Here are 9 takeaways from today’s 38 Studios lawsuit rulingAugust 28th, 2013 at 5:26 pm by Ted Nesi under Nesi's Notes, On the Main Site
R.I. Superior Court Judge Michael Silverstein handed down a 98-page ruling in the 38 Studios lawsuit on Tuesday, with the headline being that he will allow Rhode Island to move forward with much of its case against 14 individuals and firms involved in crafting the $75-million deal back in 2010.
The full decision from Silverstein is available on WPRI.com [pdf], but for those who don’t want to read all 98 pages, here are some of the key points that emerge from a close reading of the document.
1) This is a complicated legal matter. Obvious, but worth highlighting. The lawsuit has 14 defendants and 16 different counts, with many of the arguments “intertwined,” as the judge put it. Lawyers for the parties filed 1,500 pages of documents and had two days of oral arguments before Judge Silverstein over this motion to dismiss. Much of his 98-page decision Wednesday is taken up with extensive reviews of the arcane provisions of the law and case history around fraud, negligence, standing and other issues. And the actual trial is still at least months away.
2) The EDC can’t sue for $75 million – but it can sue for $90 million. Some of the initial reporting today seemed to reflect confusion about what Judge Silverstein actually decided. On the one hand, the judge dismissed the EDC’s argument that it lost $75 million on the 38 Studios deal – because the lost money was actually the bondholders’, not the EDC’s. But the judge will allow the EDC to try to recoup whatever money the General Assembly has to pony up to make good on the bond payments – an amount expected to total roughly $90 million through 2020. It’s a legal distinction between different pots of money, but effectively Rhode Island is still going after the deal’s architects to get as much of the $90 million as it can. (He also said the state can try to win damages for “injury to its reputation and credit” and for “payments of salaries and fees to the defendants.”)
3) 38 Studios always needed all $75 million, not the $49.5 million it got. From a business perspective, 38 Studios went bankrupt because it was under-capitalized: the company didn’t have enough money to stay solvent long enough to finish developing its big game, Project Copernicus. In their initial discussions with Rhode Island leaders, 38 Studios executives made clear they needed $75 million cash to move to Rhode Island and finish the game – but in an apparent effort to show caution with taxpayer-backed funds, the state structured the deal so 38 Studios would only receive $49.5 million initially, with the rest set aside to pay the debt. That left a gap of $25.5 million between what 38 Studios said it needed and what Rhode Island actually provided. Arguably, the state gave 38 Studios just enough money to fail spectacularly.
4) The officials doing the deal knew about the $25.5 million funding gap. Some of the most damning allegations in the EDC complaint against the 38 Studios defendants, including Wells Fargo, is the suggestion that they actively withheld key information about 38 Studios’ funding needs from the EDC board of directors. (See page 6-10 of today’s decision for the evidence.) There were apparently even discussions about doing a “gross up” to bring the size of the deal to $85 million, so 38 Studios could get $75 million. But details about the funding gap were papered over – and in some cases actively removed from documents – and there’s no evidence, so far, that anyone ever leveled with the EDC board that $49.5 million wasn’t going to be enough.
5) Dissenting voices were stifled – or changed their tunes. Sean Esten, the EDC’s financial portfolio manager, has been one of the few Rhode Island officials to come out of the 38 Studios deal looking good. As he now famously wrote in an internal May 28, 2010, email: “To be honest, I have more information on the typical $10k micro loan than I have on a $75 million request.” After that, according to the judge’s ruling, EDC Deputy Director J. Micahel Saul told Esten “not to prepare an internal credit memorandum and excluded the analyst from further analysis of the loan. … Other contents of Saul’s presentation to the EDC Board conflcit with [Esten's] list of risks.” And it wasn’t just Saul, apparently. The ruling says Strategy Analytics, a firm hired to vet the deal, urged the EDC not to go forward with the 38 Studios deal during a June 2 conference call – then, eight days later, “issued a written report that, at least in part, contradicted its June 2, 2010 opinions.”
6) “I was just following orders” may not work as a defense for Keith Stokes or Mike Saul. One of the lingering layman’s questions about the EDC-38 Studios lawsuit is whether Stokes, the former EDC chief, and Saul can be sued by their former employer for carrying out the clear wishes of its own chairman, former Gov. Don Carcieri, who had ordered them to make the 38 Studios deal happen. But the judge said such a “public duty” defense – the idea that they shouldn’t be sued for carrying out their government duties – doesn’t work when the entity suing them is the government itself. The same applies to the law firms and other advisers. The judge writes: “If a person engages in deceptive action with the agent of a corporation and thereby harms the principal corporation, why should that person be able to shield itself from liability? The victimized entity should be able to seek recovery against all who deceived it.” This is why so much of the suit hinges on distinguishing between what EDC officials and advisers knew, and what they actually told (or hid from) the EDC board.
7) Wells Fargo says it didn’t need to be totally upfront with the EDC. Wells Fargo, one of the two banks that sold the 38 Studios bonds, doesn’t come off too well in the judge’s ruling. The bank apparently never told Rhode Island officials it was going to receive $473,512 from 38 Studios separately from the proceeds from the bond transaction because of an earlier relationship they had. The judge also rejected Wells Fargo’s argument that it didn’t owe a fiduciary duty to the EDC. Its partner in selling the bonds, Barclays, isn’t held to the same standard by Silverstein because Barclays didn’t know as much about 38 Studios and wasn’t the lead bank.
8) The motion to dismiss isn’t a sign Rhode Island will win the lawsuit. It’s easy to read the judge’s decision Wednesday and end up feeling like Rhode Island has a slam-dunk case against the 38 Studios defendants. But it’s important to remember that this was a motion to dismiss, which requires the judge to read the original complaint “in the light most favorable to the plaintiff” – basically, to always give the most weight to the state’s strongest arguments. The defendants’ lawyers will argue vigorously that even if the EDC did have enough reason to bring this lawsuit, they don’t have the goods to actually win the suit and win damages.
9) Judge Silverstein is fun to read. Whether he’s describing one argument as the point where “the law firms and the banks throw their executive co-defendants under the bus” or describing a “smorgasbord” of points made by one side, the veteran Superior Court jurist knows how to throw a wink or two into a serious and weighty decision.
Tags: 38 studios