I am not the guy that likes to spread rumors, but I also don't have any evidence to prove it. You're just going to have to believe me or get Icculus drunk as hell :')
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I'm inclined to believe it was a middleware issue, followed up by a failure to pay up because they had funds problems because UT3 tanked on them.
I wouldn't know if the Unreal II story would be true or not, but I would be leery of working for a client that didn't pay a substantive portion up-front on something after getting shafted the first time on payment with a previous contract. If true, it's a bit troubling to hear that- as much as the current story with UT3.