Epic Games, Inc. v. Murphy-Johnson

IN THE COURT OF APPEALS OF NORTH CAROLINA

No. COA15-454

Filed: 19 April 2016

Wake County, No. 14 CV 003722

EPIC GAMES, INC., Plaintiff

v.

TIMOTHY F. MURPHY-JOHNSON, Defendant

Appeal by defendant from order entered 18 July 2014 by Judge G. Bryan

Collins, Jr. in Wake County Superior Court. Heard in the Court of Appeals 6 October

2015.

Hunton & Williams, LLP, by R. Dennis Fairbanks, Douglas W. Kenyon, Ryan
G. Rich, and Michael R. Shebelskie, for plaintiff-appellee.

David E. Shives, PLLC, by David E. Shives, and McGowan, Hood & Felder,
LLC, by Chad A. McGowan, William A. McKinnon, and Jordan C. Calloway,
for defendant-appellant.

CALABRIA, Judge.

Timothy F. Murphy-Johnson (“Johnson”) appeals from an order granting Epic

Games, Inc.’s (“Epic Games”) application for judicial relief to enjoin arbitration in

part. We reverse.

I. Background

Defendant, Johnson, is a computer programmer. While attending college in

the United Kingdom, he founded a software company, Artificial Studios, and created

Reality Engine, a successful computer software program that served as a platform for

game developers to construct video games. In March 2005, Timothy Sweeney, the
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Opinion of the Court

founder and largest shareholder of Epic Games, along with Michael Capps, the

company’s president, negotiated with then-twenty-one-year-old Johnson to purchase

Reality Engine and recruited him to move from London to North Carolina to work for

Epic Games. On 10 May 2005, Johnson executed seven contracts that purported to

sell Artificial Studios and Reality Engine and its related intellectual property to Epic

Games, in exchange for employment with Epic Games, company stock options, and

cash.

The seven contracts can be divided into two groups. First, Epic Games bought

Reality Engine from Artificial Studios and then licensed it back to Artificial Studios.

Those agreements were labeled “Reality Engine Acquisition Agreement” and “Reality

Engine Limited License Agreement.” Second, Epic Games hired Johnson and

executed five related contracts. Those agreements were labeled “Stock Option

Agreement,” “Residual Rights Acquisition Agreement,” “Non-Competition

Agreement,” “Confidentiality Obligations and Intellectual Property Rights

Agreement,” and “Employment Agreement.”

The Employment Agreement contained the following arbitration clause:

Any disputes between Employee and Epic in any way
concerning his employment, this Agreement or this
Agreement’s enforcement, including the applicability of
this Paragraph, shall be submitted at the initiative of
either party to mandatory arbitration before a single
arbitrator and conducted pursuant to the rules of the
American Arbitration Association [(“AAA”)] applicable to
the arbitration of employment disputes then in effect, or its

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successor, provided however, that this Paragraph does not
apply to the Confidentiality Obligations and Intellectual
Property Rights Agreement referred to in Paragraph 7, and
attached as Exhibit A. The decision of the arbitrator may
be entered as judgment in any court of the State of North
Carolina.

The Employment Agreement also contained a choice-of-law provision: “This

Agreement shall be governed by the law of the State of North Carolina[.]”

According to the Stock Option Agreement, Johnson’s stock options and bonuses

were to vest over a four-year period. For this reason, according to Johnson, he

requested that Epic Games draft a strict for-cause termination provision in the

Employment Agreement. Johnson wrote Capps:

My lawyer’s been explaining to me that “for cause”
termination is not something I should count on as ensuring
I will be employed, as so long as the determination of cause
rests on Epic you can terminate me and the burden of proof
would be on me, which means I’d have to litigate at a cost
that would be prohibitive. Therefore while he thinks that’s
“fair” for purely employment terms, he said it’s not very
sensible to tie the $75K and stock options related to the
deal to employment in this way if I feel this is part of the
value for selling my company.

My first question is therefore whether you’re prepared to
narrow “for cause” to what we initially agreed, namely that
I’d have to commit some crime or other malicious act or act
of total incompetence, and the burden of proof in “for cause”
termination rests on Epic, not me. . . . .

Epic Games’ Vice President of Business Development, Jay Wilbur, responded:

Our goal is to have you join the Epic family. What you read
in the employment agreement is that [sic] same for all Epic

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employees. I’m willing to consider changes but I need a
little something back for it.

I’ll give you the narrower “for cause” if you give me the
Reality Engine marks, domains, websites, etc. as part of
that assignment.

Johnson agreed. The narrowed “for cause” provision read:

b. Termination For Cause. Employer may terminate
Employee’s employment at any time, with or without
notice, for any one or more of the following reasons: (i)
willful and continual failure to substantially perform his
duties with Employer (other than a failure resulting from
the Employee’s disability) and such failure continues after
written notice to Employee providing a reasonable
description of the basis for the determination that
Employee has failed to perform his duties, (ii) indictment
for a criminal offense other than misdemeanors not
required to be disclosed under the federal securities laws,
(iii) breach of this Agreement in any material respect and
such breach is not susceptible to remedy or cure and has
already materially damaged the [sic] Epic, or is susceptible
to remedy or cure and no such damage has occurred, is not
cured or remedied reasonably promptly after written notice
to Employee providing a reasonable description of the
breach, (iv) Employee’s breach of fiduciary duty to
Employer, material unauthorized use or disclosure of
Employer’s confidential or proprietary information or
competition with Employer; (iv) [sic] Employee's
intentional conduct or omission which reasonably has or is
likely to have the effect of materially harming Employer's
business; (v) conduct that the Employer has reasonably
determined to be dishonest, fraudulent, unlawful or grossly
negligent, and such conduct is not cured or remedied
reasonably promptly after written notice to Employee
providing a reasonable description of the conduct at issue,
any one of which shall be deemed “Cause” for dismissal.
The determination of whether an event, act or omission
constitutes “Cause” hereunder shall rest in the reasonable

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exercise of the Employer’s discretion. . . .

On 20 March 2006, approximately two months before his first round of stock

options and bonuses were scheduled to vest, Epic Games fired Johnson. When

Johnson was “terminated with cause” by Epic Games, he had been employed for less

than one year, from 10 May 2005 until 20 March 2006. The termination letter stated,

in pertinent part:

We regret to inform you that your employment with Epic
Games is terminated with cause effective March 20, 2006
as a result of your repeated performance problems, conduct
issues and attendance concerns, which you have failed to
remedy despite verbal and written warnings. Epic has
determined that these issues at the very least amount to a
material failure to devote your entire professional time,
attention, skill and energies to Epic’s business and the
responsibilities assigned to you by Epic, a willful and
continual failure to substantially perform your duties,
gross negligence, and intentional conduct that is
potentially materially damaging to Epic’s business. Any
one of these supports a “for cause” termination.

On 7 March 2014, Johnson filed a demand for arbitration with the AAA

alleging breach of contract, breach of the covenant of good faith and fair dealing, and

breach of fiduciary duty. Specifically, Johnson alleged that Epic Games breached the

Employment Agreement by wrongfully terminating him; breached the covenant of

good faith and fair dealing under the Employment Agreement and the related

agreements by depriving him of the benefit of the sale of Artificial Studios and Reality

Engine; and breached fiduciary duties owed to him under the Employment

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Agreement, Stock Option Agreement, and related agreements. Johnson sought the

following pertinent forms of relief:

1. [A] declaration that Epic Games, Inc. willfully breached
[the] Employment Agreement;

2. . . . [D]amages for [Epic Games’] breach of at least
$11,300,000, representing the value of stock, bonus, and
other payments due [Johnson] under the Employment
Agreement, or, in the alternative, that [Johnson] be
awarded 1,966 shares of undiluted stock in Epic Games,
Inc. and $4,300,000 in other payments due;

3. . . . [A]ny copyright or other intellectual property
assignment from [Johnson] or Artificial Studios to Epic be
declared null and void;

4. . . . [L]ost profits of Artificial Studios;

5. . . . [P]unitive damages for conduct that reflects fraud,
deceit, or malicious behavior[.]

On 24 March 2014, Epic Games filed a motion, as an application for judicial

relief, to enjoin arbitration in part in Wake County Superior Court, alleging that Epic

Games never consented to arbitrate certain claims asserted by Johnson. Epic Games

also alleged that Johnson did not object for eight years to the termination of his

employment. Johnson denied this allegation in his answer and counterclaim.

On 18 April 2014, Johnson removed the case to the United States District

Court for the Eastern District of North Carolina. On 2 May 2014, after hearing Epic

Games’ application to enjoin arbitration in part, the Honorable G. Bryan Collins, Jr.

of Wake County Superior Court entered an order in favor of Epic Games. (This order

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was later stricken due to lack of jurisdiction.) On 9 July 2014, the federal court

remanded the case to Wake County Superior Court.

On 18 July 2014, the trial court held a de novo hearing on Epic Games’

application for judicial relief and to enjoin arbitration in part. Subsequently, the trial

court granted Epic Games’ application for judicial relief and entered a written order

enjoining arbitration of the following claims:

4.1 The third cause of action for breach of fiduciary duty
alleged in his arbitration demand.

4.2 The claim for stock or its monetary value under the
parties’ former Stock Option Agreement.

4.3 The request for a declaration that any copyright or
other intellectual property assignment [Johnson] gave to
Epic be declared null and void.

4.4 The request for a declaration that any copyright or
other intellectual property assignment Artificial Studios,
Inc. gave to Epic be declared null and void.

4.5 The claim for lost profits of Artificial Studios.

According to the trial court’s order, Johnson could “proceed to arbitrate the

issue whether Epic [Games] breached the Employment Agreement by discharging

him[.]” However, the court permanently enjoined Johnson from arbitrating the

matters identified in paragraphs 4.1 to 4.5. Johnson appeals.

II. Jurisdiction

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The order on appeal permanently stays arbitration of five claims but permits

Johnson’s claim of breach of contract to proceed. Although this order is interlocutory,

[a]ppellate review of an interlocutory order is permitted
under N.C.G.S. § 7A–27(d)(1) when the order affects a
substantial right, and review is permitted under N.C.G.S.
§ 1–277(a) of any order involving a matter of law or legal
inference which affects a substantial right. It is well
established that the right to arbitrate a claim is a
substantial right which may be lost if review is delayed,
and an order denying arbitration is therefore immediately
appealable.

In re W.W. Jarvis & Sons, 194 N.C. App. 799, 802, 671 S.E.2d 534, 536 (2009)

(citations, quotation marks, brackets, and ellipses omitted). Because the order

enjoins certain claims from proceeding to arbitration, a substantial right exists which

may be lost absent immediate appellate review. Id. Therefore, this Court has

jurisdiction.

III. Analysis

A. Governing Law

As an initial matter, it is unclear whether the arbitration clause is governed

by North Carolina’s Revised Uniform Arbitration Act (“RUAA”), the Federal

Arbitration Act (“FAA”), or some other law. Determining whether the FAA applies

“is critical because the FAA preempts conflicting state law[.]” Sillins v. Ness, 164

N.C. App. 755, 757–58, 596 S.E.2d 874, 876 (2004). In this case, although the trial

court’s order referenced provisions of the RUAA as conferring upon it the authority

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to permanently enjoin certain claims asserted by Johnson, the court below made no

determination as to whether state or federal arbitration law governs. “[T]he trial

court should have addressed the issue of choice of law before addressing any other

legal issue.” Bailey v. Ford Motor Co., __ N.C. App. __, __, 780 S.E.2d 920, 924 (2015)

(citation omitted), disc. review denied, __ N.C. __, __ S.E.2d __ (2016). This is because

“ ‘[w]hether a contract evidence[s] a transaction involving
commerce within the meaning of the [FAA] is a question of
fact’ for the trial court[,]” King v. Bryant, 225 N.C. App.
340, 344, 737 S.E.2d 802, 806 (2013) (citation omitted), and
this Court “cannot make that determination in the first
instance on appeal[.]” Cornelius v. Lipscomb, 224 N.C.
App. 14, 18, 734 S.E.2d 870, 872 (2012).

T.M.C.S., Inc. v. Marco Contractors, Inc., __ N.C. App. __, __, 780 S.E.2d 588, 592

(2015).

Our appellate courts have remanded cases for the trial court to make the initial

determination of whether the FAA governs an arbitration agreement, when that

determination was critical to the disposition of the case. See Eddings v. S. Orthopedic

& Musculoskeletal Assocs., P.A., 147 N.C. App. 375, 385, 555 S.E.2d 649, 656 (2001)

(Greene, J., dissenting) (reasoning that remand was required for trial court to

determine initially whether FAA or RUAA governed arbitration clause, because the

majority determined initially that FAA applied and resolution of governing law was

dispositive to the case), rev’d per curiam for reasons stated in the dissent, 356 N.C.

285, 286, 569 S.E.2d at 645, 645 (2002); see also Sillins v. Ness, 164 N.C. App. 755,

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759, 596 S.E.2d 874, 877 (2004) (reversing and remanding order denying motion to

compel arbitration “[b]ecause the question whether the FAA or the UAA governs this

arbitration agreement determines whether the trial court properly denied the motion

to compel arbitration”).

In the instant case, however, whether federal or state arbitration law governs

has no bearing on our disposition of the case. Both the FAA and the RUAA dictate

that arbitration is strictly a matter of contract. See Volt Info. Sciences, Inc. v. Bd. of

Trustees of Leland Stanford Junior Univ., 489 U.S. 468, 478 (1989) (noting “[t]he

thrust of the federal law is that arbitration is strictly a matter of contract[.]”)

(citation, quotation marks, and brackets omitted); see also Sloan Fin. Grp., Inc. v.

Beckett, 159 N.C. App. 470, 478, 583 S.E.2d 325, 330 (2003) (“[W]hether a dispute is

subject to arbitration is a matter of contract law.”), aff'd per curiam, 358 N.C. 146,

593 S.E.2d 583 (2004). Under either law, the plain language of the arbitration clause,

properly interpreted, delegates the threshold issue of substantive arbitrability to the

arbitrator—not to the trial court. Therefore, we decline to reverse and remand the

trial court’s ruling on the basis that it did not expressly find whether the FAA applies.

See Sloan Fin. Grp., 159 N.C. App. at 479, 583 S.E.2d at 330 (declining to reverse and

remand trial court’s order in light of party’s argument that trial court failed to apply

the FAA, when the analysis was virtually identical and the same conclusion would be

reached under either federal or state law).

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B. Standard of Review

“[W]hether a particular dispute is subject to arbitration is a conclusion of law,

reviewable de novo by the appellate court.” Carter v. TD Ameritrade Holding Corp.,

218 N.C. App. 222, 226, 721 S.E.2d 256, 260 (2012) (citation omitted). Issues relating

to the interpretation of terms in an arbitration clause are matters of law, which this

Court reviews de novo. See, e.g., Bailey, __ N.C. App. at __, 780 S.E.2d at 924 (citation

omitted).

C. Arbitrability

Johnson contends that the trial court erred by enjoining certain disputes from

proceeding to arbitration, because according to the plain language of the arbitration

clause, the threshold issue of substantive arbitrability was delegated to an arbitrator.

We agree.

“[O]nly those disputes which the parties agreed to submit to arbitration may

be so resolved.” Rodgers Builders, Inc. v. McQueen, 76 N.C. App. 16, 23, 331 S.E.2d

726, 731 (1985). “To determine if a particular dispute is subject to arbitration, this

Court must examine the language of the agreement, including the arbitration clause

in particular, and determine if the dispute falls within its scope.” Fontana v. S.E.

Anesthesiology Consultants, P.A., 221 N.C. App. 582, 589, 729 S.E.2d 80, 86 (2012)

(citation omitted). Because arbitration is a matter of contract, contract principles

govern the interpretation of an arbitration clause. See, e.g., Harbour Point

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Homeowners’ Ass’n, Inc. v. DJF Enters., Inc., 201 N.C. App. 720, 725, 688 S.E.2d 47,

51, disc. review denied, 364 N.C. 239, 698 S.E.2d 397 (2010).

“When the language of the arbitration clause is ‘clear and unambiguous,’ we

may apply the plain meaning rule to interpret its scope.” Fontana, 221 N.C. App. at

588–89, 729 S.E.2d at 86. If the language is ambiguous, “[o]ur strong public policy

requires that the courts resolve any doubts concerning the scope of arbitrable issues

in favor of arbitration.” Johnston Cty. v. R.N. Rouse & Co., 331 N.C. 88, 91, 414

S.E.2d 30, 32 (1992); see also Cyclone Roofing Co. v. LaFave Co., 312 N.C. 224, 229,

321 S.E.2d 872, 876 (1984) (“[A]ny doubts concerning the scope of arbitrable issues

should be resolved in favor of arbitration, whether the problem at hand is the

construction of the contract language itself or an allegation of waiver, delay, or a like

defense to arbitrability.”) (quoting Moses H. Cone Mem. Hosp. v. Mercury Constr.

Corp., 460 U.S. 1, 24–25, 74 L. Ed. 2d 765, 785 (1983)). Furthermore, “[p]ursuant to

well settled contract law principles, the language of the arbitration clause should be

strictly construed against the drafter of the clause.” Harbour Point, 201 N.C. App. at

725, 688 S.E.2d at 51.

In this case, Epic Games drafted the arbitration clause, which provided in

pertinent part:

Any disputes between Employee and Epic in any way
concerning his employment, this Agreement or this
Agreement’s enforcement, including the applicability of
this Paragraph, shall be submitted at the initiative of

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either party to mandatory arbitration before a single
arbitrator and conducted pursuant to the rules of the
[AAA] applicable to the arbitration of employment disputes
then in effect, or its successor, provided however that this
Paragraph does not apply to the Confidentiality
Obligations and Intellectual Property Rights Agreement
referred to in Paragraph 7, and attached as Exhibit A.

The plain language of the arbitration clause is clear and unambiguous. It

provides for mandatory arbitration of “[a]ny disputes between [Johnson] and Epic

[Games] in any way concerning his employment, this Agreement or this Agreement’s

enforcement[.]” These broad phrases indicate the drafter, Epic Games, intended for

an extensive range of issues relating to Johnson’s employment or the Employment

Agreement to fall within the arbitration clause’s scope. Moreover, this expansive

clause expressly covers disputes “in any way concerning . . . the applicability of this

Paragraph[.]” Indeed, the “dispute[] between [Johnson] and Epic [Games]” on appeal

is whether particular claims asserted fall within the scope of the arbitration clause,

implicating a matter “concerning” the arbitration clause’s “applicability.” The

language Epic Games employed in drafting the clause makes it clear that any

disputes regarding whether the arbitration clause applied to a particular claim

should be submitted to arbitration and decided by the arbitrator.

Furthermore, the arbitration clause incorporates the rules of the AAA. Under

AAA Employment Rule 6(a), “[t]he arbitrator shall have the power to rule on his or

her own jurisdiction, including any objections with respect to the existence, scope or

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validity of the arbitration agreement.” (emphases added). Although our state

appellate courts have never addressed or decided this issue when interpreting an

arbitration clause subject to the RUAA, this Court recently adopted the majority rule

among the federal courts of appeal when interpreting an arbitration clause subject to

the FAA. In Bailey, this Court held that under the FAA, an arbitration clause which

incorporated an arbital body’s rules, when those rules explicitly delegate the

threshold issue of arbitrability to an arbitrator, constitutes “clear and unmistakable”

evidence—a more exacting standard than currently exists when interpreting

arbitration clauses subject to the RUAA—that the parties agreed to arbitrate issues

of substantive arbitrability. Bailey, __ N.C. App. at __, 780 S.E.2d at 927. Therefore,

both the plain language of the arbitration clause and its incorporation of the AAA

rules demonstrate that the parties agreed the arbitrator should decide issues of

substantive arbitrability. Even if this broad clause, by itself, does not resolve the

issue of whether the parties agreed to arbitrate arbitrability, the requirement for

arbitration to be conducted pursuant to the AAA rules does.

As a secondary matter, we note that although the “Confidentiality Obligations

and Intellectual Property Rights Agreement” was excluded from the arbitration

clause’s scope, Epic Games concedes in its brief that this agreement merely

“prescrib[es] Johnson’s confidentiality obligations and his assignment to Epic of

intellectual property created while employed.” (emphasis added). Neither party

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asserts that Johnson’s claims fall within the scope of this agreement. Therefore, that

agreement is of no consequence to our analysis or disposition of the case.

IV. Conclusion

Based on its plain language and incorporation of the AAA rules, the arbitration

clause drafted by Epic Games, properly interpreted, contained a valid agreement to

delegate issues of substantive arbitrability to the arbitrator. Therefore, the trial

court was without authority to issue an injunction and determine the scope of

arbitrable issues. The trial court’s order must be reversed.

REVERSED.

Judges BRYANT and ZACHARY concur.

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