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In re Stingfree Technologies Co.

March 31, 2010

IN RE: STINGFREE TECHNOLOGIES COMPANY
STINGFREE TECHNOLOGIES COMPANY, APPELLANT
v.
AMERIC INVESTMENTS CAPITAL COMPANY; VI CAPITAL COMPANY; LISA VITO; AND ROBERT A. VITO, APPELLEES
FONIKA VENTURES, LLC, MOVANT



The opinion of the court was delivered by: James Knoll Gardner, United States District Judge

BKY NO. 08-16232(bif)

OPINION

This matter is before the court on the Notice of Appeal dated February 16, 2009 by debtor-appellant StingFree Technologies Company ("StingFree"), by which StingFree appeals the February 4, 2009 Order and accompanying Memorandum of United States Bankruptcy Judge Bruce Fox ("Memorandum") dismissing StingFree's Chapter 11 bankruptcy proceeding.*fn1

Also before the court is the Motion of Fonika Ventures, LLC to Intervene, which motion was filed June 17, 2009.*fn2

On January 12, 2010, I heard oral argument on the entire matter, including the motion to intervene, and took the matter under advisement.*fn3 Hence this Opinion. For the reasons articulated below, I deny Fonika's motion to intervene, and I affirm the Order of the bankruptcy court.

JURISDICTION

This Court has subject matter jurisdiction over this bankruptcy appeal pursuant to 28 U.S.C. § 158(a)(1).

FACTS AND PROCEDURAL HISTORY

The facts and procedural history herein are gleaned from the February 4, 2009 Order and accompanying Memorandum of the bankruptcy court, the record of this matter, and, to the extent they are in agreement, the briefs of the parties.*fn4

Appellee Robert Vito previously served as president, chief executive officer, and chairman of the Board of StingFree, a Pennsylvania corporation which owned and developed patents for technology designed to reduce or absorb undesirable shock vibrations when using golf clubs. The company was originally formed by Dr. Thomas Fallone and Dr. Carmen DiMario as Pendulum Corp.

In June 2001, Drs. Fallone and DiMario formed a new Pennsylvania corporation called Inner Core, which purchased the patent rights held by Pendulum, changed the name in 2003 to Stingfree, and renamed the corporation in 2005 as StingFree Technologies.*fn5 StingFree operated from a basement office at the home of Mr. Vito and his wife, Lisa Vito (appellees "the Vitos"). The Vitos charged StingFree rent.*fn6

StingFree hired an accountant, Christopher Nawn, CPA, to review its books and records. Mr. Nawn issued a report in January 2008 based on his review of limited corporate records. Also in January 2008, StingFree replaced Mr. Vito with Richard Rudinger as its chief executive officer and board chairman. Litigation ensued, involving Mr. Vito, StingFree, Mr. Rudinger, and StingFree director Dr. Thomas Fallone.

Ultimately, the Vitos and StingFree entered into a "Stock Redemption, Separation and Settlement Agreement" ("Settlement Agreement") dated February 29, 2008.*fn7 The bankruptcy court summarized the Settlement Agreement, in part, as follows.*fn8

This agreement provided for the Vitos to sell 68,219,000 shares of Stingfree stock titled in their names (and to transfer 6,460,000 options to purchase stock) to Stingfree for $3,900,000, plus the assumption by Stingfree of certain corporate debts payable, or otherwise guaranteed, by the Vitos. The Vitos received a promissory note in this amount, with payments to be made at three stated intervals over roughly a 25-month period, from February 29th. The first payment of $1 million was due by May 19, 2008. The promissory note contained a confession of judgment provision.

The Settlement Agreement also provided that Mr. Vito would resign immediately as Stingfree's president; a June 2006 employment agreement between Stingfree and Mr. Vito was terminated immediately; and Mr. Vito agreed not to compete with Stingfree for 12 months and to keep confidential corporate information. Furthermore, the two pending lawsuits involving Stingfree and the Vitos were to be withdrawn. A mutual release attached to the settlement agreement was signed that included all claims "in law or equity which the Releasors ever had, [or] now have...."

The settlement agreement also recited that Stingfree was the sole owner of its patents. However, as security for promised payments from the corporation, the Vitos received a pledge of the stock being sold to the corporation as well as a "first lien security interest in the patents held by the Company on the date hereof," along with an assignment of patent rights.*fn9 The Vitos also promised to return all property belonging to StingFree including, but not limited to, all corporate records, including "corporate accounting records, corporate bank account statements, [and] corporate correspondence".*fn10

The Settlement Agreement included a mandatory arbitration clause, which provided, in part, that "[a]ny controversies or disputes arising out of or relating to this Agreement shall be resolved by binding arbitration in accordance with the then current Commercial Arbitration Rules of the American Arbitration Association."*fn11

Additionally, the Settlement Agreement contained a section titled "Default", which provided, in part, that "A default under the terms of any of the Transaction Agreements shall be considered a default under all such agreements. All defaults, except monetary defaults, are curable, and if not so cured shall be resolved according to the Dispute Resolution Section herein."*fn12

The bankruptcy court found that Mr. Vito delivered certain boxes of records and materials that Mr. Rudinger found deficient, and that digital copies of corporate financial records had been altered since their original entries. The bankruptcy court further found that StingFree refrained from seeking further investors "because it considered the corporation's financial records unauditable...and because recent tax returns had not been filed for the debtor."*fn13

The bankruptcy court found that on March 28, 2008, StingFree sent the Vitos a notice of default under the terms of the Settlement Agreement. The Vitos responded that they had cured any alleged defaults, which StingFree rejected, and sent their own notices to StingFree when they did not receive their $1 million payment by the extended deadline of May 31, 2008. Thereafter, the Vitos confessed judgment against StingFree in Pennsylvania state court in the amount of $4.11 million, and recorded that judgment in California and possibly Maryland.*fn14

The bankruptcy court further found that, as part of the Settlement Agreement, the Vitos recorded the patent assignment obtained with the United States Patent Office on July 9, 2008, and have been attempting to market and license those patents.*fn15

StingFree filed a petition to strike the Vitos' confessed judgment in Pennsylvania state court and sought, unsuccessfully, in state court to enjoin the Vitos from using the patents, pending the outcome of its petition to strike the confessed judgment. As part of its petition, StingFree asserted that the Vitos' claims against them were subject to arbitration.*fn16

StingFree filed a Chapter 11 bankruptcy petition on September 25, 2008, just prior to a hearing on StingFree's state court petition to strike the confessed judgment. The bankruptcy court found that, at the time of its bankruptcy filing, StingFree was conducting business and had only two part-time employees, neither of whom was being paid. At the time, StingFree had two directors, one of whom has since resigned.*fn17

The bankruptcy court notes that StingFree stated in its post-bankruptcy "Small Business Statement of Operations" that it has received no income nor made any disbursements since the bankruptcy filing; that its bankruptcy schedules disclose no real property; and that StingFree leases no business location. Its assets included one outstanding receivable at the time of the bankruptcy filing, in the amount of $60,000; a bank deposit of $4,810; unknown value for licensing agreements with Lamkin Corporation; unknown value for its alleged claims against the Vitos; and a valuation of $300,000 for the patents, trademarks and other intellectual property rights.*fn18

In August 2008, Mr. Rudinger decided to attempt to sell the patent rights and communicated with an attorney, who formed Fonika Ventures, LLC as a vehicle to purchase StingFree's intellectual property and negotiated a purchase price of $300,000. The bankruptcy court found that two of Fonika's members are Dr. DiMario and Dr. Fallone, as well as a few other StingFree shareholders, but that the majority membership interests in Fonika are not owned by StingFree's shareholders.*fn19

The bankruptcy court further found that StingFree's patent valuation of $300,000 is based on the September 23, 2008 sales agreement between Fonika and StingFree, and not on an appraisal of the patent rights. Moreover, the bankruptcy court notes that the sales agreement expressly contemplates that StingFree would file a bankruptcy petition and obtain the bankruptcy court's approval to sell the patent rights free and clear of all claims, interests and liens.*fn20

The bankruptcy court also made the following findings:

(1) Fonika has offered employment to Mr. Rudinger and Dr. DiMario, in the event Fonika successfully purchases the patents; (2) upon the sale of the patents, StingFree intends to use the sale proceeds to fund litigation against the Vitos rather than to continue operations; (3) StingFree lacks sufficient funds to engage counsel in filing bankruptcy; and (4) StingFree used a $35,000 down payment from Fonika to retain counsel and pay the requisite bankruptcy filing fees.*fn21

The bankruptcy court further found that, within a week of filing its bankruptcy petition, StingFree filed a motion to approve the sale of substantially all of its assets (the patent rights) to Fonika, as well as a motion to approve bidding procedures. On October 17, 2008, less than one month after the filing of the bankruptcy petition, StingFree filed a complaint against the Vitos, docketed as Adv. No. 08-0290 (the "adversary action"), and the complaint was soon amended.

The thirteen-count amended complaint in the adversary action alleges, inter alia, that as president and chief executive officer of StingFree, Mr. Vito diverted StingFree revenues and capital investments for his own benefit; obtained company stock improperly and without board of director authorization; failed to provide full and complete company records after his removal as controlling officer in January 2008; and falsified company records.*fn22

The amended complaint alleges that StingFree entered into the Settlement Agreement "without knowledge of the full extent of Robert Vito's fraud and in reliance on representations made by the Vitos regarding the management and financial operations of the company, that would later prove to be false."*fn23

It further alleges that the Vitos breached the settlement agreement by failing to provide all of StingFree's books, records, inventory and supplies; that the Vitos "secretly modified" the Settlement Agreement after it had been presented to StingFree for execution; and that Mr. Vito had destroyed company records.*fn24

The amended complaint in the adversary action asserts two federal bankruptcy-related claims and eleven claims under Pennsylvania state law.*fn25

Bankruptcy Court Decision

By its February 4, 2009 Order and Memorandum, the bankruptcy court dismissed StingFree's Chapter 11 bankruptcy petition and denied as moot StingFree's motion to approve bidding procedures in connection with its proposed sale of its patents. Specifically, the bankruptcy court found that StingFree's petition had not been filed in good faith as implicitly required by 11 U.S.C. § 1112(b)(1).*fn26

In support of this conclusion, the bankruptcy court found that the petition was not filed to serve a valid bankruptcy purpose, but rather to gain a tactical advantage in litigation. In particular, the bankruptcy court concluded that the petition was not filed to preserve any going-concern value of StingFree because StingFree intended to liquidate its assets, is not presently an operating entity, and has no intention of resuming operations.

Moreover, the bankruptcy court concluded that StingFree's state-law claims could have been raised without the necessity of filing any bankruptcy petition, and noted that some of them already had been raised in state court. In addition, it concluded that the state-law claims fell within the scope of the mandatory arbitration provision of the Settlement Agreement.

Although StingFree contended that the Vitos had waived the contractual arbitration provision, the bankruptcy court determined that StingFree had not met its burden of establishing that a waiver had occurred. Also the court concluded that, to the extent StingFree may suffer any prejudice if arbitration were compelled, such prejudice would be insufficient to overcome the federal preference for enforcement of contractual arbitration provisison.

Thus, the bankruptcy court concluded that many of StingFree's claims in the adversary action, which action "serves as the centerpiece" of StingFree's bankruptcy case, cannot be heard in bankruptcy court.*fn27

Regarding StingFree's federal bankruptcy-related claims for preference and fraudulent conveyance, the bankruptcy court noted that those claims would not be arbitrable because they are created by the Bankruptcy Code and are to be prosecuted by a bankruptcy fiduciary. The bankruptcy court concluded that those two claims were unlikely to succeed on the merits.

Thus -- having concluded that StingFree was not a "going concern" entity; had virtually no employees, no operations, minimal tangible assets aside from the patent rights, which appeared to have been assigned to the Vitos; and had state-law claims which must be arbitrated -- Judge Fox determined that permitting StingFree's bankruptcy filing to continue for the sole purpose of litigating two bankruptcy-related ...


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