The Reckoning of 38 Studios

The United States video game industry has been left shaken after financially embattled developer 38 Studios declared bankruptcy on June 7. The studio experienced a very public downfall over the past month with Rhode Island government officials and studio executives working around the clock in a desperate attempt to keep the company solvent. Now, the state of Rhode Island’s one million taxpayers are left to repay up to $112.5 million of the loan that the bankrupt developer secured back in 2010. The studio had been working on its own massively multiplayer online roleplaying game, Project Copernicus. Analysts were critical of the investment since its inception, questioning the chance of success in a heavily occupied MMORPG market. Now their fears outlaid two years have become a reality and developers, publishers, and government officials are facing the long-term repercussions of this disaster.

Former Major League Baseball player Curt Shilling founded 38 Studios in 2006 with the long-term goal of releasing a MMORPG – codenamed Project Copernicus - that would go toe-to-toe with Blizzard heavyweight, World of Warcraft. In 2009, they acquired developer Big Huge Games from California-based video game publisher THQ as part of a move to acquire their propriety game engine and assets, which will be integrated in the development of 38’s Copernicus IP. Big Huge Games would thus begin transforming their current game under development into what is now known as Kingdoms of Amalur: Reckoning, released in February to widespread critical praise. The company moved from Maynard, Massachusetts to Providence, Rhode Island in 2010 as part of a funding partnership with the State of Rhode Island. The partnership helped 38 Studios secure funds to the sum of $75 million in taxpayer-backed bonds. In exchange, the company was to create 450 new jobs within the area.

The deal spurred a great deal of controversy. The requirements of 38 Studios were enormous. A video game development company with 450 full-time employees was a massive undertaking and few companies have such large development teams, let alone a company that has not even released a title. Also, $75 million may be considered more than sufficient for a regular video game, but MMORPG development requires costs upwards of $100 million - BioWare’s MMORPG Star Wars: The Old Republic is purported to have minimum development cost of $200 million. If these figures were to be an industry standard, 38 Studios would have been out of funds well before completion.

Even more perplexing were the consequences of failing to perform. If, by the end of 2012, 38 Studios did not reach their employment quota, they would be penalised $7,500 per year for each of the 450 jobs that they did not create. This meant that it was in fact cheaper to not hire the full quota of employees than hire and have to pay wages, insurance, and other entitlements. They also put their IP up as collateral against the company, which had not been publicly showcased yet. 38 studios was an unproven developer, and they were being handed $75 million dollars to make a game that would be entering into the riskiest genre of the video game industry.

The first sign of the incoming storm arrived when 38 Studios failed to make a $1.125 million loan repayment on May 1, effectively defaulting on their loan. Once these details became public, Rhode Island officials held an emergency meeting with 38 Studios on May 16 to determine the company’s solvency and develop a plan to mitigate any potential damage that it would eventually cause. The officials were caught off-guard when Shilling abruptly asked for more money. Not knowing what to do, the officials were frozen in indecision. No vote was cast as to what should be done so the question of where this $1.125 million was to come from, was still hanging precariously over everyone’s heads. A day later, a cheque for the required sum was hand-delivered to the Rhode Island Economic Development Corporation.

The cheque bounced.

Eventually, enough funds were procured to clear the cheque at the expense of that week’s payroll. To make matters worse, it was discovered that employees had not been paid since May 1 and their health care was going to end at midnight on May 24. Come May 24, the entire 379 staff members of both 38 Studios and Big Huge Games received this internal memo:

“The Company is experiencing an economic downturn. To avoid further losses and possibility of retrenchment, the Company has decided that a companywide lay off is absolutely necessary. These layoffs are non-voluntary and non-disciplinary. This is your official notice of lay off, effective today, Thursday, May 24th, 2012.”

Everyone was laid off. Some were hit with more bad news when it was discovered that their houses the company was supposed to sell on their behalf as part of the company relocation in 2010 had not been sold and were now stuck with a second mortgage. It was all but certain at this point that the $50 million that 38 Studios received so far in funding was going to be irrecoverable. The government was unwilling to provide any additional financial support and interest from private investors had dried up. Rhode Island was set to acquire the Amalur IP and any other games they might have had in development at the time, the collateral used to secure the funds in the first place.

Industry Analysts valued the IP at approximately $20 million. However, with a now-displaced team, a decline in interest for MMORPGs in the west and the poor performance of major franchise, subscription-based MMOs such as Star Wars: The Old Republic andDC: Universe Online, few parties would be willing to pony up large sums of cash for the rights to Amalur and its attached technology. Even the moderate success of Big Huge Games’ debut title Kingdoms of Amalur: Reckoning could not offset any of the incoming damage. The game sold 1.2 million units in its first 90 days of sales. For a new IP, this is considered to be a success within the industry. Unfortunately for the companies involved, Rhode Island Governor Lincoln Chafee claimed that it needed to sell over 3 million copies just to break even.

“The game failed” – Lincoln Chafee to press conference attendees.

On the morning of June 7, 38 Studios declared Chapter 7 bankruptcy, leading to an investigation by the attorney general’s office, the US Attorney’s office and the FBI into how the company handled its finances. Discussions with potential investors and buyers for 38 Studios’ assets began immediately and continuing as this article is being written. Reports from the Rhode Island EDC say that figures discussed are in the tens of millions. Time will tell however, and the state cannot expect a great return on the assets sold. In 2009, Midway Games Inc. filed for bankruptcy and Warner Bros. swept up most of the company’s assets, including the Mortal Kombat IP, for the modest sum of $33 million. Rhode Island officials will have to fight tooth and nail for every cent.

It is too early to tell what the exact repercussions for the wider video game development community are, but it is certain that the bitter taste of the 38 Studios collapse will linger for a long time to come, especially since both parties feel like they have been wronged by each other. 38 Studios accused the Rhode Island Government of turning their back on them in a time of need and sabotaging talks with investors by continually speaking with pessimism and a lack of confidence. Rhode Island Governor Lincoln Chafee responded by reiterating that his obligation was to the state and would not misrepresent the direness of the situation.

Current developers and publishers working to garner tax incentives and breaks from states will be met with the same statements citing concerns that what happened in Rhode Island could very well happen again. While the industry is expected to see revenue of $68.4 billion in 2012, the specifics of the development process are not common knowledge. It is possible that many officials will be too scared of public backlash if they were to apply any similar schemes in their own state. Unfortunately, politicians may not recognise the difference between the well-established, coordinated companies and studios like 38.

As the State of Rhode Island is left to pick up the tab, 397 ex-employees are looking for new jobs, two government officials have resigned, and one man leaves behind a shattered dream. Within the hard drives of Big Huge Games lies pre-production data onReckoning 2, waiting to be bought in the eventual fire sale for a negligible sum. The video game community has been incredibly supportive of those laid off in this tumultuous affair. A Google Docs folder has been created with companies that are currently hiring, sharing it over twitter with the hash tag #38jobs. Neighbouring developers have picked up numerous displaced workers. Epic Games announced that they were creating a new studio in Baltimore, Maryland, made up of members of Big Huge Games. The suffering and fallout is nowhere near being over, but hopefully more instances like Epic’s generosity will help those affected get back on their feet as soon as possible.

Sometimes big, huge problems need epic solutions.