Design your Dispute Resolution Mechanisms Before the Relationship Turns Sour

This is a success story where the relationship of the contributors has turned sour”. These are the words which introduce a judgment rendered on 7 January 2013 by judge Woo of the Hong Kong Court of First Instance (Emagist Entertainment Ltd v Nether Games (Hong Kong) Ltd. HCA 1659/2012, DHCJ Woo, 7th January 2013).

The story took place in Hong Kong,  the “port of the perfumes” (香港) now flourishing in the field of information technology with strong support from local authorities. Under this background, some startups have a great success. Emagist Entertainment Company Ltd. (here and after, “Emagist”) is one of them.

Emagist is a young company run by talented people. It is mainly composed of three directors (A, F and E) and three creators (B, C and D). All together, they were involved in conceiving, creating and developing an online game called “Ninja Saga”. This game is remarkably successful on Facebook and Emagist began to generate significant profits. However, an internal dispute caused troubles in the company, to such a point that four members of the team (B, C, D and E) took advantage of the absence of A i) to create a new company under the name of “Nether Games (Hong Kong) Ltd.” (hereinafter, “Nether”) and ii) to take control of all the data needed to manage the game. It is reported, in the decision, that Emagist and A blamed the two other directors and the three creators for having moved the servers, modified passwords and transferred the databases, the source codes and the graphic files. In a nutshell: all the data needed to manage the game were not under the control of Emagist anymore.

It is in this poisonous atmosphere that the plaintiffs sued Nether Games, B C, D, E and F on various grounds, including infringement of copyright, breach of employment contracts and breach of confidentiality. In the meantime, the plaintiffs made an application for an interlocutory mandatory injunction for delivery of all the data needed to run the game. In other words, the plaintiffs sought injunctions from the court for the purposes of restoring the status quo ante bellum. Emagist relied on section 14(1)(a) of the Copyright Ordinance, which provides that “[w]here a literary, dramatic, musical or artistic work, or a film, is made by an employee in the course of his employment, the employer is the first owner of any copyright in the work subject to any agreement to be contrary”.

The three creators (B, C and D) raised the counterargument claiming ownership of the copyrights attached to the game. They argued that i) they were not employees but consultants; ii) they were owners of the copyright; iii) they licensed the copyright to Emagist; iv) they finished this license by taking control of the data needed to manage the game.

One of the main questions before the judge was as follows: what was the nature of the legal relationship between Emagist and the three creators? Were they self-employed, employees, or shareholders? It is clear from the decision that Emagist had a strong position on this point. The documents provided by Emagist convinced the judge that there were effective employment contracts between the company and the three creators. In any event, it is clear that it is not appropriate to terminate a license agreement by acting in such an offhand manner. Finally, judge Woo granted the injunction for delivery of all the data needed to run the game.

In fact, it seems that the dispute arises out of a disagreement as to the distribution of the shares. This is evidenced by the testimony of the parties, under which A promised B, C and D that they would get some shares and a portion of profits generated from the game. Such situations often occur in the startups. This is particularly unfortunate because, in such circumstances, an interesting and profitable project can quickly fall through. This deplorable outcome can be avoided by using the appropriate legal tools.

In the present case, it might have been useful for the parties to move toward mediation. When properly conducted, mediation can produce excellent results. Mediation is regarded as a preferred dispute resolution mechanism in Hong Kong. It benefits from a modern legislative framework and a strong institutional support: the Judiciary implemented a practice direction (Practice Direction No. 31) at the very beginning of 2010 and the Mediation Ordinance passed on 22nd June 2012 came into effect on the 1st January 2013 (Cap. 620).

Startups can find significant advantages in mediation. First, the parties may resort to mediation before the outbreak of the dispute. Nip the problem in the bud, the sooner the better! Second, the resolution of the dispute occurs faster and is less expensive than litigation before the state courts. It must be added that one of the most important advantages is the confidentiality of all the mediation communications. Confidentiality is essential for startups to preserve their business secrets and protect their reputation. Hong Kong companies can rely on Section 8 of the Mediation Ordinance, which provides that a mediation communication shall not be disclosed, and Section 2(1) defines a mediation communication as “anything said or done, any document prepared or any information provided for the purpose of or in the course of mediation, but does not include an agreement to mediate or a mediated settlement agreement”.

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