Perpetual License Grant Award Did Not Exceed Arbitrator's Remedial Powers: Fifth Circuit

Practical Law Legal Update 1-525-7184 (Approx. 4 pages)

Perpetual License Grant Award Did Not Exceed Arbitrator's Remedial Powers: Fifth Circuit

by PLC Intellectual Property & Technology

Key Litigated Issue

The key litigated issue before the US Court of Appeals for the Fifth Circuit was whether an arbitrator's modification of a video game publishing agreement to award a video game publisher a perpetual license to a video game should be vacated because it exceeded the arbitrator's powers by utterly contorting the "essence" of the contract, that is the evident purpose of the agreement and the parties' intent.

Background

This dispute arose out of a 2007 video game publishing agreement entered into by appellee Timegate Studios, Inc., a video game developer, and defendant-appellant Gone Off Deep, L.L.C., d/b/a as Gamecock Media Group, a video game publisher (Gamecock). Under the agreement, Timegate was to develop and Gamecock was to publish a new video game titled "Section 8." The agreement included:

An exclusive license for Gamecock to reproduce, manufacture, package, advertise, publish, market, sell to end-users, wholesalers, and retailers, distribute and display Section 8 and related add-ons. However, this license was of a limited duration and included only right of first refusal to one sequel of the game, rather than a broad right to create derivative works.
A non-exclusive license to use trademarks relating to the game solely for packaging, advertising and promotion of the game and any add-ons or sequels.

In 2009, after Section 8 was released, the parties' relationship deteriorated. Timegate sued Gamecock and both parties alleged multiple claims against each other. Based on Gamecock's demand, the district court stayed the suits pending arbitration. In the arbitration, Timegate sought recovery for breach of contract, quantum meruit and copyright infringement. Gamecock sought recovery for breach of contract and fraud.

After an evidentiary hearing, the arbitrator issued his Final Award, Findings of Fact, and Conclusions of Law, where he rejected Timegate's claims and ruled in favor of Gamecock's counterclaims for breach of contract and fraud. Finding that Timegate had actively engaged in a variety of fraudulent misrepresentations and contractual breaches, the arbitrator awarded Gamecock $7 million dollars and amended the agreement to:

Give Gamecock a perpetual license to Timegate's intellectual property in Section 8.
Give each party the right to unilaterally create derivative Section 8 merchandise and property.
Dissolve the parties' obligation to report, share and distribute revenues from Section 8 in order for each party to pursue commercial activities relating to the game independently.

After Gamecock moved the US District Court for the Southern District of Texas to confirm the arbitration award, Timegate asked the court to vacate the award because the arbitrator exceeded his authority. The district court vacated the entire award on the grounds that the grant of a perpetual license was not a remedy rationally rooted in the contract. Gamecock appealed this decision to the Fifth Circuit.

Outcome

In its April 9, 2013 opinion, the Fifth Circuit reversed the district court's vacatur and remanded to the district court with instructions to reinstate the arbitrator’s award, finding that the perpetual license did not exceed the arbitrator's power and was a rational remedy furthering the essence of the publishing agreement.

The Fifth Circuit stated that under the Federal Arbitration Act a district court may vacate an arbitration award if the arbitrator has exceeded his powers. Further, the court explained an arbitration award will be sustained if the arbitrator's decision draws its essence from the contract. The Fifth Circuit then explained that it applies a highly deferential standard of review to whether an arbitrator has exceeded his powers and would only vacate an award if the arbitrator utterly contorted the evident purpose and intent of the parties.

The "Essence" of the Contract

Evaluating the essence of the publishing agreement, the court summarized the agreement as one intended to create a mutually beneficial business relationship. The parties were to work jointly to create, market and popularize a video game whose success would yield financial benefits to both parties. The court stated that the arbitrator's perpetual license furthered these general aims, because it attempted to restore to each party the fundamental goals of the agreement.

The court concluded that the arbitrator could have reasonably found that only by severing the parties' obligations to work with each other could the essence of the agreement be fulfilled. The court noted that the parties' relationship could not be expected to be healed, primarily due to Timegate's fraud against Gamecock. Therefore, the only way to give Gamecock the opportunity to benefit from the future development of variations of Section 8 was to allow Gamecock to operate independently.

Arbitral Remedy May Conflict With Specific Agreement Provisions

The Fifth Circuit rejected Timegate's argument that the awarding of a perpetual license remedy could not further the agreement's essence because it conflicted with specific provisions in the agreement. The court found the arbitrator could fashion an award which conflicted with agreement's provisions because:

If the "essence" of such a complex contract rested on every provision in the contract, an arbitrator could not possibly fashion a remedy.
Under Texas law, a finding of fraudulent inducement can provide an arbitrator with a basis for voiding provisions of a contract.
Under Fifth Circuit precedent, an arbitrator can implicitly void contractual provisions in a fraudulently induced contract merely by ordering an award which partially conflicts with the contract.
The cases that Timegate cited did not stand for the proposition that an arbitration award can never alter a provision of the underlying contract.

California Supreme Court decision

To support its decision, the Fifth Circuit also discussed the only case it identified with similar facts, Advanced Micro Devices, Inc. v. Intel Corp., 885 P.2d 994 (Cal. 1994). In that case, two computer-chip manufacturers, AMD and Intel, had entered into a joint development and manufacturing agreement. The manufacturers entered arbitration after one party became aware of the other's detrimental unilateral development and outsourcing activities. The arbitrator awarded AMD monetary damages and a permanent, non-exclusive and royalty-free license to any Intel intellectual property embodied in the relevant chip.

The California Supreme Court considered whether the arbitrator had exceeded his powers, applying a similarly deferential standard of review. The California Supreme Court concluded that the permanent license remedy was rationally drawn from the arbitrator’s conception of the contract's subject matter and the effects on AMD of Intel’s breach.

Practical Implications

The Fifth Circuit's decision demonstrates the potentially broad scope of an arbitrator's authority and that, where this authority is clearly established, courts may not second guess arbitrator awards that represent rational attempts to maintain an agreement's essence.

Parties negotiating license agreements should carefully consider whether arbitration is a desirable forum for all conflicts arising under their agreement. In this case, the arbitration clause was quite broad and contained no limits relevant to the parties' dispute. In contrast, parties may find it appropriate to limit the bounds of an arbitrator's authority and seek to more clearly embody within their agreement the parties' rights and obligations in the event of a dispute.

Perpetual License Grant Award Did Not Exceed Arbitrator's Remedial Powers: Fifth Circuit | Practical Law