Curt Schilling's 38 Studios sued by Rhode Island over $75 million loan guarantee

The state of Rhode Island is suing Curt Schilling's bankrupt game development studio over the $75 million loan guarantee provided by the state, Gov. Lincoln Chafee said in a public statement. The 96-page complaint against the defunct game developer and its advisors alleges fraud, negligence and civil conspiracy over the state-backed funding of 38 Studios' relocation to Rhode Island and the development of MMO Copernicus.

Kingdoms of Amalur: Reckoning developer 38 Studios, founded by Schilling in 2006, shut down in May after failing to make loan payments and employee payroll.

"When it became clear that the company would not survive, I publicly stated my commitment to you that my primary goal would be to do everything within my power to protect the taxpayers of Rhode Island," Gov. Chafee said in a prepared statement aimed at Rhode Islanders. "I will work to minimize any loss of your hard-earned taxpayer dollars."

Chafee says the state of Rhode Island enlisted the help of attorney Max Wistow to investigate the state's position and 38 Studios' financial situation.

"In executive session of the Economic Development Corporation Board, we received an extensive briefing from Mr. Wistow on his findings," Chafee said. "In that meeting, the Board voted without opposition to authorize legal action."

Rhode Island has published the complaint against 38 Studios online, claiming that "38 Studios failed because of risks that had not been disclosed to the EDC Board, but were or should have been known by" 38 Studios and named defendants including Curt Schilling, 38 Studios CEO Jennifer MacLean, CFO Richard Wester and director of 38 Studios' board Thomas Zaccagnino.

The state backed a $75 million loan guarantee in 2010 designed to bring 38 Studios and 450 jobs to Rhode Island.

Rhode Island's complaint alleges that "even with the loan from the EDC, 38 Studios was undercapitalized by many millions of dollars and would not have nearly enough money to relocate to Rhode Island and complete Copernicus, and that, as a result of this cash shortfall, 38 Studios was likely to run out of money in 2012."

The complaint against 38 Studios claims that the Rhode Island EDC was misled by the advisors of the game company, which did not disclose certain risks, including that Wells Fargo was earning "nearly $500,000 in hidden commissions" from 38 Studios while the bank "owed fiduciary duties to the EDC Board to disclose all negative material information concerning 38 Studios' business plan and financial projections.

"Wells Fargo secured its hidden commissions by concealing these facts from the EDC Board, notwithstanding that the undisclosed information showed that the loan was not in the interests of the EDC and probably would never be paid back," reads the complaint.

The claim of intentional misconduct is fueled by allegations that the advisors and the company tricked the EDC Board into breaking a series of state laws either by providing false information about the company, confusing the board or bullying them.

According to the suit, the idea for the move was first floated by Curt Schilling to then-Gov. Donald Carcieri during a chance encounter at a fundraiser at Schilling's home in Massachusetts. Schilling told the governor that 38 Studios was interested in relocating to Rhode Island in exchange for economic incentives.

Within a few days, Carcieri contacted the executive director of the EDC and legal counsel Robert Stolzman and asked them to use the EDC to "accomplish the relocation." Stolzman, in turn, told EDC deputy director J. Michael Saul and other EDC management. Later that month, the staff of the EDC began looking into methods to provide financing. Early on in those discussions, Schilling and others with 38 Studios said they needed $75 million to do the move.

But the state had to hold some money back from the loan guarantee to set aside funds in case the company failed to make a payment, according to the suit.

The suit argues that since the company was set to receive far less than the $75 million it said it needed to complete the move and finish Copernicus, the defendants should have known that the state-backed loan was a bad idea. The projections for the cost of the game shipping from a new Rhode Island office also failed to factor in the estimated $10 million cost of the actual move, according to the suit.

Once the deal was done, the actual money 38 Studios received was over $27 million less than it would have needed to complete the game and pay for its move, according to the suit.

The suit also alleges that the company's own projections, once the move and the lessened proceeds were factored in, showed that 38 Studios would be out of money by 2012.

Despite this and grave initial concerns raised by the EDC's own financial analyst, who said he didn't think he could support the loan guarantee before being removed from the analysis of the company, Saul pushed the approval forward, according to the suit.

None of the analysts' concerns were presented by Saul to the board, according to the report. Instead Saul told the board that the worst-case projection still had the company paying the state back. The suit also alleges that Saul deliberately kept important information from the board.

The suit goes on to assert that Saul told Stolzman and former EDC director Keith Stokes that Wells Fargo understood that they "[needed] to convince the EDC board that 38 Studios' business model and projections are what will sell the bond."

Gov. Chafee and then-Rhode Island state treasurer Frank Caprio — who originally supported the 38 Studios deal — asked the board to reconsider the loan guarantee. Prompted by this pressure, according to the suit, Stokes sent an email to the members of the board telling them they were legally obligated to move forward on the loan, although they weren't.

The 96-page filing goes on to paint a picture of an EDC board increasingly misled and lied to by the people it looked toward for advice in helping make its decision.

All told, the complaint alleges 17 counts against the defendants, including breach of fiduciary duty, fraud, fraudulent misrepresentations and omissions, negligent misrepresentation, legal malpractice, negligence, breach of implied covenant of good faith and fair dealing, damages under Rhode Island general laws for violating general laws, civil damages, unjust enrichment, civil conspiracy and violation of the state's RICO statute.

"The complaint on its own contains a great deal of important and illuminating information on how this deal unfolded," Chafee said in his statement to taxpayers today.

"Litigation is often long and tedious," Chafee added. "The filing of this complaint is only the beginning."

38 Studios' financial turmoil was made public in May when the developer of Kingdoms of Amalur: Reckoning and online role-playing game Project Copernicus failed to make a loan payment to the state of Rhode Island and failed to make payroll. Shortly thereafter, 38 Studios laid off its entire staff and filed for bankruptcy protection.

Brian Crecente contributed to this report.