Casablanca Trax v. Trax Records

• Court: Appellate Court of Illinois
• Decided: June 6, 2008
• Docket: 1-06-2194 NRel
• Status: Unpublished

Opinion

SIXTH DIVISION June 6, 2008

No. 1-06-2194

CASABLANCA TRAX, INC., ) Appeal from the ) Circuit Court of Plaintiff-Appellee, ) Cook County ) v. ) ) TRAX RECORDS, INC.; SANLAR PUBLISHING; ) TRAX CONTINENTAL LTD.; PHAT TRAX; R&L ) RECORDS, INC.; SABER RECORDS, LTD.; HOT ) MIX 5 RECORDS; HOUSE-TIME RECORDS; ) DANGEROUS RECORDS; DEMAND RECORDS; MAAD ) RECORDS; PRECISION RECORDS, LTD.; LARRY ) SHERMAN; and RACHEL CAIN SHERMAN, ) Honorable ) Alexander P. White, Defendants-Appellants. ) Judge Presiding

JUSTICE McNULTY delivered the opinion of the court:

What happens when the parties to a contract put a broad

arbitration clause in one document, but include no such clause in

a second document providing security for the promises made in the

first document? At least under the circumstances of this case,

we hold that the parties must submit the question of

arbitrability to the arbitrator first, before addressing any

claims that may not be subject to the arbitration clause.

BACKGROUND

Rachel Cain Sherman and Larry Sherman used a number of trade

names and record labels, including Trax Records, Inc., to create

and market "house" music. In 2002 they negotiated an agreement

with Casablanca Trax, Inc., for production and distribution of

recordings. On December 17, 2002, the parties signed three

separate documents detailing the terms of the agreement. 1-06-2194

The joint venture agreement (JVA) assigned to the Shermans

responsibility for finding new artists and producing their

recordings while Casablanca bore responsibility for marketing the

recordings. Casablanca promised, in the JVA, to advance the

Shermans $20,000 each month for expenses. Casablanca would

recover the advances from sales of recordings released by the

joint venture. The JVA also included the following provisions:

"19. Casablanca shall advise Trax and keep Trax

up to date with respect to revenues generated by the

joint venture on a monthly basis. A formal accounting

shall be forwarded to Trax on a semi-annual basis ***

setting out those revenues generated by the joint

venture during the prec[e]ding semi-annual period and

the deductions of all allowable recoupments, costs,

fees and expenses. ***

* * *

24. Any dispute arising ou[t] of or pursuant to

this agreement shall not be taken to litigation, but

shall be settled in the following sequence, although

steps may be passed by mutual consent:

a) Negotiation;

b) Mediation (non-binding arbitration);

c) Binding arbitration."

In a separate document Casablanca promised to loan the

Shermans $100,000, with scheduled monthly repayments deducted

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from the $20,000 advanced each month under the JVA. The loan

agreement further provided:

"To the extent that any monies have been advanced by

the Lender to the Debtor prior to the effective date of

this Agreement, it is hereby acknowledged by the

parties hereto that all such prior advances shall

comprise amounts advanced as part of the Advance under

the Loan and that such prior advances were made to the

Debtor on and subject to the terms and conditions

contained in this Agreement."

The loan agreement did not include an arbitration clause.

In the third document the Shermans gave Casablanca a

security interest in their music-related assets, including their

recording equipment and the recordings made thereon. The

security agreement secured "all duties and obligations of the

Debtor to the Lender." If the Shermans defaulted on their

secured debts, the security agreement gave Casablanca the right

to "take possession of all or any part of the collateral with

power to *** sell, lease or dispose of all or any part of the

Collateral." The security agreement did not include an

arbitration clause.

Casablanca advanced to the Shermans the sums promised. In

March 2004 the parties signed a modification of the JVA. The

modification specified sales targets and granted Casablanca the

right, if sales did not meet the targets, to recoup all of the

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monetary advances it made to the Shermans. The modification did

not affect the arbitration clause or Casablanca's duty to account

for sales.

On May 26, 2005, Casablanca sued the Shermans, along with

the many recording companies the Shermans operated, seeking

replevin of the collateral listed in the security agreement. In

a second count Casablanca sought to recover for breach of both

the JVA and the loan agreement. When the court awarded

Casablanca judgment on the replevin count, Casablanca seized most

of defendants' assets described in the security agreement.

In their answer to the second count defendants admitted that

Casablanca had loaned them $100,000 under the loan agreement and

advanced them $367,000 under the JVA. Because Casablanca

deducted loan repayments from the advances, according to the

complaint defendants owed a balance of less than $28,000 on the

$100,000 loan covered by the loan agreement. Casablanca claimed:

"7. *** Plaintiffs advanced over $367,000.00 in

cash and expenses for the benefit of Defendants (the

'Advances'). Defendants are obligated to repay the

Advances pursuant to the Joint Venture Agreement. ***

8. The amounts due under the Loan Agreement and

the Advances are collectively referred to as the

'Indebtedness.'

9. The Indebtedness is secured by a security

interest in certain assets and equipment of the

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Defendants (the 'Collateral') and evidenced by that

certain General Security Agreement."

Defendants admitted the allegations of those three paragraphs.

Defendants posed three affirmative defenses to the breach of

contract claim, including charges that Casablanca breached the

JVA by failing to account for sales and by failing to seek

arbitration. The court struck the affirmative defenses, but it

permitted defendants to file a motion for alternative dispute

resolution. Defendants filed such a motion in December 2005.

Defendants also sought leave to file a counterclaim that

reiterated its affirmative defenses. Casablanca then moved for

summary judgment on its claim for breach of contract. It offered

in support the affidavit of its president, who swore to the

allegations in the complaint, including the allegation that

Casablanca "performed all its obligations under the Loan

Agreement, Joint Venture Agreement, and Security Agreement."

Defendants verified their answer in which they charged Casablanca

with failing to send defendants the semiannual accounting reports

the JVA required.

In April 2006 the trial court granted Casablanca summary

judgment on the breach of contract claim and denied the motion

for arbitration. The court agreed with Casablanca's contention

that the arbitration clause in the JVA did not apply to a dispute

over the repayment of advances made pursuant to the JVA:

"While the Joint Venture Agreement deals generally with

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how the parties are to cooperate and further their

common interest under the venture, the Loan Agreement

and Security Agreement govern the lending relationship

created when Defendants borrowed money and took

substantial Advances from Casablanca. *** [T]hese

instruments unmistakably evidence the intent to treat

the lending relationship differently and more formally

than the other aspects of the venture relationship."

The court also held that "Defendants did not invoke the

arbitration provision [and] made no demand for arbitration."

Defendants moved to vacate the judgment. In June 2006,

several weeks before the hearing on the motion to vacate,

Casablanca began the process of selling, pursuant to the security

agreement, the assets it seized under the replevin count.

Casablanca claimed that it circulated a notice of public sale

setting a sale date of June 28, 2006. Defendants responded with

affidavits stating that they did not receive statutorily

requisite notice. The court denied defendants' motion to stay

the sale. On June 28 Casablanca sold itself all of the assets it

had seized. Two days later the trial court denied defendants'

motion to vacate the judgment on the breach of contract claim.

Defendants now appeal.

ANALYSIS

Defendants claim that the court committed reversible error

when it denied the motion for arbitration. On appeal we need to

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determine whether the record sufficiently supports the trial

court's decision denying arbitration. Bass v. SMG, Inc., 328

Ill. App. 3d 492, 496 (2002). Insofar as the trial court decided

the issue as a matter of contract interpretation, we review the

ruling de novo. Bass, 328 Ill. App. 3d at 496; In re Marriage of

Turrell, 335 Ill. App. 3d 297, 305 (2002).

Defendants formally moved for arbitration in December 2005,

less than seven months after Casablanca filed this lawsuit. We

find on this record no indication that defendants ever acted in a

manner inconsistent with the assertion of their right to

arbitrate. See Liberty Chevrolet, Inc. v. Rainey, 339 Ill. App.

3d 949, 953 (2003). The record contradicts the trial court's

finding that defendants failed to invoke the arbitration clause.

Defendants did not waive the right to arbitrate.

Casablanca argues that the trial court correctly interpreted

the contracts. The JVA requires arbitration of "[a]ny dispute

arising ou[t] of or pursuant to" the agreement. The parties

adopted the language of "[t]he broadest arbitration clauses."

Donaldson, Lufkin & Jenrette Futures, Inc. v. Barr, 124 Ill. 2d

435, 445 (1988). Our supreme court noted that in some cases,

even in cases where the parties adopted such a broad clause, the

subject matter of a dispute may not clearly fall within the scope

of the agreement. Barr, 124 Ill. 2d at 446. The court said that

"when the language of an arbitration clause is broad and it is

unclear whether the subject matter of the dispute falls within

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the scope of arbitration agreement, the question of substantive

arbitrability should initially be decided by the arbitrator."

Barr, 124 Ill. 2d at 447-48.

Here the security agreement and the loan agreement include

no arbitration clause. Casablanca argues that the entire debt

protected by the security agreement arose solely under the loan

agreement, without reference to the JVA. We disagree. The loan

agreement applies to only the $100,000 loan specified therein and

to "any monies [that] have been advanced by the Lender to the

Debtor prior to the effective date of this Agreement." The loan

agreement sets its effective date at the same date on which the

parties signed the JVA, before Casablanca started making the

advances of $20,000 per month that form the bulk of the debt

here. As Casablanca did not make those advances prior to the

effective date of the loan agreement, the loan agreement does not

cover the advances under the JVA. In the complaint Casablanca

recognized that the security agreement protected a debt that

included both the amount due under the loan agreement and the

advances made pursuant to the JVA. Because defendants have

repaid most of the debt under the loan agreement, the remaining

debt arose almost entirely from the JVA. Thus, Casablanca seeks

to enforce the security agreement, a contract that includes no

arbitration clause, but which relates closely to the JVA, which

has a broad arbitration clause.

In A.E. Staley Manufacturing Co. v. Robertson, 200 Ill. App.

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3d 725 (1990), the defendant, an executive with the plaintiff,

agreed to continued employment in exchange for certain retirement

benefits. The contract included a clause broadly requiring

arbitration of "'[a]ny controversy or claim arising out of or

relating to this Agreement.'" A.E. Staley, 200 Ill. App. 3d at

728. The parties later signed a "'Supplemental Executive

Retirement Plan'" (A.E. Staley, 200 Ill. App. 3d at 728) that

included no arbitration clause. When the plaintiff terminated

the defendant's employment, it paid amounts it calculated under

both agreements. The defendant demanded full payment of benefits

due under the supplemental plan and sought arbitration of the

dispute. The plaintiff sued for a judgment declaring that it had

no duty to arbitrate because the defendant made no claim under

the original retirement agreement and the supplemental plan had

no arbitration clause. The court granted the plaintiff the

summary judgment the plaintiff sought. The appellate court

reversed, holding: "In order to get the full scope of defendant's

benefits, the documents must be read in conjunction." A.E.

Staley, 200 Ill. App. 3d at 731. The court found that the

dispute arose out of the initial retirement agreement. A.E.

Staley, 200 Ill. App. 3d at 731.

The appellate court followed A.E. Staley in Nagle v.

Nadelhoffer, Nagle, Kuhn, Mitchell, Moss & Saloga, P.C., 244 Ill.

App. 3d 920 (1993). In that case the parties signed an

employment contract that included an arbitration clause. Later

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they signed a stock redemption agreement that did not include

such a clause. The plaintiff resigned and sought payment of

amounts due under the stock redemption agreement. The trial

court denied defendants' motion for arbitration. The appellate

court held:

"A generic arbitration clause in an employment contract

is broad enough to encompass any dispute which concerns

[the plaintiff's] employment *** or his termination

thereof ***. ***

The extent to which the stock redemption agreement

depends on, or is interrelated with, the employment

agreement is unclear from the record before us. *** The

arbitrator, not the court, is the entity designated to

interpret ambiguities in the contract. [Citation.]

Therefore, we conclude that the question of whether the

arbitration clause in the employment agreement covers

disputes under the stock redemption agreement is itself

arbitrable." Nagle, 244 Ill. App. 3d at 925-30.

Here the debt for which Casablanca seeks repayment arose

under the JVA. The arbitrator should, in the first instance,

address Casablanca's arguments that the arbitration clause does

not apply to its claims.

The loan agreement governs repayment of the $100,000 loan

Casablanca made to defendants. Neither that agreement nor the

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security agreement that protects that loan includes an

arbitration clause. According to section 2(d) of the Uniform

Arbitration Act:

"Any action or proceeding involving an issue

subject to arbitration shall be stayed *** or, if the

issue is severable, the stay may be with respect

thereto only." 710 ILCS 5/2(d) (West 2004).

This section leaves the court two options when a case includes

one issue subject to arbitration and a separate issue not subject

to arbitration. The court may "stay the entire proceeding

pending arbitration, or, if the issue is severable, the stay may

be granted with respect to that issue only." Board of Managers

of the Courtyards at Woodlands Condominium Ass'n v. IKO Chicago,

Inc., 183 Ill. 2d 66, 74-75 (1998). Policies favoring

arbitration support a stay of all court proceedings pending

arbitration "where the arbitrable and nonarbitrable issues,

although severable, are also interrelated in terms of a complete

resolution of the cause between the parties." Kelso-Burnett Co.

v. Zeus Development Corp., 107 Ill. App. 3d 34, 41 (1982); see

also IKO Chicago, 183 Ill. 2d at 76.

The security agreement establishes that the same collateral

protects the loan under the loan agreement and the advances under

the JVA. The arbitrator's resolution of the debt under the JVA

and use of collateral to pay the debt may dispose of all issues

concerning repayment of the separate $100,000 loan. We find the

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issues surrounding the loan agreement and the arbitrable advances

under the JVA so interrelated that judicial economy favors a stay

of all court proceedings pending arbitration. Accordingly, we

reverse the judgment entered in favor of Casablanca on its claim

for breach of contract and we remand for arbitration of that

claim.

Casablanca contends that it had a right to conduct the

judicial sale to itself of all of defendants' assets under

section 9-610 of the Uniform Commercial Code (810 ILCS 5/9-610(a)

(West 2004)), without reference to this lawsuit. Casablanca

concludes that reversal of the judgment on the claim for breach

of contract does not affect the validity of the sale.

Section 9-610 establishes that "[a]fter default, a secured

party may sell *** or otherwise dispose of any or all of the

collateral." 810 ILCS 5/9-610(a) (West 2004). The security

agreement here gives Casablanca the right to sell the collateral

to satisfy the debt after defendants default. The Uniform

Arbitration Act requires the court to stay proceedings in any

case involving an issue subject to arbitration, unless that issue

is severable from nonarbitrable issues in the case.

The court resolved a similar issue in Morrie Mages & Shirlee

Mages Foundation v. Thrifty Corp., 916 F.2d 402 (7th Cir. 1990).

There a purchase agreement included an arbitration clause. In a

separate agreement, with no arbitration clause, the defendant

guaranteed payment of amounts required by the purchase agreement.

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The guarantee specifically made the defendant's liability

absolute and unconditional if the purchaser defaulted. Morrie

Mages, 916 F.2d at 403. The plaintiff sued to enforce the

guarantee. The trial court denied the defendant's motion to stay

proceedings pending arbitration, finding the absolute guarantee

immediately enforceable. The United States Court of Appeals for

the Seventh Circuit reversed. The broad arbitration clause in

the purchase agreement assigned to the arbitrator the initial

decision as to whether the purchaser had defaulted. Morrie

Mages, 916 F.2d at 406-07; see also Stone Distribution Co. v.

Meyers, 157 F.R.D. 405, 408 (N.D. Ill. 1994).

Here, too, the broad arbitration clause in the JVA gives the

arbitrator authority to decide whether the parties have agreed to

arbitrate issues of default and the amount of debt that remains

unpaid. The separate security agreement, like the separate

guarantee in Morrie Mages, includes no arbitration clause.

Following the reasoning of Morrie Mages, we hold that the trial

court should have stayed proceedings on the sale of defendants'

assets pending arbitration.

Casablanca made the advances at issue pursuant to the JVA,

which includes a broad arbitration clause. Therefore, the

arbitrator must decide the arbitrability of issues related to

repayment, even where those issues also involve a security

agreement that has no arbitration clause. Because the loan

agreement interlocks with the JVA, judicial economy favors a stay

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of proceedings on any claims related to the loan agreement

pending the arbitrator's decision on arbitrability of claims for

repayment of advances under the JVA. The arbitrator's decision

must precede any sale pursuant to the security agreement. We

reverse the judgment of the trial court and remand for

proceedings consistent with this opinion.

Reversed and remanded.

McBRIDE, P.J., and JOSEPH GORDON, J., concur.

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