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
-2-
1-06-2194
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
-3-
1-06-2194
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
-4-
1-06-2194
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
-5-
1-06-2194
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
-6-
1-06-2194
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
-7-
1-06-2194
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.
-8-
1-06-2194
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
-9-
1-06-2194
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
-10-
1-06-2194
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
-11-
1-06-2194
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.
-12-
1-06-2194
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
-13-
1-06-2194
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.
-14-