Source: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-casd-3_07-cv-00120/USCOURTS-casd-3_07-cv-00120-1/pdf.json

Nature of Suit Code: 190
Nature of Suit: Other Contract Actions
Cause of Action: 28:1332 Diversity-Breach of Contract

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-1- 07cv120

UNITED STATES DISTRICT COURT

SOUTHERN DISTRICT OF CALIFORNIA

MICHAEL EBERLE, et al.,

Plaintiffs,

CASE NO. 07-CV-120 W (WMc)

ORDER DENYING

RENEWED MOTION TO

COMPEL ARBITRATION

v.

JEFF SMITH, et al.,

Defendants.

On March 26, 2007, Defendants Jeff Smith and dX/dY Voice Processing, Inc.

filed a motion to compel arbitration of this dispute. On May 15, the court denied the

motion without prejudice. Having conducted discovery on two relevant issues, the

defendants now present a renewed motion to compel arbitration. Because Smith and

dX/dY have not met their burden to show that a contractual arbitration provision binds

Plaintiff Michael Eberle and Paramount International Telecommunications, Inc., the

court will DENY the motion.

Case 3:07-cv-00120-W-WMC Document 55 Filed 10/26/07 Page 1 of 8
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I. Background & Legal Standards

On December 11, 2006, Eberle and Paramount filed suit for breach of contract

in the San Diego Superior Court. After removing the case here, Smith and dX/dY

counterclaimed for breach of contract and fraud. The court denied the defendants’

motion to compel arbitration for two reasons. First, a December 2005 email may have

superseded the prior contract between the parties. (Order Denying Mot. to Compel

Arb’n at 2–3.) Second, the agent who signed the original agreement (dated August 15,

2003: the “2003 Agreement”) may have lacked authority. (Id. at 3–5.) But the court

permitted limited discovery on two issues: (1) whether the parties intended to

incorporate an arbitration provision in the 2005 email; and (2) whether the agent had

authority to sign the 2003 Agreement.

Under the Federal Arbitration Act, courts should uphold contractual arbitration

provisions wherever possible. Moses H. Cone Mem’l Hosp. v. Mercury Constr. Corp.,

460 U.S. 1, 24 (1983) (describing the FAA as a “declaration of a liberal federal policy

favoring arbitration agreements”). Without an agreement, however, an arbitration clause

has no effect. Thus, on a motion to compel arbitration, the court must decide whether

the agreement to arbitrate is valid and covers the dispute. See Chiron Corp. v. Ortho

Diagnostic Sys., Inc., 207 F.3d 1126, 1130 (9th Cir. 2000).

II. Discussion

The defendants argue that (1) the 2003 Agreement governs, and the 2005 email

exchange merely modified its payment terms, or (2) alternatively, the parties’ conduct

created an implied contract extending an agreement dated January 1, 2002 (the “2002

Agreement”) indefinitely. Both the 2002 and 2003 agreements included an arbitration

provision. The plaintiffs contend that the 2005 email exchange, together with terms

implied from partnership law, governed the entire relationship between the parties.

Because the parties did not intend to incorporate an arbitration provision into their

2005 contract, and they effected a novation, the court will DENY the renewed motion.

Case 3:07-cv-00120-W-WMC Document 55 Filed 10/26/07 Page 2 of 8
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-3- 07cv120

A. The terms of the 2005 email exchange do not include arbitration.

To begin, the court must decide whether the parties merely modified an existing

contract or substituted a new contract via the 2005 email exchange. If the 2005 email

exchange was a new contract, its terms did not explicitly include mandatory arbitration.

Nothing in the series of emails between Eberle and Smith evidences an intent to include

such a provision by implication either. (See Defs.’ Notice of Lodgment [NOL] Ex. 7.)

B. The parties intended to substitute, not modify, contractual obligations.

Based on the 2005 emails and surrounding facts, however, the court must

conclude that the 2005 email exchange substituted new contractual obligations for

old—whatever those may have been. Eberle and Smith discussed their prior revenuesharing agreement (id. at 2–3), their expense-sharing agreement (id. at 2, 4), and their

joint line of credit (id. at 3–4, 6, 8). Smith initiated the exchange to remedy actual or

perceived breaches of an April 13, 2005 oral agreement in New York (id. at 2, 6). Smith

states and reiterates that he will “forget about” these breaches (id. at 4) but is “NOT

willing to ‘continue’ with the way things are now—period” (id. at 7). Mainly, the text

of the emails relates to Smith’s proposals on “how to move forward” (id. at 3–4, 8–9),

either continuing their business in a different form or ending it (id. at 7, 8).

Regardless of whether the 2003 Agreement was valid, the email exchange

forecloses the argument that either party considered that agreement an essential

element of a continued business relationship. Neither party mentions it, refers to it, or

even indicates it crossed his mind. The sole reference to a specific prior agreement—the

April 13, 2005 oral agreement in New York—does not establish that the parties

intended to incorporate the arbitration clause. On the contrary, without evidence that

the parties discussed arbitration during that conversation, the court must conclude that

the only aspect of the prior agreement that survived the email exchange was Eberle’s

(unkept) promise to split the profits in half. But that is tantamount to concluding the

parties agreed to forgive breaches and enter a new contract entirely.

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-4- 07cv120

1. Each email constitutes a valid offer and counteroffer.

Accordingly, the court rejects the defendants’ argument that the December 2005

email exchange must have been a modification because it could not stand alone. (Def.’s

Mem. in Supp. of Mot. to Compel at 7.) Its terms are sufficiently precise; indeed, at

several points, Smith lays out three distinct options he finds agreeable for Eberle to

consider. An offer does not fail simply because it requires extrinsic evidence to

interpret. An offer need only confer a power of acceptance. Restatement (Second) of

Contracts § 24 (“An offer is the manifestation of willingness to enter into a bargain, so

made as to justify another person in understanding that his assent to that bargain is

invited and will conclude it.”). Smith is abundantly clear that Eberle may choose one

of several options, or no option at all. Accepting the defendants’ argument would mean

any offer requiring extrinsic evidence to interpret would fail unless the parties were

already under contract—an obvious fallacy.

2. The parties’ discussion of past breaches suggests an intent to substitute.

Further, Smith states on more than one occasion his belief that Eberle breached

the agreement then in force—whatever it may have been—and insists that Eberle has

reneged on the 50/50 agreement all along: “Anything short of [a 50/50 split] and [he]

is just not interested—because that is the deal [they were] supposed to have.” (NOL

Ex. 7 at 7.) Smith “only care[s] about getting [his] share of what [he] and [Eberle]

already agreed to.” (Id. at 3.) Thus, Eberle’s consideration for the new contract is, in

part, Smith’s forbearance, and vice-versa. According to Eberle: “If you go back to when

I made you the offer and calculate what I have put in or what I have taken out from that

time forward you will see that I am actually owed more than what I am telling you.” (Id.

at 6.) According to Smith: “[I]f we continue together, the ‘owed’ money is considered

paid back . . . . I forget about some and you forget about some.” (Id. at 4.) Further,

Smith does “want to be paid back” before he “moves forward.” (Id.) The court cannot

construe discussion of past material breaches as evidence of mere modification.

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 The defendants cite a declaration from George Demakis, an employee of Eberle’s company who drafted the purported modification. (Defs.’ Mem. in Supp. at 4 n.15.) The court concludes that testimony of a non-party drafter is irrelevant to show Eberle’s

intent.

-5- 07cv120

3. Smith’s willingness to leave the business also suggests an intent to substitute.

Finally, Smith brings up the possibility of ending the business relationship on

numerous occasions. In the first email, he states that if he doesn’t have an answer by

Sunday then he will “assume [Eberle] do[es]n’t want [their] relationship to continue.”

(NOL Ex. 7 at 9.) Also, he states that he is “not willing to continue unless [they] ARE

50/50.” (Id.) Later, he repeats his demand, as if to prove he does not intend it as an

empty threat: “If you decide that you don’t like any of the choices—that is fine—it is

up to you. If that is what you decide then my choice will be to end our relationship and

walk away. Things will be tight for us but with my voice mail business, my channel bank

business and my real estate dealings we will make it.” (Id. at 3.)

C. Factual issues do not preclude denying the motion.

A court may decide factual issues in deciding a motion to compel arbitration. See

Rosenthal v. Great W. Fin. Secs. Corp., 14 Cal. 4th 394, 406 (1996). Therefore, the

court finds that the parties intended to start afresh.1

 Having scrutinized the business

cash flow, Smith found Eberle in material breach of the 50/50 deal both parties believed

they had. He offered several alternatives to Eberle, on a take-it-or-leave-it basis. In

offering and accepting these terms, both parties agreed to “put the past behind them,”

i.e., forbear from pursuing one another for the discrepancies, and restructure the cash

flow and expense accounting for greater transparency and fairness. But the core—“nonnegotiable”—term of the agreement was the 50/50 profit-sharing arrangement.

On these facts, the court cannot construe the exchange as a mere negotiation to

modify certain terms. The parties acknowledged material breaches, altered pricing (“we

stop the 25 cents deal because we split it on the front end”), and eliminated expense

charges from a line of credit all to agree on one material term—a true 50/50 split.

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-6- 07cv120

Under California law, “when a material term in a contract is altered . . . , a new

agreement between the parties has been reached.” See Mitchell v. Am. Fair Credit

Ass’n, 99 Cal. App. 4th 1345, 1354 (2002) (invalidating an arbitration provision

included in a contract modification).

On this point, Davies Machinery Co. v. Pine Mountain Club, Inc., 39 Cal. App.

3d 18, 26 (1974), does not compare. There, the material term in the original agreement

was a sale, but the purported novation said nothing about the Smiths’ title to the

equipment. Consistent with the principle that a new contract results from a modified

material term, the court refused to extinguish a material term (the sale) without

evidence that the parties intended to modify it. In other words, the sale was the central

object of the prior contract; the payment terms were secondary. Here, by contrast, the

substituted agreement directly alters the central object of the prior contract: the profitsharing arrangement. Characterizing the substitution as affecting merely the “manner

and timing of payments” misses the point: Smith was prepared to leave because of them.

The defendants cite several cases in an effort to persuade the court otherwise.

But these cases are unavailing. Hunt v. Smyth, 25 Cal. App. 3d 807, 818 (1972), for

example, does not require clear and convincing evidence of intent to substitute rather

than modify; it states that the intent must “clearly appear” while permitting evidence

of surrounding facts and circumstances. Here, the quoted statements of intent to end

the business relationship clearly appear, and the surrounding facts and circumstances

support the court’s finding that the parties intended to create a new contract. The

parties had very recently gone over the accounting records. (NOL Ex. 7.) Smith was

so dissatisfied with the prior arrangement he had discussed it with a third party,

presumably his wife. (Id. at 7.) The parties had reduced their agreement to a standardform contract in the past, but evidently never did so on this occasion, suggesting they

consciously omitted the arbitration term. And the defendants have introduced no

evidence that the parties ever discussed arbitration, either during or after negotiations.

//

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-7- 07cv120

Columbia Casualty Co. v. Lewis, 14 Cal. App. 2d 64, 72 (1936), is entirely off

point. It requires clear and convincing evidence for an oral modification of a written

contract. Columbia says nothing until the court concludes the later agreement is

actually a modification rather than a novation—and only distracts from the issue of

intent when (as here) a written contract follows a prior written contract.

Finally, Fanucchi & Limi Farms v. United Agri Products, 414 F.3d 1075, 1083

(9th Cir. 2005), actually erodes the defendants’ position. Fanucchi reasons that even

minor changes to a contract may effect a novation if they (a) affect a party’s equity in

an asset, (b) reduce the principal on a debt, or (c) involve more than a new repayment

schedule. See id. at 1084. While it is unnecessary to offer an opinion on the parties’

status as partners—and thus, their equity stake in any partnership assets—the court

emphasizes that both Eberle and Smith believed the other owed him money. Thus, the

court must conclude the parties intended to create a new contract in which both agreed

not to pursue the other for the entire amount of the debt. Further, the nature of their

business relationship was far more complex than a debtor-creditor relationship. At a

minimum, their novation resulted in sharing at least some expenses and employees, and

jointly pursuing litigation against former clients.

In short, all available evidence of Smith’s contemporaneous intent suggests he

wanted to scrap the prior arrangement and move forward on new terms of his choosing.

While some evidence may be equivocal (the word “addendum,” the phrases “move

forward,” “I do want to continue with you”), Smith left no doubt that he was unhappy

with the status quo and would leave the business if Eberle refused to agree to his terms.

The court finds these objective manifestations of intent more persuasive than Smith’s

self-serving declarations nearly two years later, and more persuasive than the few words

and phrases consistent with an intent to modify the agreement in a few particulars.

Furthermore, the nature of the transaction defies characterization as new payment

terms. Most important, nothing suggests either party considered the arbitration clause

material. Therefore, the clause did not survive the 2005 email exchange.

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III. Conclusion & Order

For the foregoing reasons, the court hereby DENIES the defendants’ motion to

compel arbitration [Doc. No. 43].

IT IS SO ORDERED.

DATED: October 26, 2007

Hon. Thomas J. Whelan

United States District Judge

Case 3:07-cv-00120-W-WMC Document 55 Filed 10/26/07 Page 8 of 8