MATTER OF SI RESTRUCTURING, INC. 532 F.3d 355 (2008) CASE BRIEF

MATTER OF SI RESTRUCTURING, INC.

532 F.3d 355 (2008)

NATURE OF THE CASE: Wooley (D) appealed an order affirming equitable subordination pursuant to § 510(c), which converted secured claims filed by Ds to unsecured claims.

FACTS: Ds were officers and directors and the largest shareholders of Schlotzsky's. Schlotzsky's was faced with cash flow problems. Ds made two loans: one in April 2003 for $1 million and another in November 2003 for $2.5 million. The April loan was secured with the company's royalty streams from franchisees, the company's intellectual property rights, and other intangible property. Both sides were represented by separate legal counsel for the April loan negotiations. The loan terms were approved by the audit committee and Schlotzsky's board of directors and the transaction was disclosed in the company's filings with the SEC. IBC declined to make a loan to the company but agreed to allow Ds to borrow the funds directly from the bank so that Ds could lend the proceeds to Schlotzsky's. The loan to the company was approved by the board and made on November 13, 2003. IBC formally approved the loan to Ds on November 10. The following day, the board was provided notice of a special meeting scheduled for November 13 to approve Ds' loan to the company. Board members were provided with copies of the proposed promissory note and the security agreement along with e-mails from the company's assistant general counsel. The November loan was secured with the company's rights to the royalty streams from franchisees, intellectual property rights, and, and general intangibles. When the loan was made, Ds had in place personal guarantees which guaranteed pre-existing Schlotzsky's debt in the amount of $4.3 million. With the November loan Ds also secured this potential liability under the guarantees with the same collateral that secured the April and November loans. At the November 13board meeting via telephone conference call, the board was told that without the infusion of additional funds, payroll could not be met and that the company would default on a payment to a secured creditor. All of the non-interested directors in attendance approved the loan without objection. An independent audit committee also approved the loan, and the transaction was publicly disclosed in SEC filings. In mid-2004, Ds were removed as officers of the corporation and resigned their positions as directors. The company filed Chapter 11 in August 2004. Ds filed secured claims relating to the April and November loans. The committee of unsecured creditors brought an adversary proceeding against Ds, challenging their right to be treated as secured creditors with respect to these claims. The court found that D, as fiduciaries, engaged in inequitable conduct by the manner in which they presented the November loan transaction to the board. It held that the transaction was presented as the only option available, at the eleventh hour, as a fait accompli; 'approve the loan or the company collapses tomorrow.' By securing the loan with the income stream of the franchise company, the bankruptcy court concluded that Ds grabbed for everything and got it. Further, it held that securing their pre-existing contingent liability on their personal guarantees with the revenue stream of the franchise company securing their contingent liability effectively released them as guarantors on the debt at the expense of the corporation and its unsecured creditors. The court made no specific findings that Ds' actions in securing either of the 2003 loans or their pre-existing contingent liability on the guarantees resulted in harm to the corporation or to the unsecured creditors. The court ordered equitable subordination and the district court agreed. Ds appealed.

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RULE OF LAW:

HOLDING AND DECISION:

LEGAL ANALYSIS:

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