In re Stone Res., Inc., Bankruptcy No. 11-11124-MDC
| Decision Date | 04 May 2017 |
| Docket Number | Bankruptcy No. 11-11124-MDC |
| Parties | In re: Stone Resources, Inc., Debtor. |
| Court | U.S. Bankruptcy Court — Eastern District of Pennsylvania |
On April 28, 2015, this Court held a hearing (the "Hearing") to address the Motion for Orders of Determination of Outstanding Motions dated February 26, 2015 [Docket No. 398] (the "Motion"), filed by Gary F. Seitz, Chapter 7 Trustee for the Estate of Stone Resources, Inc. (the "Chapter 7 Trustee"). The Motion sought adjudication of three motions that were originally addressed by this Court at a hearing held on May 23, 2012 (the "Initial Hearing," collectively with the "Hearing," the "Hearings"), but were not adjudicated due to the entry, by this Court, of an Order dated November 6, 2012 [Docket No. 315] (the "Suspension Order"), that suspended the bankruptcy case of Stone Resources, Inc. (the "Debtor") pending the resolution of the Debtor's then-pending appeal to the Third Circuit.
The three motions are: (1) Motion for an Order Prohibiting Compensation and the Disgorgement of Funds dated February 1, 2012 [Docket No. 141] (the "Disgorgement Motion"), filed by MarbleLife, Inc. ("MarbleLife");1 (2) a Motion to Pay Compensation to Joseph T. Smith ("Mr. Smith") dated February 15, 2012 [Docket No. 157] (the "Compensation Motion"); and (3) a Motion to Disqualify Debtor's Counsel dated March 2, 2012 [Docket No. 178] (the "Disqualification Motion"), filed by the United States Trustee (the "US Trustee"). As agreed by the parties at both of the Hearings, this Court must address the Disqualification Motion prior to addressing the other motions.
For the reason elaborated below, this Court will deny the Disqualification Motion. While therepresentation of the Debtor by Paul J. Winterhalter ("Mr. Winterhalter") raises concern for the Court,2 this Court does not believe, and the US Trustee did not argue, that Mr. Winterhalter should be disqualified based upon any alleged failure to abide by his obligations to this Court and to his client. See, e.g., In re Gress, Bky. No. 13-06202, 2015 WL 1744165, *3-4 (Bankr. M.D. Pa. Apr. 14, 2015) (). While the behavior of Mr. Winterhalter may be reason for this Court to revisit other matters,3 this Court does not find that his dual representation implicates a disqualifying conflict.
This dispute is one of many skirmishes resulting from the execution of a Franchise Agreement dated April 3, 2000 (the "Franchise Agreement"), by and between MarbleLife, as franchisor, and the Debtor, as franchisee. Pursuant to the Franchise Agreement, the Debtor obtained the right to operate as a "MarbleLife" franchisee within a specific geographic area that included certain areas of Pennsylvania, New Jersey and Delaware. In return, the Debtor agreed to be abide by certain obligations, including a noncompetition agreement and confidentiality agreement (the "Restrictive Covenants"), that becameeffective upon the expiration or termination of the Franchise Agreement. Mr. Smith, as the Debtor's principal and sole shareholder, separately agreed to be bound by the restrictive covenants contained within the Franchise Agreement.
By its terms, the Franchise Agreement was scheduled to terminate upon April 3, 2010. For whatever reason, the Debtor did not seek to renew the Franchise Agreement. Upon termination, MarbleLife immediately informed the Debtor and Mr. Smith of its intent to enforce the Restrictive Covenants and to install a new franchisee within the Debtor's former geographic area. Rather than cease operations as required by the terms of the Franchise Agreement, the Debtor through Mr. Smith continued to operate. See, e.g., In re Stone Resources, Inc., 458 B.R. 823, 827 (E.D. Pa. 2011) ().
The 10-2480 District Court Proceeding
To enforce the non-compete provisions of the Franchise Agreement, MarbleLife filed a complaint dated May 21, 2010, in the Eastern District of Pennsylvania, Civ. No. 10-2480, seeking injunctive relief against the Debtor (the "2480 Litigation"), naming the Debtor as the sole defendant. Simultaneously, MarbleLife filed a Motion for a Preliminary Injunction dated May 21, 2010 [Docket No. 6, Civ. No. 10-2480]. In response, the Debtor argued that the Franchise Agreement in general and Restrictive Covenants in particular were not enforceable because MarbleLife had fraudulently induced the Debtor to agree to the terms of the Franchise Agreement. Specifically, the Debtor argued that MarbleLife had misrepresented the nature of its ownership of certain patents governing MarbleLife's business practices and that these alleged misrepresentations served as a defense to the enforcement of the Restrictive Covenants.
After holding a three-day hearing that commenced on December 7, 2010, to address MarbleLife's request for a preliminary injunction, the District Court entered a preliminary injunction on December 23, 2010 (the "First Injunction Order"). Pursuant to the First Injunction Order, the District Court ordered the Debtor to immediately undertake certain acts, including but not limited to, the cessation of the Debtor's use of the MarbleLife trademark, the delivery of a list of the Debtor's existing customers since May 2000 including all invoices for such customers, and the transfer of certain business phone numbers toMarbleLife. In addition, the Debtor was ordered to cease and desist from engaging, participating or assisting in any business that provides certain stone restoration and refinishing services. The Debtor subsequently filed a motion for reconsideration as well as requested the District Court to set a bond for the preliminary injunction. In response, the District Court entered a second order on February 11, 2011, docketed on February 14, 2011 (the "Second Injunction Order") (collectively with the first, the "Injunction Orders"), denying the Debtor's motion for reconsideration. Shortly after the Second Injunction Order, the Debtor filed its Chapter 11 petition on February 16, 2011 (the "Petition Date"). As a result of the Debtor's filing for Chapter 11 relief, the 2480 Litigation was placed in civil suspense pursuant to an Order dated February 28, 2011.
The Debtor's Bankruptcy
On February 16, 2011, the Debtor filed a voluntary petition for Chapter 11 relief. Seven days later, MarbleLife filed a motion requesting that this Court, on an expedited basis, issue an order dismissing the Debtor's bankruptcy petition or, in the alternative, granting MarbleLife relief from the automatic stay to enforce the Injunction Orders. As elaborated by this Court's Memorandum Opinion dated March 28, 2011,4 this Court denied MarbleLife's motion.
The Initiation of District Court Contempt Proceedings
Despite the placement of the 2480 Litigation in civil suspense, MarbleLife filed in that action a Motion for Contempt dated April 1, 2011 [Docket No. 61, Civ. No. 10-2480] (the "First Contempt Motion"), requesting the District Court find Mr. Smith, and not the Debtor, in civil contempt of the District Court's Second Injunction Order. MarbleLife did not seek to enforce the Injunction Orders against the Debtor. Mr. Winterhalter filed a Response dated April 15, 2011 [Docket No. 62, Civ. No. 10-2480], on behalf of Mr. Smith, "individually and as the sole corporate fiduciary on behalf of Stone Resources, Inc." As argued by the US Trustee, Mr. Winterhalter's representation of Mr. Smith commenced as of the filing of this pleading. In addition, the US Trustee argues that this filing triggered the existence of the alleged conflict that warrants Mr. Winterhalter's disqualification.
After considering the parties' arguments, the District Court entered an Order dated April 25, 2011 [Docket No. 63, Civ. No. 10-2480] (the "First Contempt Order"). In its First Contempt Order, the District Court observed:
[T]his case presents a situation where Smith, although not a party to this action, is the real party defendant. Here, Smith is the sole shareholder, director and officer of Stone Resources. The Court appreciates that Smith is independently bound by the non-compete provision, however, for all intents and purposes the issuance of a civil contempt order against Smith would be the functional equivalent as issuing the order against Defendant, as Stone Resources would be forced to indemnify Smith... Any judgment against Smith would in effect be a judgment against Defendant and would be in direct conflict with the mandates of §362.
First Contempt Order, n.1 (emphasis added).
The 11-2526 District Court Proceeding
In response to this Court's Order denying MarbleLife relief to enforce the Injunction Order, and while MarbleLife's First Contempt Motion remained pending in the 2480 Litigation, MarbleLife filed a Certificate of Appeal dated April 12, 2011, in the Eastern District of Pennsylvania, Civ. No. 11-2526, seeking review by the District Court of this Court's decision to deny relief from the automatic stay (the "2526 Litigation"). After hearing oral arguments on June 11, 2011, the District Court entered an Order dated June 24, 2011, upholding this Court's denial of MarbleLife's request to dismiss the Debtor's bankruptcy case and reversing this Court's determination that the Injunction Orders were subject to the automatic stay.5 In addition, the District Court modified its Order dated February 11, 2011, entered in the 2480 Litigation to, inter alia, extend the term of the injunction preventing the Debtor from operating.
In addition to its review of this Court's Order denying MarbleLife relief from the automatic stay, the District Court took the opportunity to make a series of factual findings relating to the Debtor's compliance with the Injunction Orders. Among the District Court's findings, the District Court determined that the Debtor had ...
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