Fit Tech, Inc. v. Bally Total Fitness Holding Corp. ( 2004 )

United States Court of Appeals
For the First Circuit
No. 03-2622
FIT TECH, INC.; PLANET FITNESS CENTER OF MAINE, INC.;
PLANET FITNESS CENTER, INC.; PLANET FITNESS CENTER OF DARTMOUTH,
INC.; PLANET FITNESS CENTER OF SALEM, INC.; PLANET FITNESS CENTER
OF BRIGHTON, INC.; STRATFORD FITNESS CENTER, INC.;
DAVID B. LAIRD; SCOTT G. BAKER,
Plaintiffs, Appellees,
v.
BALLY TOTAL FITNESS HOLDING CORPORATION;
HOLIDAY UNIVERSAL, INC.,
Defendants, Appellants.
__________
JOHN H. WILDMAN,
Defendant.
APPEAL FROM THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF MASSACHUSETTS
[Hon. Morris E. Lasker,* U.S. District Judge]
____________________
Before
Boudin, Chief Judge,
Torruella and Howard, Circuit Judges.
Juliet A. Davison with whom Howard M. Cooper and Todd & Weld
LLP were on brief for appellants.
*
Of the Southern District of New York, sitting by designation.
Deborah L. Thaxter, P.C. with whom Jonathan Sablone, Stephen
M. LaRose and Nixon Peabody LLP were on brief for appellees.
July 1, 2004
BOUDIN, Chief Judge. This appeal, presenting issues of
contract law and appellate jurisdiction, arises out of the sale of
a business. The principal plaintiffs in the district court, David
Laird and Scott Baker, previously owned and operated eight health
and fitness centers in New England doing business under several
names (e.g., "Planet Fitness"; "Fit Tech"). On April 19, 2002,
Laird and Baker executed an "Asset Purchase Agreement" effective as
of March 14, 2002, by which defendant Bally--a major owner of such
fitness facilities--acquired plaintiffs' centers.1
The purchase agreement fixed the purchase price at $14.7
million payable at closing but provided that the total amount could
be increased by a maximum of $12 million depending on earnings of
the eight centers in the two years following the closing. The
formula for computing the extra payment depended primarily on
earnings of the centers before corporate overhead, interest, taxes,
depreciation and amortization; this figure is defined in the
purchase agreement and called "EBITDA". The purchase agreement
sets out both procedures for calculating the amount and a time
table.
Specifically, Bally was required to provide Laird and
Baker quarterly reports setting forth Bally's calculation of the
EBITDA. An initial (75 percent) payment by Bally, based on the
1
The principal defendants are Bally Total Fitness Holding
Corporation and its subsidiaries, Holiday Universal, Inc. We refer
to them collectively as "Bally."
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"advance earn-out schedule," was to be determined within 90 days
after the first anniversary of the closing date (i.e., by mid-July,
2003). The final calculation of the full supplemental amount,
designated the "earn-out schedule," was due on the second
anniversary of the closing. Section 3.5 of the purchase agreement
then set out a process for dealing with disputes as to the
schedules:
(e) Protest Notice. Within sixty (60) days
after delivery to the Sellers of the Advance
Earn-Out Schedule or the Earn-Out Schedule, as
applicable, the Sellers may deliver written
notice (each, a "Protest Notice") to the Buyer
of any objections, and the basis therefor,
which the Sellers may have to the Advance
Earn-Out Schedule or the Earn-Out Schedule, as
applicable. Any such Protest Notice shall
specify the basis for the objection, as well
as the amount in dispute. The failure of the
Sellers to deliver a protest notice within the
prescribed time period will constitute the
Sellers' acceptance of the Advance Earn-Out
Schedule and the Earn-Out Schedule set forth
therein, as applicable.
(f) Resolution of the Sellers' Protest. If
the Buyer and the Sellers are unable to
resolve any disagreement with respect to the
Advance Earn-Out Schedule or the Earn-Out
Schedule within twenty (20) days following the
Buyer's receipt of any Protest Notice, then
the items in dispute will be referred to the
Accountants for final determination within
forty-five (45) days, which determination
shall be final and binding on all of the
parties hereto. The Accountants shall be
engaged by the Sellers and the Buyer regarding
the Advance Earn-Out Schedule or the Earn-Out
Schedule, as applicable, based upon the
written submissions of the Sellers and the
Buyer, and the Accountants may, but shall not
be required to, audit the Advance Earn-Out
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Schedule or the Earn-Out Schedule or any
portion thereof. The Advance Earn-Out
Schedule and the Earn-Out Schedule as
ultimately prepared and finalized in
accordance with this Section 3.5(f) shall
thereafter be deemed to be and constitute the
"Advance Earn-Out Schedule" and the "Earn-Out
Schedule" respectively, for all purposes.
Elsewhere in the agreement, PriceWaterhouseCoopers
(“Price Waterhouse”) was designated as the accountants. A choice
of law provision specified that the purchase agreement was to be
governed by Illinois law.
The purchase agreement also provided that Laird and Baker
would each sign an "Employment Agreement," making them area
directors to manage and operate Bally's New England fitness
centers. The employment agreement, unlike the purchase agreement,
contained a standard arbitration clause providing that "[a]ny
controversy or claim arising out of or relating to this employment
agreement, or the breach thereof, shall be settled by arbitration"
pursuant to the rules of the American Arbitration Association or a
similar organization selected by Bally.
Laird and Baker began to serve pursuant to the employment
agreements, but disagreements soon developed between them and
Bally. In February 2003, Laird and Baker brought this diversity
action against Bally in the federal district court in
Massachusetts, charging Bally primarily with breach of contract and
of an implied covenant of good faith and fair dealing. Claims were
also made under the Massachusetts statute governing unfair and
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deceptive trade practices, Mass. Gen. Laws ch. 93A, and a
counterpart Illinois statute, 815 Ill. Comp. Stat. 505/2.
The complaint included extensive factual allegations of
improper conduct by Bally. The district court essentially grouped
these alleged wrongful acts in two categories. The first,
comprising what we will call “accounting violations,” alleged that
Bally in its initial EBITDA calculations had improperly calculated
earnings contrary to applicable accounting principles so as to
reduce the extra purchase price that would be due. For example,
Bally was alleged to have spread revenues from new memberships over
the projected 22-month expected life while accruing the entire
commission expense of the agent in the month that the membership
was sold.
The second category consisted of numerous alleged actions
taken by Bally that Laird and Baker said were wrongfully designed
to reduce the extra earnings that would boost the purchase price.
For instance, the complaint charged that Bally had used its
computer system to direct phone inquiries away from the former
Laird-Baker centers and toward Bally's pre-existing New England
facilities and that Bally had provided the centers products unfit
for sale. These and acts like them we will call “operating
violations.”
On March 21, 2003, Bally moved to dismiss the complaint,
relying inter alia on the purchase agreement's requirement that
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claims be submitted to "binding alternative dispute resolution" by
the accountant under the purchase agreement. Bally did not mention
the employment agreement's arbitration clause. On August 21, 2003,
the district court concluded that certain of the factual
allegations raised matters within the purview of the accountants
under section 3.5(f) but that the majority--concerning Bally’s
allegedly improper operation of the businesses--did not and that
those latter claims were properly reserved for disposition by the
district court.
Bally then filed a motion to reconsider or clarify,
asking the court to identify more clearly which claims were to be
submitted to the accountant and also arguing that new events
warranted reconsideration of the district court's decision to
retain any of the claims for its own consideration. The new events
concerned a traditional arbitration proceeding that Bally had begun
against Laird in Chicago on June 30, 2003, under the arbitration
clause in Laird's employment agreement.
In the Chicago proceeding, Bally sought a ruling that it
was entitled to terminate Laird's employment for cause; later it
asked for a declaration that both Laird and Baker were subject to
restrictive non-compete covenants in their respective employment
agreements. Laird and Baker then counterclaimed in the arbitration
to seek monetary compensation for Bally's own alleged breaches of
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the employment agreement, including four alleged episodes that had
also been listed in Laird and Baker’s federal complaint.
Bally argued that these overlapping claims should be
dismissed because Laird and Baker "have elected to submit these
claims to arbitration" in Chicago. More broadly, Bally contended
that all of the issues retained by the district court for its own
resolution were properly subject to arbitration under the
employment agreement. By order entered on November 6, 2003, the
district court clarified its apportionment of issues as between the
court and the accountant, but it declined to refer any of the
claims (overlapping or not) to the Chicago arbitration.
Bally has now filed an interlocutory appeal. It argues
that the district court should not have retained any of the
plaintiffs' claims; Bally says that all must be submitted to Price
Waterhouse or, in the alternative, subject to the Chicago
arbitration. At the very least (says Bally), the district court
should not proceed to address the overlapping claims that are being
presented both in the federal complaint and in Laird's and Baker's
answer and counterclaim in the Chicago arbitration.
Jurisdiction. At the outset Laird and Baker say that we
lack jurisdiction over Bally's appeal. The challenge to our
jurisdiction arises because the district court’s refusal either to
dismiss the case or to leave all of the issues to Price Waterhouse
or the Chicago arbitration is not a “final order” disposing of all
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claims against all parties. Thus, it is not appealable as a final
judgment under 28 U.S.C. § 1291 (2000), and our jurisdiction must
be based on one of the several statutory or case law exceptions to
the final judgment requirement.
Section 16 of the Federal Arbitration Act, 9 U.S.C. §
16(a)(1)(B) (2000), explicitly permits an immediate appeal from a
district court order “denying a petition under section 4 of this
title to order arbitration to proceed.” See also Colón v. R.K.
Grace & Co., 358 F.3d 1, 4 (1st Cir. 2003). We think that the
district court’s orders are appealable under this section insofar
as the district court refused to send all of the issues to the
Chicago arbitration proceedings and–-this is the trickier
jurisdictional issue–-as to the court's refusal to send them all to
Price Waterhouse.
We start with Bally’s request to refer the issues to the
Chicago arbitration. This request was made only in the motion for
reconsideration following the district court’s original August 21,
2003, order but the delay is not a bar: the district court did not
decline to address the request as forfeited by failure to make it
earlier but instead decided on the merits that a reference to the
Chicago arbitrator was not required. Bally’s explicit request for
a reference to the Chicago arbitrator was effectively a request for
an order to arbitrate under section 4, 9 U.S.C. § 4 (2000), which
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is immediately appealable under section 16, 9 U.S.C. § 4,
16(a)(1)(B).
For two separate reasons, the refusal to send all the
claims to Price Waterhouse is more difficult to equate with a
refusal to order arbitration. One reason is that, as plaintiffs
point out, Bally’s request was not for a stay pending submission to
Price Waterhouse or an order to arbitrate but for dismissal of the
case because of the Price Waterhouse remedy. So far as pertinent,
section 16 allows an interlocutory appeal only from an order
denying a petition to compel arbitration; or from the denial of a
stay pending such an arbitration. 9 U.S.C. §§ 3, 4, 16 (2000).
The courts are divided as to whether a request to dismiss
a case based on an arbitration clause should be treated as a
request for an order compelling arbitration.2 Circumstances vary
and one rule may not suit all cases. But here Bally clearly argued
to the district court that under the purchase agreement the
accountant had sole authority to resolve all issues. If that was
right and Bally wanted the accountant to decide the issues, then
2
Several courts have treated requests to dismiss on this
ground as equivalent to a petition for an order compelling
arbitration. E.g., Thomassen & Drijver-Verblifa N.V. v. Sardee
Indus., Inc., NO. 88 C 4271, 1988 WL 102258, at *1 (N.D. Ill. Sept.
28, 1988); Interstate Sec. Corp. v. Siegel, 676 F. Supp. 54, 55
(S.D.N.Y. 1988). The District of Columbia Circuit held otherwise
but suggested that the aggravated facts made a difference.
Bombardier Corp. v. National R.R. Passenger Corp., 333 F.3d 250,
252-54 (D.C. Cir. 2003). See also Harrison v. Nissan Motor Corp.
in U.S.A., 111 F.3d 343, 347-49 (3d Cir. 1997)(noting the problem
without deciding).
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the proper remedy would have been to stay the court proceeding and
order arbitration--assuming that the accounting remedy is
arbitration.
If Bally had wanted a dismissal but no decision by the
arbitrator, then we would refuse to entertain an appeal by Bally to
provide a reference that Bally had not sought and did not want.
But in this case Bally clearly is invoking the accountant dispute
resolution remedy, even if a stay rather than dismissal ensues.
Since no one has been prejudicially misled by Bally’s request for
an over-favorable remedy of dismissal, its request for dismissal in
favor of the accountant remedy can be treated as encompassing the
lesser alternative remedy of a stay and reference.
This brings us to Bally’s second hurdle, namely, to the
question whether the accountant remedy is arbitration at all. If
it is not arbitration, then remedies under the Federal Arbitration
Act, including an interlocutory appeal, would be unavailable. The
Act itself does not define "arbitration", see Harrison v. Nissan
Motor Corp. in U.S.A., 111 F.3d 343, 350 (3d Cir. 1997). Whether
the accountant remedy is “arbitration” under the federal statute is
a characterization issue, which in our view is governed by federal
law.
That a uniform federal definition is required is obvious
to us. True, the substance of the purchase agreement-–who promised
to do what--is governed by state law (here, the parties agree, by
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Illinois law), but whether what has been agreed to amounts to
“arbitration” under the Federal Arbitration Act depends on what
Congress meant by the term in the federal statute. Assuredly
Congress intended a "national" definition for a national policy.
Analogous cases are numerous.3
Curiously, there is a Ninth Circuit case to the contrary,
Wasyl, Inc. v. First Boston Corp., 813 F.2d 1579, 1582 (9th Cir.
1987), followed by Hartford Lloyd's Ins. Co. v. Teachworth, 898
F.2d 1058, 1061-63 (5th Cir. 1990), but Wasyl assumed without real
analysis that state law governed, and the Wasyl decision itself was
rightly criticized by a more recent Ninth Circuit panel when forced
to follow the earlier case. See Portland Gen. Elec. Co. v. United
States Bank Trust Nat. Ass'n as Tr. for Trust No. 1, 218 F.3d 1085,
1091 (9th Cir. 2000) (Tashima, J., concurring); id. at 1091-92(McKeown, J., specially concurring).
Whether the accounting remedy is “arbitration” under the
federal statute is the more interesting question. The answer does
not depend on the nomenclature used in the agreement, see AMF Inc.
v. Brunswick Corp., 621 F. Supp. 456, 460 (E.D.N.Y. 1985); rather,
3
See, e.g., Taylor v. United States, 495 U.S. 575, 590-92
(1990) (definition of "burglary" in 18 U.S.C. § 924(e) providing
sentencing enhancement for possession of a firearm); NLRB v. Hearst
Publ'ns, 322 U.S. 111, 120-123 (1944) (definition of "employee"
under the National Labor Relations act); Jerome v. United States,
318 U.S. 101, 104-05 (1943)(definition of "felony" under the Bank
Robbery Act); cf. Rankin v. Allstate Ins. Co., 336 F.3d 8, 12 n.3
(1st Cir. 2003)(waiver issues involving the Federal Arbitration Act
to be determined by federal, not state, law).
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the question is how closely the specified procedure resembles
classic arbitration and whether treating the procedure as
arbitration serves the intuited purposes of Congress. For example,
other circuits (defensibly, in our view) have declined to treat an
agreement for non-binding arbitration as "arbitration" within the
meaning of the Act. See Dluhos v. Strasberg, 321 F.3d 365, 371 (3d
Cir. 2003); Harrison, 111 F.3d at 349-52. But see Wolsey, Ltd. v.
Foodmaker, Inc., 144 F.3d 1205, 1208-09 (9th Cir. 1998).
By contrast, in our case, the purchase agreement makes
the Price Waterhouse remedy “final” (whether any more final than
ordinary arbitration is doubtful but need not be decided now), and
other common incidents of arbitration of a contractual dispute are
present: an independent adjudicator, substantive standards (the
contractual terms of the pay-out), and an opportunity for each side
to present its case. See General Motors Corp. v. Pamela Equities
Corp., 146 F.3d 242, 246 (5th Cir. 1998); Harrison, 111 F.3d at
350; AMF Inc., 621 F. Supp. at 460. To us, this is arbitration in
everything but name.4
In one respect, the accounting remedy departs from a
common feature of many arbitrations. The district court found that
4
Selecting an expert to handle arbitration is by no means
uncommon. E.g., Rosenberg v. Merrill Lynch, Pierce, Fenner &
Smith, Inc., 170 F.3d 1, 8 n.4 (1st Cir. 1999); Merit Ins. Co. v.
Leatherby Ins. Co., 714 F.2d 673, 679 (7th Cir.), cert. denied 464
U.S. 1009 (1983).
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the purchase agreement refers to Price Waterhouse for its
resolution only the accounting issues and not the operational
disputes that affect the pay-out. So, unlike many arbitrations,
this limited reference cannot resolve the whole, or even the
greater part, of the controversy between the parties. In
consequence, a reference does not fully spare the court’s
resources, and it creates a two-track proceeding even as to claims
of breach of contract.
Yet arbitrations sometimes do cover only a part of the
over-all dispute between the parties. E.g., Coady v. Ashcraft &
Gerel, 223 F.3d 1, 4 (1st Cir. 2000); McDonnell Douglas Fin. Corp.
v. Pa. Power & Light Co., 858 F.2d 825, 831-33 (2d Cir. 1988). If
this adds to the procedural complexity, it may still provide a
swifter (and depending on the arbitrator a more expert) answer to
the questions that are arbitrated. References to agencies under
the somewhat analogous primary jurisdiction doctrine sometimes
comprise only a single narrow issue referred to the agency before
the federal law suit goes forward. See, e.g., U.S. Pub. Interest
Research Group v. Atl. Salmon of Me., LLC, 339 F.3d 23, 34 (1st
Cir. 2003); Mass. v. Blackstone Valley Elec. Co., 67 F.3d 981, 992
(1st Cir. 1995).5
5
Our conclusion makes it unnecessary to consider Bally's
alternative argument that the failure to order resort to the
accountant is appealable under 28 U.S.C. § 1292(a)(1)(2000), giving
appellate jurisdiction over "orders that grant or deny injunctions
and orders that have the practical effect of granting or denying
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Arbitrability of the issues. Having confirmed our
jurisdiction over the appeal, we turn next to the question whether
the district court correctly construed the purchase agreement when
it referred to Price Waterhouse only the accounting issues and
retained the remaining misconduct charges for itself. The district
court’s bifurcation might at first surprise a reader given to
literalism; but it rests on a realistic parsing of the purchase
agreement and is ultimately correct.
The pertinent language of the purchase agreement, quoted
more fully above, says that "any disagreement with respect to the
Advance Earn-Out Schedule or the Earn-Out Schedule" will, if
unresolved after the protest notice, be referred to the accountants
for a "final" determination. The operational misconduct could,
just like ordinary accounting errors, alter the figures in the two
schedules and reduce the pay-out. So, Bally seemingly argues,
whether operational misconduct occurred is for the accountants to
decide.
injunctions and have 'serious, perhaps irreparable, consequence.'"
Gulfstream Aerospace Corp. v. Mayacamas Corp., 485 U.S. 271, 287-
288 (1988)(quoting Carson v. Am. Brands, Inc., 450 U.S. 79, 84,
(1981)). The case law on this subject is complicated. See
generally Gulfstream Aerospace Corp., 485 U.S. at 279-88; Tejidos
de Coamo, Inc. v. Int'l Ladies' Garment Workers' Union, 22 F.3d 8,
10-11 (1st Cir. 1994). Compare Kan. Gas & Elec. Co. v. Westinghouse
Elec. Corp., 861 F.2d 420, 422 (4th Cir. 1988), and Nordin v.
Nutri/System, Inc., 897 F.2d 339, 342 (8th Cir. 1990) (appealable
under 28 U.S.C. § 1292(a)(1)), with DSMC Inc. v. Convera Corp., 349
F.3d 679, 682 (D.C. Cir. 2003), and Cent. States v. Cent. Cartage
Co., 84 F.3d 988, 990-92 (7th Cir.), cert. denied, 519 U.S. 912(1996) (not appealable).
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Absent admissible extrinsic evidence bearing upon intent,
a court in interpreting disputed contract language asks what
reasonable persons in the position of the parties would ordinarily
have intended by using the words in question in the circumstances.
2 Farnsworth on Contracts §§ 7.9, 7.10 (3d ed. 2004), a view
followed in Illinois; Horbach v. Kaczmarek, 988 F. Supp. 1126, 1129
(N.D. Ill. 1997); Tatar v. Maxon Constr. Co., 294 N.E.2d 272 (Ill.
1973). By this test, referring the operational issues to the
accountants makes no sense.
The phrase "any disagreement" refers to earning schedules
whose components are defined in detail in the purchase agreement in
accounting terms: specifically, the EBITDA formula for earnings of
the eight centers before certain other costs (e.g., interest,
taxes, depreciation) are taken into account. And, the unresolved
disagreements are to be referred to "accountants." In context, it
therefore makes most sense to read "any disagreements" as referring
to disagreements about accounting issues arising in the
calculations that underpin the schedules.
Conversely, it makes no sense to assume that accountants
would be entrusted with evaluating disputes about the operation of
the business in question. Yes, operational misconduct may well
affect the level of earnings and therefore the schedules, but the
misconduct itself would not be a breach of proper accounting
standards. Nor would one expect accountants to have special
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competence in deciding whether business misconduct unrelated to
accounting conventions was a breach of contract or any implied duty
of fair dealing.
Thus, the accounting treatment of new membership sales
was correctly regarded by the district court as an issue properly
reserved for Price Waterhouse; but whether Bally had manipulated
the phone system to divert calls from the eight centers to other
Bally centers involves not an accounting question but contract
interpretation and judgments about reasonable business practices.
Whether specific issues fall on one side or the other of the
dividing line could be disputed; but on this appeal Bally has
attacked only the district court's general bifurcation approach and
not its classification of particular misconduct claims.
The district court's reading is supported by at least
four different cases in which clauses directing certain disputes to
accountants were read as implicitly limited to accounting issues.6
In two of the cases, the precise phrasing of the clauses made this
conclusion even easier to reach than it is in the present case, see
Blutt v. Integrated Health Servs., Inc., No. 96 CIV. 3612 LLS.,
1996 WL 389292, at *2 (S.D.N.Y. July 11, 1996); United Steelworkers
6
Blutt v. Integrated Health Servs., Inc., No. 96 CIV. 3612
LLS., 1996 WL 389292 (S.D.N.Y. July 11, 1996); Powderly v.
MetraByte Corp., 866 F. Supp. 39 (D. Mass. 1994); United
Steelworkers of Am. v. Nat'l Roll Co., No. 89-1491, 1990 WL
10043689 (W.D. Pa. May 3, 1990); Parker v. Twentieth Century-Fox
Film Corp., 173 Cal. Rptr. 639 (Cal. Ct. App. 1981).
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of Am. v. Nat'l Roll Co., No. 89-1491, 1990 WL 10043689, at *2 n.1
(W.D. Pa. May 3, 1990), but the other two decisions are not very
far from our own. In all events, if the Red Sox' sports announcer
says that the batter hit the ball out of the park, everyone knows
that a baseball is implied.
Bally relies principally upon Mayfair Constr. Co. v.
Waveland Assocs. Phase I Ltd. P'ship, 619 N.E.2d 144 (Ill. App. Ct.
1993). There the court read contract language as requiring the
submission to an architect (essentially for non-binding
arbitration) of disputes about schedule extensions and cost
increases in the construction of a building. Id. at 146-53. The
case gives Bally a bit of support but not too much.
The need for extensions of time for construction and
resulting cost effects of delay are arguably matters within the
normal competence of an architect. Further, the clause in Mayfair
explicitly directed that the architect "will be the interpreter of
the requirements of the Contract Documents and the initial judge of
the performance thereunder by both the Owner and Contractor. . . .
In his capacity as interpreter and judge, he will endeavor to
secure faithful performance by both the Owner and Contractor." Id.
at 147. Mayfair is thus quite distinguishable.
This brings us to Bally's alternative claim, in its
petition for reconsideration to the district court, that the
Chicago arbitration alters the situation and calls for deferral of
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the court-retained claims in favor of the Chicago proceeding.
Bally has two versions of this argument. In the "strong" version,
Bally argues that the general arbitration clause in the employment
agreement covers the claims made by Laird and Baker in the court
case. The short answer is that it does not.
The arbitration clause says that "[a]ny controversy or
claim arising out of or relating to this Employment Agreement, or
the breach thereof, shall be settled by arbitration" as specified
in the agreement. The "arising out of" language is plainly
inapplicable; the complaint itself makes clear that all of the
claims in the district court case arise out of supposed breaches of
the purchase agreement, its implied covenant of fair dealing and
associated statutory duties.
The "relating to" language is more vague, and therefore
potentially broader, but if no proceedings had been begun in
Chicago, no one would claim that district court case involved a
claim "relating to" the employment agreement. It would be a far
more normal use of words to say that such a claim was related to
the purchase agreement whose alleged breach is the umbrella cause
of action in the district court. That the same misconduct could
also play a role in the Chicago arbitration is a different matter
to which we return below.
Bally says that the distinction between the two
agreements is artificial. It points out that the employment
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agreements were referenced in, and required by, the purchase
agreement; that the earn-out opportunities provided by the latter
were related to the plaintiffs' continued employment; and that the
integration clause in the purchase agreement refers to the purchase
agreement and documents referred to in it as comprising the
complete and exclusive agreement between the parties.
These inter-relationships are real but the juxtaposition
of the two documents hurts Bally more than it helps it. The two
agreements do comprise understandings related to the same business
sale and, in interpreting the documents, one provides context for
the other. But the two documents deal with different aspects of
the sale (asset purchase and subsequent employment). No one can
seriously argue that clauses can be plucked at random from one
agreement and inserted into the other.
The general arbitration clause appears only in the
employment agreements and refers to disputes arising under or
related to that agreement. Further, not only is such a clause
omitted from the purchase agreement (although it would have been
child's play to insert it there) but the purchase agreement has
instead a different, and narrower, dispute resolution process
relying on the accountants; that process would be redundant--
indeed, inconsistent--if the same matter were covered by the
general arbitration clause in the employment agreement.
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The Rosenblum decision is more or less on point,
Rosenblum v. Travelbyus.com Ltd., 299 F.3d 657 (7th Cir. 2002).
There a business sale and employment agreement were paired and,
when the seller sued under the sale agreement for failure to pay,
the buyer invoked the arbitration clause of the employment
agreement. Id. at 659-665. The Seventh Circuit rejected the
attempt. In language no less applicable here, the court said:
"Generally, one instrument may incorporate
another instrument by reference." Turner
Constr. Co. v. Midwest Curtainwalls, Inc., 543
N.E.2d 249, 251 (Ill. App. Ct. 1989). "The
contract must show an intent to incorporate
the other document and make it part of the
contract itself." Id. "When determining
under Illinois law whether something is
incorporated into a contract, we limit our
inquiry to the four corners of the contract."
Atl. Mut. Ins. Co. v. Metron Eng'g & Constr.
Co., 83 F.3d 897, 901 (7th Cir. 1996). . . .
None of the [] provisions relied upon by the
district court incorporates the Employment
Agreement by reference. There is no doubt
that the Acquisition Agreement refers to the
Employment Agreement, but there is no
"intention to incorporate the document and
make it a part of the contract" on the face of
the Acquisition Agreement itself. . . . A
merger clause does not incorporate other
contracts by reference, rather, a merger
clause negates the impact of earlier
negotiations and contract drafts, and states
that the written contract is the complete
expression of the parties' agreement.
Id. at 664-65.
A pair of Fifth Circuit cases invoked by Bally did
transpose arbitration clauses among contemporaneously executed
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related contracts, but the cases are distinguishable, especially
because in our case each agreement has its own dispute resolution
process. Personal Sec. & Safety Sys. Inc. v. Motorola Inc., 297
F.3d 388, 392-93 (5th Cir. 2002); Neal v. Hardee's Food Systems,
Inc., 918 F.2d 34, 36-37 (5th Cir. 1990). Further, both the
Seventh and Fifth Circuits said they were applying state law in
construing the scope of their respective contracts, Rosenblum v.
Travelbyus.com Ltd., 299 F.3d at 662 n.2; Neal, 918 F.2d at 37 &
n.5, and as between Illinois and Texas law, the former is the
governing law in our own case so far as the substance of the
agreement is concerned.
Alternatively (this is the “weak” version of Bally's
argument), Bally says that, even if its incorporation argument
fails, Laird and Baker have affirmatively "elected" arbitration as
to those misconduct issues that they have themselves raised in the
Chicago proceeding by answer and counterclaim. These include some
but not all of the issues retained by the district court. The
district court said briefly in its order on reconsideration that
the plaintiffs' answer and counterclaim in the Chicago arbitration
proceeding was not a waiver of their right to proceed in the
district court.
The terms “election” and “waiver” are used in various
ways by the cases, in different contexts, and are often used for
conclusion rather than analysis. In some recurring situations, the
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labels are easy to apply–-for example, one who has an option to
arbitrate or sue and chooses to arbitrate ordinarily makes an
election that cannot be rescinded after an unfavorable result.
E.g., Kiernan v. Piper Jaffray Cos., 137 F.3d 588, 594 (8th Cir.
1998). The present case is less straightforward.
Laird and Baker did not initiate the arbitration: the
Chicago proceeding was begun by Bally after the court case had
started and was directed at a different agreement than was the
court case. Still, plaintiffs have sought to make certain of the
misconduct claims in the court case do double duty as defenses or
counterclaims in the arbitration. This overlap, which is the
source of several problems, is the linchpin of the Bally’s election
or waiver argument.
To the extent that Laird and Baker could without
prejudice to their interests in the arbitration have withheld these
misconduct allegations from the Chicago proceeding, their choice to
assert them in the arbitration might be treated by a court as an
election or waiver of the right to present them in court. But to
the extent that failing to assert them meant that arguable defenses
in the arbitration would be foregone, or possible damage claims for
breach of the employment contract would be precluded in the
arbitration, the answer and counterclaim were compelled by Bally’s
own choice to pursue arbitration.
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To us, it seems likely that any defense to Bally’s claims
in arbitration would have to be presented there or be forfeit;
whether plaintiffs were also effectively compelled to assert
matching counterclaims is less clear. But given the breadth of the
arbitration clause, the start of arbitration by Bally, and the
opportunity for Laird and Baker to assert their damage claims in
arbitration, it would have been a foolish lawyer who told them that
they could safely withhold the misconduct charges from their answer
and counterclaim.
This threat of prejudice would not necessarily preclude
treating the defense and counterclaim as an election of arbitration
over the court suit; we are dealing with judicial policy not self-
executing labels. But it is less clear what judicial policy ought
to be where, as here, a misconduct issue turns out to be common
both to an arbitrable dispute (as to one agreement) and to a
judicial dispute (as to another) that was never the subject of an
arbitration agreement. The Federal Arbitration Act favors
arbitration; but only as to what the parties have agreed to
arbitrate. Restoration Pres. Masonry, Inc. v. Grove Europe Ltd.,
325 F.3d 54, 60 (1st Cir. 2003).
Nor is it clear that economy would be served by deferring
to arbitration as to the overlapping issues. For several reasons,
arbitration is less likely to yield findings that resolve common
issues under res judicata doctrine; arbitrators do not always make
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explicit findings and whether findings by an arbitrator bind a
court faced with the same issue and parties but a different claim
is less than crystal clear. See generally 18B Wright, Miller, and
Cooper, Federal Practice and Procedure § 4475.1 (2d ed. 2002).
Bally cites two cases to support its claim of waiver or
election but both can readily be distinguished. In both cases the
party seeking to litigate had initially elected arbitration and
only sought to bring the case to court when the arbitration seemed
to be going against them. Kiernan, 137 F.3d at 594; Nghiem v. NEC
Elec., Inc., 25 F.3d 1437, 1440 (9th Cir.), cert. denied, 513 U.S.
1044 (1994). There, the policies supporting waiver or election
apply with full force; in our case they do not.
To sum up, on these facts we think that the argument for
waiver or election is weak and the district court was right to
reject it. The court case was filed first, plaintiffs were more or
less forced to answer and counterclaim in the arbitration, and the
fact that only some of the issues overlap makes two proceedings
inevitable. In these circumstances--and without prejudice to the
authority of the trial judge to manage the case before him--we do
not see why the arbitration should have an invincible and automatic
priority in the decision of common issues.
Absent more help and reflection, we decline to lay down
general rules for situations where a court case and an arbitration
address distinct legal claims but common issues of fact or
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characterization. The range of possible situations is great and
the precedents bearing on the overlap problem scarce. More
experience may generate useful rules, but for now an ad hoc
judgment based on the circumstances of this peculiar case will have
to do.
Affirmed.
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