Since Monday’s coverage, highly placed sources inside both 38 Studios and Big Huge Games have come forward with clarifications and new information in the ongoing story of 38 Studios’ demise. A previously fuzzy picture of an unbelievably swift collapse has come into sharper focus as a tale of two studios: one a group of hardy survivors, the other doomed by its own ambition.

After the jump, the best of times, the worst of times

First the good news. The Verge reports Epic, the folks behind Gears Of War and the Unreal engine, are forming a new studio in Baltimore based on hiring a number of core people laid off from Big Huge Games. In a touching letter to his employees, Epic President Dr. Michael Capps says, “The way we see it, there’s been a big storm in Baltimore, and we’re taking in a few of the refugees — as are the awesome folks at Zynga East, ZeniMax Online, and other southeastern studios”. It’s not clear how many employees from Big Huge are signing on, but Epic’s stated goal is keeping as many key team members together as possible.

The bad news — and it is very bad news — hit yesterday. Rhode Island Police Colonel Steven O’Donnell announced the beginning of investigation of 38 Studios in conjunction with the US Attorney’s office, the Rhode Island Attorney General, and most ominously, the FBI.

Later that day, 38 Studios filed papers to declare Chapter 7 bankruptcy protection. The studio’s assets will be liquidated to pay off creditors — or in this case “creditor”. The state of Rhode Island, as a secured creditor owed on the order of $115 million, will likely sponge up most if not all monies received from the sale and disbursement of 38 Studios’ assets. The bankruptcy filing lists approximately $22m in assets, but it is unclear if that includes a valuation of the Amalur intellectual property, which analyst Michael Pachter estimates at $20 million.

In further developments, we’ve been approached by inside sources who take issue with some elements of the story so far. The Providence Journal’s reports that founder Curt Schilling says “38 Studios hasn’t seen any money from Reckoning’s sales, nor did it expect to: that money was committed to EA, which had paid 38 Studios an up-front publishing fee of $35 million”. According to highly placed sources familiar with that deal, this is incorrect. The publishing deal with Electronic Arts was actually $20 million paid up front, with a royalty rate in the range of 25-30% on sales (one source at Big Huge says that was a higher percentage than the studio earned from Microsoft for Rise Of Nations). 38 Studios also received an additional $5 million from Electronic Arts for the development of two DLC releases. This suggests that Reckoning may have provided a revenue stream for 38 Studios over the past few months, although it is unclear whether the studio had received any of those payments, or if there was a sales threshold to meet before royalties would be paid. Outstanding profit share payments might make up part of the assets of the now bankrupt company.

Highly placed sources with first-hand knowledge furthermore confirm indications long before 2012 that all was not well with 38 Studios. In July of 2010, barely a month after EA and 38 Studios dubbed “Project Mercury” as Kingdoms Of Amalur: Reckoning, the top-ranking staff at Big Huge Games left the company under circumstances that don’t seem voluntary. In August of 2010, founder and general manager Tim Train, founder and technical director Jason Coleman, founder and art director Dave Inscore, director of development Kerry Wilkinson, and executive producer Ike Ellis were relieved of duties after they had expressed deep concerns over what they felt were highly unrealistic sales projections for Reckoning and Project Copernicus. The group apparently questioned the company’s survivability if those projections were the backbone of 38 Studio’s financial model.

Those overly optimistic sales projections may also be at the heart of comments from Rhode Island Governor Lincoln Chafee that Reckoning was an “abject failure“. If Chafee was working from 38 Studios’ internal sales projections — which could have been as high as 3 million copies of Reckoning sold at launch — the rather respectable 1 million that it actually sold could indeed be interpreted as a “failure” by someone unfamiliar with normal returns for a new videogame IP launch.

Meanwhile, the details of the investigation by state police, the Rhode Island Attorney General, and the FBI are still unclear, but we do have some clues. What should be obvious is that the investigators are engaged in a full audit of 38 Studios to determine where the money went and how the studio managed a monthly $4 million “burn rate”. Another more troubling aspect of the investigation centers around millions of dollars of film tax credits that 38 Studios may have traded on.

In January of 2012, a Providence lawyer named Michael Corso — apparently a close friend of Rhode Island’s House Speaker Gordon Cox and the man who helped broker the deal to get 38 Studios together with the Rhode Island Economic Development Corporation — secured $8.5 million from Bank RI as a bridge loan to help keep 38 Studios solvent. That loan was secured based upon $14 million in film tax credits that 38 Studios had applied for. According to 38 Studios president Bill Thomas, the company had been given “initial certification” for the tax credits. 38 Studios also had agreements to sell parts of those tax credits to other business entities in Rhode Island. The investigation might focus on whether the approval for those tax credits was as cut-and-dried as 38 Studios indicated to Bank RI and the entities that purchased them.

The application eligibility and process for those tax credits contain two potentially troubling items. Various news stories suggest 38 Studios was actually ineligible for the tax credits. The explicit legal requirement is that a company was incorporated in Rhode Island. 38 Studios was incorporated in Delaware, and while there were apparently discussions to re-incorporate in Rhode Island, there are no filings that this was ever pursued. Furthermore, the rules as listed indicate the actual receipt of the tax credits is payable “upon completion” of production, which in this case would presumably be the launch of Project Copernicus. It is still unclear whether 38 Studios assumed the “initial certification” was in any way binding, or given by a person with authority to speak to that “certification”. It’s also unclear in what way it was represented to the bank and interested purchase parties, and if that representation can be legally construed as fraud. But whatever the case, in April 30 negotiations regarding approval for the tax credits, 38 Studios asked Rhode Island to waive the company’s Delaware incorporation and the pay-upon-completion requirement. Given the resignations of Rhode Island Economic Development Corporation executive director Keith Stokes and vice-chairwoman Helena Foulkes in the wake of the studio’s collapse, it is reasonable to assume that a political situation favorable to 38 Studio’s requests had changed dramatically when the company missed a May 1st payment to the state.

In discussing the investigation, O’Donnell cites the $75 million in state money that Rhode Island’s Economic Development Corporation offered 38 Studios, of which $49.5 million was received. Rhode Island taxpayers have precious little to show for this investment. Just a week before laying off all staff, 38 Studios released a video “fly through” of the Project Copernicus game world. While the video is quite pretty, there is a noticeable lack of inhabitants: no player characters, no NPC’s, and no monsters are present. Yet that video and some concept art are the sum total of what taxpayers have seen for all their money.

Sources familiar with Project Copernicus have painted varying pictures of the state of development at the time of 38 Studios shutting down. Developers and artists at the company headquarters in Providence suggest that the game was on track for a June 2013 release. Sources at the subsidiary studio, Big Huge Games in Baltimore, question its progress. Those sources tell us that it wasn’t until March 2012 that the studio made an internal decision to switch from a subscription MMO to a free-to-play model, which would push the release well past any chance of its initially targeted September 2012 window. They also describe a game limited in content beyond the starting area and with nondescript gameplay.

In fact, in various conversations with current and former employees at Big Huge Games/”Epic Baltimore”, a schism between the Maryland studio who developed Reckoning and the Providence studio working on Copernicus is apparent. A frequent refrain is that there was much doubt at Big Huge Games that those running 38 Studios had any realization of what was involved in finishing Copernicus and bringing the game to market.

In the final analysis, it seems that the teams at Big Huge Games were the tail that wagged the 38 Studios dog. Acquired for a nominal fee from THQ back in 2009, Big Huge Games delivered Kingdoms of Amalur: Recoking and potential DLC as some hope of revenue for the rest of the company during its final months. That they will continue on as a studio under Epic is one of the few pieces of good news in a story that continues to develop.

Chris Hornbostel is a freelance technical writer and occasional restaurant consultant. He posts on the Quarter To Three forums with the terrible user name ‘triggercut’ and blogs occasionally on music, baseball, and whatever else he feels like at Popnarcotic. He can be reached at [email protected]