Dream Theater, Inc. v. Dream Theater

• Decision Date: 30 November 2004
• Docket Number: No. B174152.,B174152.
• Citation: 21 Cal.Rptr.3d 322,124 Cal.App.4th 547
• Court: California Court of Appeals Court of Appeals
• Parties: DREAM THEATER, INC., et al., Plaintiffs and Respondents, v. DREAM THEATER et al., Defendants and Appellants.

21 Cal.Rptr.3d 322

124 Cal.App.4th 547

DREAM THEATER, INC., et al., Plaintiffs and Respondents, v. DREAM THEATER et al., Defendants and Appellants.

No. B174152.

Court of Appeal, Second District, Division 4.

November 30, 2004.

As Modified on Denial of Rehearing December 28, 2004.

Latham & Watkins, Kristine L. Wilkes, Russell F. Sauer, Jr. and Lauren S. Kim for Defendants and Appellants.

Castle & Associates, Nomi L. Castle, Farzad Tabatabai and Robert S. Blonstein for Plaintiffs and Respondents.

GRIMES, J.^*

This is an appeal from an order staying proceedings before the American Arbitration Association (AAA) based on the finding that the parties' commercial dispute is not arbitrable and jurisdiction lies with the court. We hold that: (1) the parties' agreement determines whether the court or the arbitrator decides if the dispute is subject to arbitration; (2) where the parties do not offer evidence extrinsic to the contract, on appeal we review the contract independently; and (3) the parties state a clear and unmistakable agreement that the arbitrator will decide whether the dispute is subject to arbitration when they incorporate into their agreement the AAA Commercial Arbitration Rules which specify the arbitrator will decide arbitrability and nothing in the parties' agreement excludes from the jurisdiction of the arbitrator the decision whether the dispute must be submitted to arbitration.

FACTUAL BACKGROUND

The Contract and the Arbitration Clause

Appellants are the buyer of an Internet-based multimedia and entertainment business and its managing agents. The buyer is Dream Theater, LLC. Its managing agents are The Dupuis Group, LLC, Donald J. Esters, and Steven Dupuis (Buyers). Respondents are the seller Dream Theater, Inc. and its shareholders Ali Davoudian, Mohammed Davoudian, and Darren Chuckry (Sellers). On October 17, 2001, Buyers executed an asset purchase agreement (the Contract) pursuant to which buyer Dream Theater, LLC acquired assets and liabilities of the Dream Theater business from Sellers. The parties executed various schedules and exhibits to the Contract, including a consulting agreement between buyer Dream Theater, LLC and Ali Davoudian, a former shareholder of seller Dream Theater, Inc. Among the liabilities that Buyers assumed was a credit line of $100,000 from Bank of America to Dream Theater, Inc. guaranteed by its shareholders.

The Contract has comprehensive dispute resolution provisions contained in nine separately numbered paragraphs spanning four pages of single-spaced text. The parties used broad language to express their agreement to avoid litigation as a means of dispute resolution. The Contract identifies the parties' respective obligations to indemnify one another from any and all losses, including losses arising from either party's breach of the Contract as well as those arising from third party claims. It sets forth the means to assert a claim of loss by giving an indemnification notice, provides for the enforcement of an uncontested claim by way of stipulated judgment, establishes a period of time to pursue settlement, and establishes procedures for "mandatory, final and binding arbitration" after the settlement period elapses. The Contract specifies that arbitration will be in accordance with the AAA Commercial Arbitration Rules. These rules provide that the arbitrator "shall have the power to rule on his or her own jurisdiction, including any objections with respect to the existence, scope or validity of the arbitration agreement."

The Nature and Procedural History of the Parties' Disputes

Buyers hired Mr. Chuckry, a former officer of seller Dream Theater, Inc. to run the business. Some months after the purchase, Buyers learned that Mr. Chuckry had multiple sclerosis, which they believed to have negatively affected his ability to run the business. Buyers claimed that Sellers knew about Mr. Chuckry's illness and had a duty to disclose it to Buyers before the purchase was consummated, and that Sellers' failure to disclose his disability caused Buyers to suffer losses "approaching $500,000."

Buyers served Sellers with an indemnification notice on February 11, 2003, stating their intent to offset their claimed losses by withholding any further payments on the Bank of America credit line, which had an outstanding balance due of $88,855.16. Buyers made no more payments on the credit line. In due course, Bank of America recovered the balance owing on the credit line from Sellers. On December 16, 2003, Sellers filed this lawsuit in superior court seeking recovery from Buyers of the $88,855.16 and other damages, including payments allegedly due under the consulting agreement.

After Sellers filed this lawsuit, Buyers allegedly discovered another breach of the Contract by Sellers. Buyers claimed to have learned in February 2004 that Sellers' largest customer, FX Networks, had given notice of termination of its contract with Sellers some days before the sale to Buyers, and that Sellers failed to disclose the loss of this customer. Sellers had represented in the Contract with Buyers that FX Networks generated revenues of over $1 million in 2001 (the year the Contract was executed), which was more than five times what Sellers' next largest customers generated that year. On about February 11, 2004, Buyers served Sellers with a second indemnification notice asserting losses of about $1 million as a result of Sellers' failure to disclose the loss of the FX Networks business. Sellers contested this second indemnification notice on February 13, 2004. Buyers demanded arbitration of this dispute on February 23, 2004.

On March 9, 2004, Sellers obtained an ex parte order shortening time for the hearing of Sellers' motion for an order determining the arbitrability of Buyers' claim of damages arising from the alleged failure to disclose the loss of the FX Networks contract. On March 18, 2004, the trial court ordered that the claim was not arbitrable and stayed the arbitration. This timely appeal followed.

DISCUSSION

A. Standard of Review

The issue of who should decide arbitrability turns on what the parties agreed in their contract. (First Options of Chicago, Inc. v. Kaplan (1995) 514 U.S. 938, 943, 115 S.Ct. 1920, 131 L.Ed.2d 985; Freeman v. State Farm Mut. Auto. Ins. Co. (1975) 14 Cal.3d 473, 480, 121 Cal.Rptr. 477, 535 P.2d 341.) Since the parties here introduced no extrinsic evidence, the trial court's ruling regarding arbitrability is a conclusion of law, and we independently interpret the Contract. (Merrick v. Writers Guild of America, West, Inc. (1982) 130 Cal.App.3d 212, 217, 181 Cal.Rptr. 530; Coast Plaza Doctors Hospital v. Blue Cross of California (2000) 83 Cal.App.4th 677, 684, 99 Cal.Rptr.2d 809.)

B. The Arbitrator and Not the court Will Decide What Disputes Are Arbitrable if the Parties Clearly and Unmistakably State That is Their Intent

In AT & T Technologies v. Communications Workers (1986) 475 U.S. 643, 106 S.Ct. 1415, 89 L.Ed.2d 648, the court reaffirmed the basic principles of arbitration. The first two principles guide our conclusion in this case. The first principle is that "`arbitration is a matter of contract and a party cannot be required to submit to arbitration any dispute which he has not agreed so to submit.' [Citation.]" (Id. at p. 648, 106 S.Ct. 1415.) The second principle is that the question of arbitrability is for judicial determination "[u]nless the parties clearly and unmistakably provide otherwise." (Id. at p. 649, 106 S.Ct. 1415.)

The arbitration clause at issue in AT & T Technologies v. Communications Workers, supra, was part of a collective bargaining agreement. The court reasoned that the presumption of arbitrability furthers the national policy of peaceful resolution of labor disputes and achieves the parties' presumed objectives in collective bargaining. (475 U.S. at p. 650, 106 S.Ct. 1415.) The court recognized, however, that parties would be less inclined to enter collective bargaining agreements if arbitrators were empowered to decide disputes the parties never agreed to submit to arbitration. (Id. at p. 651, 106 S.Ct. 1415.) Accordingly, regardless of policy considerations such as those at stake in collective bargaining agreements, the parties' agreement determines what disputes will be arbitrated.

In First Options of Chicago, Inc. v. Kaplan, supra, 514 U.S. 938, 115 S.Ct. 1920, 131 L.Ed.2d 985, the court applied the same basic principles of arbitration in a case involving a commercial contract. The court found that "arbitration is simply a matter of contract between the parties." (Id. at p. 943, 115 S.Ct. 1920.) "When deciding whether the parties agreed to arbitrate a certain matter (including arbitrability), courts generally ... should apply ordinary state-law principles that govern the formation of contracts." (Id. at p. 944, 115 S.Ct. 1920.) The court qualified this principle by finding it should not be assumed the parties intended the arbitrator to decide whether their dispute was arbitrable unless there is clear and unmistakable evidence that they did so. (Ibid.) The First Options court recognized that the question of who decides whether a dispute is subject to arbitration is "rather arcane," and may not have been considered and agreed upon by the parties. (Id. at p. 945, 115 S.Ct. 1920.) The court held that, where the agreement is silent or ambiguous on that question, the court and not the arbitrator should decide arbitrability so as not to force unwilling parties to arbitrate a matter they reasonably thought a judge, not an arbitrator, would decide. (Ibid.)

California courts often look to federal law when deciding arbitration issues under state law. (See, e.g., Pour Le Bebe, Inc. v. Guess? Inc. (2003) 112 Cal.App.4th 810, 829-835, 5 Cal.Rptr.3d 442.) California law is consistent with federal law on the question of who decides disputes over arbitrability. California courts use the same principles of contract interpretation...