As a breeder, you are in a position of enormous responsibility. Even if you sell the foal, which I assume is your goal, you are responsible for doing everything you possibly can to ensure a great life for him or her. In today's market, there is a terrible glut of minis and not enough people who can afford to keep a horse, so any breeding must have a great reason for putting another horse into the world. Breeding to make the stallion happy is simply NOT a good reason, especially if the result is a foal of mediocre quality that will very possibly face of life of being shuffled from one home to another, if not worse.
It's great that you care for your friend's feelings, but if she truly loves Duffy, she will see that gelding is best for him and will enable him to stay where he is loved and well cared for. I would talk to her about your plans, and let her take him back if she is so set on him remaining intact. It is absolutely not right for her to demand that you keep him as a stallion, when she didn't see fit to keep him herself.