TexStyle, LLC v. Harry Group, Inc.

UNITED STATES BANKRUPTCY COURT
SOUTHERN DISTRICT OF NEW YORK
---------------------------------------------------------------X
In re: 	:
: 	Chapter 11
TEXSTYLE, LLC, 	:
d/b/a TexStyle Home Fashions, 	: 	Case No. 11-11686 (SMB)
:
Debtor. 	:
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TEXSTYLE, LLC, 	:
d/b/a TexStyle Home Fashions, 	:
:
Plaintiff, 	:
:
-- against -- 	: 	Adv. Proc. No. 11-02265 (SMB)
:
HARRY GROUP, INC., d/b/a JMKC 	:
EXPRESS, 	:
:
:
:
Defendant. 	:
---------------------------------------------------------------X
MEMORANDUM DECISION GRANTING IN PART
AND DENYING IN PART DEFENDANT’S MOTION
TO VACATE DEFAULT AND COMPEL ARBITRATION
A P P E A R A N C E S:
LAW OFFICES OF THOMAS M GRASSO LLC
Attorneys for Defendant Harry Group, Inc. d/b/a
JMKC Express
8 Willow Street
Cranford, New Jersey 07016-1855
Thomas M. Grasso, Esq.
Of Counsel
SILVERMANACAMPORA LLP
Attorneys for the Debtor
100 Jericho Quadrangle, Suite 300
Jericho, New York 11753
Lon J. Seidman, Esq.
Of Counsel
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STUART M. BERNSTEIN
United States Bankruptcy Judge:
TexStyle, LLC (the “Debtor”) filed a complaint, dated June 20, 2011 (the “Complaint”
(ECF Doc. # 1)),1 seeking damages and equitable relief against its former warehousing, logistics
and distribution services provider, Harry Group, Inc. d/b/a JMKC Express (the “Defendant”).
The Defendant defaulted, and now seeks to vacate its default and compel arbitration (the
“Motion”). For the reasons that follow, the motion to vacate the Defendant’s default is granted,
and the motion to compel arbitration is granted in part and denied in part.
BACKGROUND
A. 	The Prepetition Agreements
The Debtor, a Nevada limited liability company, designs, manufactures and markets
home textiles and accessories. (Complaint at ¶¶ 5, 8.) The Defendant, a Nevada corporation,
provides warehouse management and logistic services. (Affidavit of Brandon Villardi in Support
of JMKC’s Motion to Set Aside Default and to Enforce Arbitration Clause, sworn to Dec. 7,
2011 (“Villardi Affidavit”), at ¶¶ 4, 5 (ECF Doc. # 23).) In August 2010, the Debtor and the
Defendant entered into a Warehousing and Distribution Service Agreement, dated August 1,
2010 (the “Agreement”), for a term of three years.2 The Defendant agreed to maintain a
warehouse (the “Warehouse”) to store the Debtor’s goods (the “Products”), (Agreement at ¶ 1.2),
and provide certain services, which generally included maintaining and providing inventory for
1 	Unless otherwise indicated, citations to “ECF” refer to the electronic docket in this adversary proceeding.
2 	The Agreement is annexed as Exhibit B to the Declaration [of Lon J. Seidman]in Opposition to
Defendant’s Motion to Vacate Default and Compel Arbitration, dated Jan. 12, 2012 (“Seidman Declaration”) (ECF
Doc. # 28).
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the Products, processing orders and shipping and transporting the Products. (See id., Annex 1.1.)
The Debtor obligated itself to make minimum monthly payments of $85,000, plus certain
percentage increases depending on the volume of sales for a given month. (Id. at ¶ 3.1.) The
Defendant expressly recognized that “it is critical that Products be shipped on a timely basis,”
(Agreement at ¶ 5.2), agreed to allow the Debtor access, (id. at ¶ 4.1), and agreed that the
Defendant was precluded from asserting a lien, claim or right of setoff against the Products. (Id.
at ¶¶ 1.2, 3.2(c).)
The actual services required of the Defendant were detailed in Annex 1.1 to the
Agreement. The Annex included specific provisions relating to the receipt, handling and storage
of the Products, order processing and shipment. The Annex arguably dealt only with shipments
to the Debtor’s customers and did not address the delivery of the Products to a new
warehouseman following termination. Furthermore, the Annex authorized the Defendant to
assess additional charges for services that it did not cover.
The Agreement also contained an arbitration clause which stated, in pertinent part, that
“[a]ny controversy or claim under this Agreement (including, without limitation, any claim for
damages arising out of a party’s breach of any of the obligations under this Agreement) will be
settled by binding arbitration . . . .” (Id. at ¶ 6.4.) Finally, the Agreement stated that it would be
governed by Nevada law. (Id. at ¶ 6.7.)
The Defendant simultaneously executed an Acknowledgment of Security Interest and
Waiver of Liens, dated August 1, 2010 (the “Acknowledgment”), in favor of Wells Fargo Bank,
National Association (“Wells Fargo”), the Debtor’s secured lender.3 The Acknowledgement was
3 	The Acknowledgement is annexed as Exhibit C to the Seidman Declaration.
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meant “[t]o induce Wells Fargo . . . to make loans or extend financial accommodations to
TexStyle, LLC . . . .” (Acknowledgment, first sentence.) Essentially, the Defendant subordinated
any possible claim or lien against the Products to those of Wells Fargo, and generally waived its
ability to assert a lien, claim, or right of setoff against the Debtor’s goods. (See id. at ¶¶ 1, 2.)
The Debtor was not a party to the Acknowledgment but expressly consented to its terms. 4 Lastly,
the Acknowledgement was governed by Wisconsin law. (Id. at ¶ 11.)
Among other things, the Acknowledgement granted the Debtor the right, upon written
notice, to “at any time require [the Defendant] to return the Goods . . . [and] deliver the Goods as
directed in such notice immediately upon receipt of such notice . . . .” (Id. at ¶ 6.) It is not clear
whether or to what extent the Debtor could enforce these rights. The Acknowledgment also
stated that it is “intended only for the benefit of Wells Fargo and its affiliates, participants,
successors and assigns” and “may be enforced, without further act or notice of acceptance, by
Wells Fargo and its affiliates, participants, successors and assigns.” (Id. at ¶ 11.)
B. 	This Adversary Proceeding
The Debtor filed a voluntary chapter 11 petition on April 12, 2011. In or around early
June, the Debtor decided to change its warehouse and logistics provider to Global One Logistics
(“Global One”). The problems the Debtor allegedly encountered with the Defendant after it
sought to terminate the Agreement and transition to Global One led to this lawsuit. According to
the Complaint, when the Defendant learned on June 8, 2011, that the Debtor intended to switch
to Global One, the Defendant refused to transfer the Debtor’s Products unless the Debtor first
agreed to fix the amount that the Debtor would pay the Defendant for terminating the Agreement
4 	The parties provided a partially executed Acknowledgement that did not include a signed copy of the
Debtor’s consent. Neither side raised this issue, and I assume the Acknowledgment was fully executed.
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early. (Complaint at ¶ 24.) On June16th, one week after the Debtor sent the Defendant a
termination notice, representatives of the Debtor appeared at the Warehouse to work out the
transition, (id. at ¶ 30), but the Defendant denied them access to the Products, called the local
police and sought to press charges for trespassing.5 (Id. at ¶¶ 31-32.)
The Debtor filed this adversary proceeding on June 21, 2011, asserting claims sounding
in (1) turnover pursuant to 11 U.S.C. § 542, (2) breach of the Agreement and the
Acknowledgement, (3) injunction pursuant to 11 U.S.C. § 105(a), (4) equitable subordination
pursuant to 11 U.S.C. § 510(c), and (5) damages and sanctions for willful violation of the
automatic stay pursuant to 11 U.S.C. § 362. Although the Complaint refers to the June 16th
incident, (Complaint at ¶¶ 30-32), the gravamen of the Debtor’s claims, asserted under both the
Agreement and the Acknowledgment, concern the Defendant’s alleged refusal to ship the
Products to the Debtor’s customers or deliver the Products to Global One on a timely basis.
These allegations are largely conclusory, (see id. at ¶¶ 20, 25, 36, 38), and the Complaint does
not identify a specific shipment that the Defendant delayed or refused to make. 6
Simultaneously with the commencement of the adversary proceeding, the Debtor filed a
motion for a preliminary injunction and temporary restraining order, seeking to compel the
Defendant to cooperate with transitioning the Products to Global One’s warehouse facility. The
5 	In prior proceedings, the Defendant offered proof calling into question the Debtor's version of what
occurred on June 16, 2011. (See Declaration of Brandon Villardi in Support of JMKC's Response to Motion for
Preliminary Injunction and Temporary Restraining Order, dated June 21, 2011, at ¶¶ 4-8 (ECF Doc. # 7).)
6 	During the proceedings relating to the temporary restraining order (discussed below), the Debtor offered
evidence that the Defendant interfered with a shipment of Products to Anna’s Linens on June 17, 2011.
(Declaration of Pat Carew in Support of Motion for Preliminary Injunction and Temporary Restraining Order, June
20, 2011, at ¶¶ 8, 9 (ECF Doc. # 3).) The Defendant disputed the Debtor’s implication, but acknowledged that the
Defendant was unable to ship to Anna’s Linens on that date. (Declaration of Rusty Peck in Support of Response to
Motion for Preliminary Injunction and Temporary Restraining Order, dated June 21, 2011, at ¶¶ 12, 13 (ECF Doc. #
8).)
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Court held a hearing on the temporary restraining order that same day (the “TRO Hearing”). The
Defendant appeared through counsel, Daniel F.X. Geoghan, Esq. of Young Conaway Stargatt &
Taylor (“Young Conaway”), who filed papers on the Defendant’s behalf and attended the
hearing.
The immediate dispute was resolved through a direction by the Court, to which the
parties consented. The parties would comply with the terms of the Agreement—i.e., the Debtor
would resume making payments and the Defendant would resume performance—on a going-
forward basis until the Products were transferred from the Warehouse to Global One’s facility.
(Transcript of Debtor’s Motion for Temporary Restraining Order and Permanent Injunction
Before the Honorable Stuart J. (sic) Bernstein United States Bankruptcy Judge, dated June 22,
2011 (Main Case ECF Doc. # 84).) Within six weeks, all of the Products were shipped to
customers or delivered to Global One. (See Villardi Affidavit at ¶¶ 44, 52 (“On July 28, 2011,
the transition of TexStyle’s goods out of the Warehouse was complete”).)7
In the meantime, however, shortly after the TRO Hearing, on June 27, 2011, Young
Conaway wrote a letter purporting to withdraw as Defendant’s counsel. (See Letter from Daniel
F. X. Geoghan to the Court, dated June 27, 2011 (ECF Doc. # 11).) The withdrawal was
ineffective since it was never presented to or approved by the Court in accordance with its Local
Rules. See S.D.N.Y. Bankruptcy Court Local Rule 2090-1(e).
7 	The transitioning of the Products suggests that the Debtor’s turnover claim (First Claim for Relief) and its
claim for injunctive relief (Third Claim for Relief) are moot. In addition, the Defendant has not filed a proof of
claim, making the Debtor’s claim for equitable subordination (Fourth Claim for Relief) unnecessary and untenable.
See Gowan v. Patriot Group, LLC (In re Dreier LLP), 452 B.R. 391, 451 (Bankr. S.D.N.Y. 2011); Tronox Inc. v.
Anadarko Petroleum Corp. (In re Tronox, Inc.), 429 B.R. 73, 109 (Bankr. S.D.N.Y. 2010).
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Abandoned by its counsel, the Defendant dealt directly with the Debtor’s counsel, Lon
Seidman, Esq., while it tried to secure substitute representation. The Defendant’s Operations
Manager, Brandon Villardi, and Debtor’s counsel exchanged several emails regarding
adjournments of the proceedings. (Villardi Affidavit at ¶ 53 & Ex. C.) On September 13, 2011,
the Court held a pretrial conference, and directed that the Defendant file and serve an answer to
the Complaint within thirty days, or by October 14, 2011. (See Order Setting Deadline to
Answer Complaint or Move under Rule 7012 of the Federal Rules of Bankruptcy Procedure,
dated September 13, 2011 (ECF Doc. # 12).) On September 20, 2011, the Clerk of the Court
issued a second summons and notice of pretrial conference (the “Second Summons”). The
Second Summons purported to set a different deadline for answering the Complaint, October 20,
2011. The inconsistency did not affect the Defendant because it failed to answer the Complaint
even by the later date.
As a consequence, on November 15, 2011, the Debtor submitted its request to the Clerk
of the Court to certify the Defendant’s default. (See Request to Enter Default, dated November
15, 2011 (ECF Doc. # 16).) At around the same time, the Defendant retained a new attorney,
Thomas M. Grasso, Esq., and Grasso filed an Answer on November 21, 2011. 8 (See Answer of
Harry Group, Inc., d/b/a JMKC Express (ECF Doc. # 17).) At the pretrial conference on
December 1, 2011, which Grasso attended, the Court ruled that although the Clerk had not
entered the default, the Defendant was in default and had to make a motion to set the default
aside. The Defendant filed the Motion on December 8, 2011, the Court heard oral argument, on
January 26, 2012, and reserved decision.
8 	Mr. Grasso was formerly substituted for Young Conaway by order dated December 8, 2011. (See Consent
Order Granting Substitution of Attorney (ECF Doc. # 22).)
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DISCUSSION
A. 	Request to Vacate the Default
Rule 55(c) of the Federal Rules of Civil Procedure allows a court to set aside the entry of
default for “good cause.” 9 “Under Rule 55(c), the factors governing whether a party should be
relieved from default are whether the default was willful, whether setting it aside would
prejudice the adversary, and whether a meritorious defense is presented.” Men’s Sportswear,
Inc. v. Sasson Jeans, Inc. (In re Men’s Sportswear, Inc.), 834 F.2d 1134, 1138 (2d Cir. 1987);
accord In re Chalasani, 92 F.3d 1300, 1307 (2d Cir. 1996); Enron Oil Corp. v. Diakuhara, 10
F.3d 90, 96 (2d Cir. 1993). 10 The standards for setting aside a default or a default judgment are
the same, but courts apply them more rigorously in the case of a default judgment because the
latter more deeply implicates the concepts of finality and litigation repose. Enron Oil Corp., 10
F.3d at 96; American Alliance Ins. Co. v. Eagle Ins. Co., 92 F.3d 57, 59 (2d Cir. 1996); see
Meehan v. Snow, 652 F.2d 274, 277 (2d Cir. 1981) (describing the standard under Rule 55(c) as
“lenient”). Although a defendant is not free to flout the rules of procedure without consequence,
defaults are generally disfavored, and there is a “strong preference for resolving disputes on their
merits.” Sony Corp. v. Elm State Electronics, Inc., 800 F.2d 317, 320 (2d Cir. 1986); accord
Enron Oil Corp., 10 F.3d at 96. (“[W]hen doubt exists as to whether a default should be granted
or vacated, the doubt should be resolved in favor of the defaulting party.”); Meehan v. Snow, 652
F.2d at 277 (“While courts are entitled to enforce compliance with the time limits of the Rules by
9 	Rule 55(c) states: “The court may set aside an entry of default for good cause, and it may set aside a
default judgment under Rule 60(b).” Rule 55(c) is made applicable to this adversary proceeding by FED. R. BANKR .
P. 7055.
10 	A court may also consider other relevant equitable factors, such as whether the failure to follow a rule of
procedure was a mistake made in good faith, and whether the entry of default would lead to a harsh result. See
Enron Oil Corp., 10 F.3d at 96.
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various means, the extreme sanction of a default judgment must remain a weapon of last, rather
than first, resort.”)
1. 	Willfulness
“Willfulness” refers to conduct that is deliberate, see Gucci Am., Inc. v. Gold Center
Jewelry, 158 F.3d 631, 635 (2d Cir. 1998) cert. denied, 525 U.S. 1106 (1999), as opposed to
negligent or careless. SEC v. McNulty, 137 F.3d 732, 738 (2d Cir. 1998), cert. denied, 525 U.S.
931 (1998); American Alliance Ins. Co., 92 F.3d at 61. Here, the Defendant’s default was not
deliberate; never ignored the litigation working diligently to resolve the business issues. After
the Defendant’s original lawyer quit, the Defendant’s Operations Manager, Brandon Villardi,
dealt directly with the Debtor’s attorney to adjourn the hearings scheduled in the adversary
proceeding while the Defendant addressed the transition problems with the Debtor.
In the meantime, Villardi actively sought substitute counsel. He contacted the
Defendant’s local California counsel shortly after receiving the Second Summons, and local
counsel advised Villardi to retain a lawyer in New York. (See Villardi Affidavit at ¶ 61.) On
September 29, 2011, Villardi contacted a relative, Dawn Farinella, Esq., who practices law in
New York, and sent her the Second Summons and Complaint. (Id. at ¶ 62.) He testified that he
followed up with Farinella on four separate occasions in October, but on October 20 she
informed him that Seidman refused to grant an extension of time to answer the Complaint. (Id.
at ¶¶ 63, 64.) Following these exchanges, Farinella informed Villardi that she could not
represent the Defendant and suggested two other attorneys. (Id. at ¶¶ 65, 66.) Villardi contacted
one of the recommended attorneys the next business day, but determined that the Defendant
could not afford to hire him. (Id. at ¶¶ 67, 68.) Villardi contacted Grasso on November 13, and
by November 21, 2011, Grasso had filed the Defendant’s Answer. (Id. at ¶¶ 69-74.)
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The foregoing demonstrates that the Defendant’s default was not willful.
2. 	Prejudice
Legal prejudice occurs when the non-defaulting party’s ability to proceed with its case
has been impaired. See MacEwen Petroleum, Inc. v. Tarbell, 173 F.R.D. 36, 40 (N.D.N.Y.
1997), appeal dismissed, 136 F.3d 263 (2d Cir. 1998). Delay alone does not constitute prejudice.
Enron Oil Corp., 10 F.3d at 98. Rather, the delay must “result in the loss of evidence, create
increased difficulties of discovery, or provide greater opportunity for fraud and collusion.”
Davis v. Musler, 713 F.2d 907, 916 (2d Cir. 1983) (internal quotation marks omitted).
Here, there is no evidence of legal prejudice. In fact, the Debtor essentially conceded the
absence of prejudice in its opposition to the Defendant’s motion. (See Debtor’s memorandum of
Law in Opposition to Defendant’s Motion to Vacate Default and Compel Arbitration, dated Jan.
12, 2012, at 8 (ECF Doc. # 27).) Although prosecuting this adversary proceeding will
inconvenience the Debtor, no evidence has been lost or compromised as a result of the delay.
3. 	Meritorious Defense
Although the movant need not establish a meritorious defense conclusively, it “must
present evidence of facts that, if proven at trial, would constitute a complete defense.” McNulty,
137 F.3d at 740 (internal quotation marks omitted); accord Sony Corp., 800 F.2d at 320-21.
Conclusory denials or statements lacking factual support are insufficient. See Pecarsky v.
Galaxiworld.com, Ltd., 249 F.3d 167, 173 (2d Cir. 2001); Enron Oil Corp., 10 F.3d at 98; Sony
Corp., 800 F.2d at 320.
As noted, the gravamen of the Debtor’s claim is the Defendant’s alleged failure to
promptly ship the Products to the Debtor’s customers or deliver them to Global One in
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connection with the transition. The Defendant has submitted two declarations that undercut the
Debtor’s conclusory allegations that the Defendant failed to ship or deliver the Products in a
timely manner. Villardi testified that “from the inception of the Contract on August 1, 2010, to
June 9, 2011, the date of TexStyle’s Notice of Termination, no events occurred that would
trigger TexStyle’s right of immediate termination,” (Villardi Affidavit at ¶ 18); no claims were
ever submitted to the Defendant regarding its performance under the Agreement, (id. at ¶ 19), or
that it “missed any Ready Dates or Required Dates for goods ordered by TexStyle’s customers,”
(id. at ¶ 20); and the Debtor never put the Defendant on notice of any canceled customer orders
or of any chargebacks assessed by customers. (Id. at ¶¶ 21, 22.)
The Defendant has also submitted the declaration of Rusty Peck, its Shipping Manager.
(See Declaration of Rusty Peck in Support of Reply to TexStyle’s Opposition to JMKC’s Motion
to Set Aside Default and to Enforce Arbitration Clause, dated January 17, 2012 (“Peck
Declaration”) (ECF Doc. # 31).) Peck annexed the Defendant’s “Bill of Lading Log” for
TexStyle to his Declaration, which, according to Peck, depicts all motor carrier shipments that
departed from the Warehouse for the period between January and July of 2011. 11 Peck testified
that “JMKC did not receive any claims or complaints for late or untimely deliveries;” did not
“miss any Ready Dates or Required Dates for goods ordered by customers for any of the
shipments set forth in the [Bill of Lading Log],” nor did any customer orders get canceled as a
result of JMKC. (Peck Declaration at ¶¶ 5, 6.)
11 	The Bill of Lading Log is annexed as Exhibit A to the Peck Declaration. In his declaration, Peck attests
that he is the custodian of the Bill of Lading Log and it is part of his daily responsibilities to keep it up to date and
accurate. (Peck Declaration at ¶ 3.)
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The only specific shipment mentioned in the earlier submissions concerned Anna’s
Linens. They were not repeated in connection with the pending motions. Based on the
foregoing, the Defendant has established a meritorious defense, its default is vacated, and its
Answer is accepted by the Court.
B. 	Arbitration
1. 	Introduction
The Federal Arbitration Act (“FAA”), see 9 U.S.C. §§ 1 et seq., requires a federal court
to enforce an arbitration agreement and stay litigation that contravenes it. See 9 U.S.C. §§ 2, 3; 12
Burns v. New York Life Ins. Co., 202 F.3d 616, 620 (2d Cir. 2000). The FAA signifies a
“congressional declaration of a liberal federal policy favoring arbitration agreements,” and “any
doubts concerning the scope of arbitrable issues should be resolved in favor of arbitration.”
Moses H. Cone Mem’l Hosp. v. Mercury Constr. Corp., 460 U.S. 1, 24-25 (1983); see AT&T
Mobility LLC v. Concepcion, 131 S. Ct. 1740, 1749 (2011).
The policy favoring arbitration is so strong that “an arbitration agreement must be
enforced notwithstanding the presence of other persons who are parties to the underlying dispute
12 	Section 2 of the FAA states:
A written provision in any maritime transaction or a contract evidencing a transaction involving
commerce to settle by arbitration a controversy thereafter arising out of such contract or
transaction, or the refusal to perform the whole or any part thereof, or an agreement in writing to
submit to arbitration an existing controversy arising out of such a contract, transaction, or refusal,
shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for
the revocation of any contract.
Section 3 states:
If any suit or proceeding be brought in any of the courts of the United States upon any issue
referable to arbitration under an agreement in writing for such arbitration, the court in which
such suit is pending, upon being satisfied that the issue involved in such suit or proceeding is
referable to arbitration under such an agreement, shall on application of one of the parties stay
the trial of the action until such arbitration has been had in accordance with the terms of the
agreement, providing the applicant for the stay is not in default in proceeding with such
arbitration.
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but not to the arbitration agreement.” Moses H. Cone Mem’l Hosp., 460 U.S. at 20; accord Dean
Witter Reynolds Inc. v. Byrd, 470 U.S. 213, 221 (1985) (“The preeminent concern of Congress in
passing the Act was to enforce private agreements into which parties had entered, and that
concern requires that we rigorously enforce agreements to arbitrate, even if the result is
‘piecemeal’ litigation.”). Faced with a motion to compel arbitration, a court must apply a four
part test: (1) did the parties agree to arbitrate, (2) does the dispute fall within their arbitration
clause, (3) if federal statutory claims are raised, did Congress intend those claims to be
arbitrable, and (4) if the court concludes that some but not all of the claims are arbitrable, should
it stay the non-arbitrable claims pending the conclusion of the arbitration? Genesco, Inc. v. T.
Kakiuchi & Co., Ltd., 815 F.2d 840, 844 (2d Cir. 1987); accord Oldroyd v. Elmira Sav. Bank,
FSB, 134 F.3d 72, 75-76 (2d Cir. 1998) ; Vander v. Epana Networks, Inc., No. 09 Civ. 4526
(LMM), 2009 WL 2365236, at *2 (S.D.N.Y. Aug. 3, 2009).
The Debtor does not dispute that the claims under the Agreement are covered by the
arbitration clause. Instead, it argues that the Defendant waived its right to arbitrate by virtue of
its delay and participation in this adversary proceeding, and even in the absence of a waiver, the
claims asserted under the Acknowledgment, which does not contain an arbitration clause, are not
arbitrable.
2. 	Waiver
The existence or nonexistence of a waiver is a question of law that must be decided in the
context of the case “with a healthy regard for the policy of promoting arbitration.” Leadertex,
Inc. v. Morganton Dyeing & Finishing Corp., 67 F.3d 20, 25 (2d Cir. 1995); accord PPG Indus.,
Inc. v. Webster Auto Parts, Inc., 128 F.3d 103, 107 (2d Cir. 1997). The factors that the court
must consider include
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(1) the time elapsed from the commencement of litigation to the request for
arbitration, (2) the amount of litigation (including any substantive motions and
discovery), and (3) proof of prejudice. There is no bright-line rule, however, for
determining when a party has waived its right to arbitration: the determination of
waiver depends on the particular facts of each case.
PPG Indus., 128 F.3d at 107-08; accord Crysen/Montenay Energy Co. v. Shell Oil Co. (In re
Crysen/Montenay Energy Co.), 226 F.3d 160, 163 (2d Cir. 2000).
These factors weigh against finding a waiver. The Debtor commenced this adversary
proceeding in June 2011, and the Defendant filed an answer in November 2011 asserting an
arbitration defense. The reason for the delay in asserting the right to arbitration was the same as
the delay in filing the answer. The Defendant’s original lawyer withdrew after approximately
ten days in the case, and it took the Defendant until November to find substitute counsel.
Furthermore, the delay in seeking arbitration does not create a waiver unless the delay
prejudices the opposing party. Leadertex, 67 F.3d at 25. Prejudice in this context “refers to the
inherent unfairness—in terms of delay, expense, or damage to a party’s legal position—that
occurs when the party’s opponent forces it to litigate an issue and later seeks to arbitrate that
same issue.” Doctor’s Assocs., Inc. v. Distajo, 107 F.3d 126, 134 (2d Cir. 1997). “Incurring
legal expenses inherent in litigation, without more, is insufficient evidence of prejudice to justify
a finding of waiver.” PPG Indus., 128 F.3d at 107; Leadertex, 67 F.3d at 26 (“[P]retrial expense
and delay—unfortunately inherent in litigation—without more, do not constitute prejudice
sufficient to support a finding of waiver.”)
The Debtor has not been prejudiced because the activity in this case has been minimal.
No discovery has taken place, cf. PPG Indus., 128 F.3d at 109 (“We have held that sufficient
prejudice to sustain a finding of waiver exists when a party takes advantage of pre-trial discovery
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not available in arbitration.”), the motion for the preliminary injunction was resolved
consensually on the first day and nothing else has been litigated (other than the Motion) or
decided. Ironically, had the Defendant insisted on arbitration when the case was commenced,
the prompt resolution sought and achieved by the Debtor might never have occurred or been
substantially delayed. Accordingly, the Court concludes that the Defendant has not waived its
right to arbitration, and is entitled to arbitrate all claims and controversies under the Agreement.
Although the parties have not distinguished among the claims, this conclusion also
applies to the claim for the violation of the automatic stay asserted in the Fifth Claim for Relief.
In MBNA America Bank, N.A. v. Hill, 436 F.3d 104 (2d Cir. 2006), the Second Circuit Court of
Appeals considered the question. Prior to bankruptcy, Hill authorized her bank (MBNA) to
deduct $159.01 from her account each month to pay down an outstanding debt. Id. at 106. After
she filed her petition, MBNA continued to withdraw monies from her account to satisfy the pre-
petition debt. Id. Hill filed a class action complaint against MBNA based on the violation of the
automatic stay. Id. Hill’s agreement with MBNA contained a clause mandating that any claim
or dispute arising from or relating to the parties’ agreement, including disputes arising under
statutes, must be arbitrated. Id. at 106-07.
The Second Circuit reversed the lower court decisions denying arbitration of the claim.
The Court first reviewed the policy underlying the enforcement of arbitration clauses and the
burden of the party opposing arbitration of statutory rights. Id. at 107-08. The Court then
considered the bankruptcy-specific issues. “Bankruptcy courts generally do not have discretion
to refuse to compel arbitration of ‘non-core’ bankruptcy matters, or matters that are simply
‘related to’ bankruptcy cases.” Id. at 108. While they have discretion to refuse to compel
arbitration of core matters, “even as to core proceedings, the bankruptcy court will not have
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discretion to override an arbitration agreement unless it finds that the proceedings are based on
provisions of the Bankruptcy Code that ‘inherently conflict’ with the Arbitration Act or that
arbitration of the claim would ‘necessarily jeopardize’ the objectives of the Bankruptcy Code.”
Id.; accord In re U.S. Lines, Inc., 197 F.3d 631, 640 (2d Cir.1999). The relevant bankruptcy
objectives include the “ ‘the goal of centralized resolution of purely bankruptcy issues, the need
to protect creditors and reorganizing debtors from piecemeal litigation, and the undisputed power
of a bankruptcy court to enforce its own orders.’ ” MBNA America Bank, 436 F.3d at 108
(quoting Ins. Co. of N. Am. v. NGC Settlement Trust & Asbestos Claims Mgmt. Corp. (In re Nat'l
Gypsum Co.), 118 F.3d 1056, 1069 (5th Cir.1997)). “If a severe conflict is found, then the court
can properly conclude that, with respect to the particular Code provision involved, Congress
intended to override the Arbitration Act’s general policy favoring the enforcement of arbitration
agreements.” Id.
The Court agreed that Hill’s claim under Bankruptcy Code § 362(h) was core, id., but
concluded that arbitration of the claim would “not seriously jeopardize” the objectives of the
Bankruptcy Code. The resolution of the dispute would not interfere with or affect the
distribution of the estate. Her estate had been fully administered and her case had been closed.
She had received a discharge and the arbitration would not affect her fresh start. Any damage
award would inure to her personal benefit, not to the benefit of her creditors. In addition, as a
purported class action, her claims lacked a direct connection with her bankruptcy case. Finally,
the bankruptcy court was not uniquely able to interpret and enforce the automatic stay. Id. at
109-110.
As in the case of Hill, the Debtor’s Fifth Claim for Relief is core “because [it] derive[s]
directly from the Bankruptcy Code and can be brought only in the context of a bankruptcy case.”
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Id. at 109. Unlike Hill, the Debtor cannot invoke 11 U.S.C. § 362(h), which is available only to
individual debtors, but can seek to punish the violator through contempt proceedings. Maritime
Asbestosis Legal Clinic v. LTV Steel Co, Inc. (In re Chateaugay Corp.), 920 F.2d 183, 186-87
(2d Cir. 1990).
Although the Debtor’s damage claim based on a stay violation has a much closer
connection to the case, the Debtor has failed to sustain its burden that arbitration of the claim will
seriously jeopardize the objectives of the Bankruptcy Code. The Debtor has confirmed its plan,
and hence, arbitration will not interfere with the administration of the case. Any alleged
violations stopped long ago; the Debtor and the Defendant have ended their business
relationship, and the Debtor’s Products have been transitioned to Global One. Although the
proceeds of any recovery would be property of the estate and available to creditors, there is no
suggestion that the outcome will have a material effect on distributions. And as the MBNA Court
explained, this Court is not uniquely situated to interpret the automatic stay.
Finally, the stay violation claim is inextricably intertwined with the breach of contract
claim under the Agreement, which is undeniably arbitrable. The Debtor alleges that “[t]he
Defendant has willfully violated the automatic stay by attempting to maintain possession and
control over the Debtor’s Goods, which are property of the Debtor’s estate.” (Complaint at ¶ 34,
p. 8.) These appear to be the same charges that underlie the claim that the Defendant breached
the Agreement by failing to ship the Products to the customers or deliver the Products to Global
One in a timely manner. The disposition of the Products is governed by the Agreement and the
extent of any violative conduct may coincide with any breach of contract by the Defendant. Put
differently, if the Defendant shipped or did not ship or deliver Products in accordance with the
Agreement, it is hard to see how it could be liable for a violation of the automatic stay.
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3. 	The Acknowledgement
The questions raised in connection with the Debtor’s claims under the Acknowledgment
are more difficult to answer. The Acknowledgment does not contain an arbitration clause, and
the Debtor is not even a party the Acknowledgment. Moreover, although the Acknowledgment
grants the Debtor certain rights, the negating language implies that the Debtor is not a third party
beneficiary with the right to assert claims under the Acknowledgment. The Defendant, for its
part, relied on New York law in arguing that the Debtor was not a third-party beneficiary of the
Acknowledgement, (see Memorandum of Law in Reply to TexStyle’s Opposition to the Motion by
Harry Group, Inc. to Set Aside Default Pursuant to BR 7055/FRCP 55(c) and to Enforce an
Arbitration Clause, dated Jan. 17, 2012, at 17 (ECF Doc. # 29)), but the Acknowledgement is
governed by Wisconsin law.
In light of the state of the record, the Court will stay any claims under the
Acknowledgement pending the results of the arbitration. Courts have the inherent power to grant
a discretionary stay of a proceeding pending arbitration, Citrus Mktg. Bd. of Israel v. J. Lauritzen
A/S, 943 F.2d 220, 225 (2d Cir.1991), where there are issues common to the arbitration and the
court proceeding, and those issues may be determined by the arbitration. Sierra Rutile Ltd. v.
Katz, 937 F.2d 743, 750 (2d Cir.1991); Am. Shipping Line, Inc. v. Massan Shipping Indus., Inc.,
885 F.Supp. 499, 502 (S.D.N.Y.1995); Kittay v. Landegger, et al. (In re Hagerstown Fiber Ltd.
P'ship), 277 B.R. 181, 199 (Bankr.S.D.N.Y.2002). 13
13 	An arbitration proceeding may form the predicate for collateral estoppel. Boguslavsky v. Kaplan, 159 F.3d
715, 720 (2d Cir. 1998).
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Here, the Debtor made no effort to distinguish between its breach of contract claims
under the Acknowledgement and the Agreement. (See Complaint at ¶ 38.) The resolution of the
Agreement claims may resolve the analogous claims under the Acknowledgement to the extent
the Debtor can assert them. The stay of these claims is without prejudice to the Defendant’s
right to make a separate motion to dismiss the claims asserted under the Acknowledgement for
the reasons stated.
In conclusion, the Defendant’s motion to vacate its default is granted, its motion to
compel arbitration is granted with respect to all claims under the Agreement, and the claims
under the Acknowledgement are stayed pending the completion of the arbitration without
prejudice to the Defendant’s right to move to dismiss those claims. The Court has considered the
parties’ remaining arguments not specifically addressed and concludes that they lack merit.
Settle order on notice.
Dated: New York, New York
April 17, 2012
/s/ Stuart M. Bernstein
STUART M. BERNSTEIN
United States Bankruptcy Judge
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