “go to the heart of the agreement” and that can give rise to treatment as material breach. For example, as provided in XX.2, developer's failure to finish the Game, and developer's permanent ceasing to do business, may well rise to the level of material breach. However, XX.2 also identifies as material breach developer's failure to have the Work Product approved by publisher (a circumstance controlled in its entirety by the subjective determination of publisher) and/or developer's failure to finish the Game on time or on budget as per the Milestone schedule, whether or not the fault of developer. Finally, XX.2 provides that failure of developer to deliver any milestone on time, even if it is one hour late, is a material breach which developer will have no opportunity to cure! It is difficult to accept, absent the language provided in XX.2, that such individual “garden variety” defaults would rise to the level of material breach. They certainly do not appear to “go to the heart of the contract.”
And publisher has a remedy for breach: its action for damages. In a contract action for breach of any of these “garden variety” provisions, if they were not called out as material in the agreement, publisher could be hard pressed to prove any actual damages when, for example, a milestone is one day or one week, or absent special circumstances, even one or more months late.
The final sentence of XX.2 provides a special remedy for publisher in the event the agreement is terminated as a result of material breach by developer. Given the economics of game development, which is a highly cash flow intensive and low profit margin business, being required to refund all amounts previously paid by publisher can amount to a prescription for bankruptcy for a developer. The money paid by publisher has been paid out in salaries, overhead, and equipment utilized by developer to meet its development obligations. Gross profit margins in the game development business are extremely low to non-existent.
If the defaults described in Section XX.2 were to be treated as simple breaches, and not material breach, publisher’s remedy would be to seek contract damages. But any such action would permit developer to present its own evidence disputing liability. Treating defaults as material and providing for the extreme remedy of full reimbursement makes it tactically advantageous for the publisher to claim material breach. And as we will see below, there are other reasons why the availability of a broad category of material defaults may be advantageous to the publisher if and when it makes a strategic business decision to stop development of the game.
Section 3: Publisher’s Right to “Terminate for Convenience”
XX.3 In addition to Publisher's other termination rights hereunder, Publisher may terminate this Agreement, or any platform under this Agreement, at any time prior to the Final Delivery Date, without cause, by providing Developer with written notice of such termination. In the event of such termination, Publisher shall have no obligation to pay Developer any additional installments of the Advance; provided, however, if Publisher has given written approval of a Milestone as set forth herein, then Publisher shall honor its payment obligations as per that Milestone. Further, in the event of such termination and in the event Publisher elects to have a third party complete the Game or Publisher completes the Game, Publisher shall have no obligation to pay Developer any additional or further amounts hereunder.
“Termination for Convenience” is a contract term and concept unique to the videogame industry. This permits a publisher, upon notice, to stop development of any game at any time under any circumstances; for example, if market conditions change, if the publisher decides to reallocate resources, if an executive change results in reappraisal of the project or work completed to date, or for any objective or subjective reason or for no reason at all.
For the developer, a termination for convenience can be unsettling, disruptive, and highly damaging. In performing its obligations under the development agreement, the developer has hired or retained staff, invested in equipment and technology, made commitments for facilities, assigned a material part of its work force to the project on an exclusive basis, refused other work or stopped pitching/soliciting for projects, and agreed contractually to the “key man” requirements provided in the development agreement so that its top people are exclusively on board for the project. Some development contracts provide that the developer will work exclusively for the publisher (and forsake all others!) during the duration of game development. Exercising the publisher’s right to terminate for convenience in such a circumstance can jeopardize the continuation of the developer as a going concern.
Motion picture producers certainly enjoy the right to not produce, or to shut down a production if they are not satisfied with the way it is coming together. However, contracts for talent are often signed on a “pay or play” basis. Under such terms, the talent is paid the full fee whether or not it has provided services.
There is no “pay or play” concept in a typical videogame development deal. Termination for convenience provides for no compensation unless it is negotiated; and this can be among the most contentious issues in making these deals. Note that the pro-forma language in XX.3 above provides for minimal payment upon termination for convenience.
In considering how to handle the contract issue of publisher payments associated with termination for convenience, the developer needs to understand its cash flow and the realities of being left without a publisher after it has geared up to undertake the project.
At a minimum, the developer should insist that it be paid for all milestones delivered up to the point of publisher’s notice (this is compensation for work performed), for all work performed in connection with the milestone then under development but not delivered (again, for work performed), the incremental and unavoidable costs of overhead incurred as a result of gearing up for the now-cancelled project (for example, equipment leases, additional office space that is now redundant, commissions to headhunters), plus an incremental payment to cover some period of overhead expenses while the company shuts down the terminated project and goes through its business development process to locate other work.
While not strictly a termination issue, the developer must also look at its staffing levels to decide whether layoffs are required.
A further issue has been raised by the pro-forma language. Once the publisher exercises its right to terminate for convenience, if it should decide to complete development of the game without the developer, there would be no further payment obligation, including royalties that could be earned, to the developer.
As provided in XX.3, the right to terminate for convenience can be exercised up until the Final Delivery Date of the game. Publisher may determine it would be economically advantageous to terminate the developer for convenience at a very late stage in order to get out from under a final payment and royalty obligation. Without the termination for convenience language, there may be a greater likelihood that such an action would be found to be acting in bad faith. A publisher who has its own financial pressures and considerations may regard late termination for convenience as an attractive alternative to paying the developer.
A final consideration when looking at termination for convenience is the risk that a publisher may attempt to wrap what is really termination for convenience into a termination for cause. This forces a re-examination of what constitutes developer’s material breach.
Financial stakes may be high for a publisher. It may have determined it no longer wants the game for any number of subjective reasons. But in considering the cost of termination for convenience, where it will be required to make some sort of negotiated contractual payment (throwing “good money after bad” for a game that is cancelled), the publisher may look long and hard at developer’s performance, its own subjective review of milestones, and try to find an instance that may rise to the level of material breach.
Using our pro-forma language above in Section XX.2, if developer were one day late or over budget in delivering any milestone, or if developer failed to have Work Product approved by publisher, such defaults may rise to the level of material breach and permit publisher to terminate the agreement with no cure period and no further payment obligation to developer. Taken to its farthest extreme, rather than making the required termination for convenience payment to developer, publisher’s termination could be accompanied by a demand for refund of all amounts paid to developer to date. In effect, the publisher has taken advantage of favorable material breach language to mask what is really a termination for convenience.
Section 3.1: “Turn Around”
XX.3.1 In the event of termination under Section XX.3 and in the event Developer elects to complete the Game with or without a third party publisher and/or with or without different licensed content, Developer shall reimburse Publisher any and all of the amount paid to Developer up to the date of termination. In the event Developer completes the Game with a third party publisher, then reimbursement shall be made by Developer within thirty (30) days of commencement of such agreement with the third party publisher. Alternatively, if Developer completes the Game without a third party publisher, then Developer shall reimburse Publisher by paying Royalties to Publisher at a rate of 25% of Net Sales until all amounts paid up to the date of termination has been fully recouped.
Section XX3.1 brings the concept of “turn around” as used in the motion picture business, to videogames. Once the publisher decides it no longer wants the game and has stopped development, developer, who is at least as invested in the project as publisher, can have the opportunity to find it a new home.
The terms under which publisher is reimbursed for its investment in the game are highly negotiable. For so long as it is sitting on publisher’s shelf, the game is just a sunk cost. There is no one better or more qualified than developer to complete the game. And there is no one more passionate than developer as an evangelist to promote the game to another publisher. Once a substitute publisher is identified, the terms under which the original publisher can recover all or a portion of its investment can be worked out. In this case, all but the most stubborn publisher recognize that “half a loaf is better than none.”
Section 4: Publisher Termination After Completion
XX.4 In addition to Publisher's other termination rights hereunder, after approval of the final Work Product by Publisher, Licensor(s), and any Third Parties, Publisher may terminate this Agreement at any time for a breach of any of the representations, warranties, obligations, or indemnifications made, or agreed to, by Developer herein, or any material breach of this Agreement.
Be careful about language that permits publisher to terminate a development agreement in the event of any post-completion default, unless the survival clause provides that publisher’s obligation to make all payments, account, pay royalties, and permit audits survives termination of the agreement.
Developer should never be put in a position where it has performed, delivered a game that has been released and is on store shelves, and risks being cut off from contractually-mandated compensation because of a purported post delivery default.
Without this language, the publisher already has a remedy in the event of such default --- the action for damages. Nothing further should be required.
Section 5: Termination for Bankruptcy or Financial Failure
XX.5 In addition to Publisher’s other termination rights hereunder, if a receiver, administrator, administrative receiver or manager shall be appointed or any distress or execution or other process shall be levied on or enforced (and not being discharged within 30 days) over the whole or any part of Developer's assets, or if Developer offers to make or makes any arrangement with or for the benefit of its creditors, or commits an act of bankruptcy, or if any petition to consider a resolution for the making of an administration order or to wind up or dissolve Developer shall be passed or presented, or if Developer ceases or threatens to cease to carry on business, or is unable to pay its debts as they fall due, or suffers any analogous proceedings under foreign law, then Publisher shall have the right to immediately terminate this Agreement upon written notice to Developer. If this Agreement is terminated pursuant to this Section XX.5, neither this Agreement nor any right or interest herein shall be deemed an asset in any insolvency, receivership, or bankruptcy arrangement proceedings, and neither Developer, its receivers, representatives, trustees, agents, administrators, successors and/or assigns shall have any right to sell, exploit or in any way deal in any of the Game or Work Product. In the event this Agreement is terminated by Publisher hereunder, any and all Work Product created by Developer hereunder shall be immediately delivered to Publisher.
XX.5 provides for publisher’s right of termination in the event of the standard financial failures of developer. Some consideration should be given to how to handle similar circumstances on the part of publisher.
Particularly when dealing with a smaller “tier two” or “tier three” company, developer may want to reserve its rights to terminate and to retain (or reacquire) ownership of Work Product in the event its publisher suffers an analogous financial setback.
Rumors of financial upheavals and consolidation are a fact of life in the games industry. Rights in the event of adverse financial circumstances should go both ways.
The second half of the pro-forma section reserves rights in the event of bankruptcy. This is very common language in game development agreements. However, we’ll leave it to the bankruptcy experts as to whether it is enforceable. Institution of bankruptcy proceedings by or against either party to a game development transaction alters the landscape in a way that goes beyond the scope of this material.
Game developers’ counsel has come to appreciate that termination provisions, like all contract language in game development deals, are driven by the generally commanding bargaining position enjoyed by game publishers. This is not unlike our hypothetical pre-nup, that can be driven by the side with the greatest assets. But by careful negotiation and an understanding of the issues, developers’ counsel can take steps to give his or her client a more even-handed agreement into which the parties may enter their relationship.
Once this contracting hurdle is passed, developer and publisher may focus on superior game development—the purpose of making the deal—and work together hand-in-hand to make sure they can “live happily ever after!”
[1] See, e.g., Richard A. Lord, 14 Williston on Contracts § 43:6 (4th ed. 1990).
[2] See, e.g., Restatement (Second) of Contracts § 242 (1981).
[3] See generally Alan J. Haus, Negotiating Ownership of Video Game Engines and Tools, Los Angeles Lawyer, May 2005, at 18 (discussing assigning ownership of software tools in game development contracts).
[4] See, e.g., Restatement (Second) of Contracts § 242 (1981).
[5] See generally Spark Unlimited, Inc. v. Activision Publ’g, Inc., No. BC 338918 (L.A. Super. Ct. Mar. 29, 2007) (development contract termination litigation).