In re SI Restructuring, Inc.

John and Jeffrey Wooley (the Wooleys) (creditors) were officers, directors, and principle shareholders of Schlotzsky’s, Inc. (debtor). The Wooleys loaned the company $1,000,000 in April 2003 and $2,500,000 in November 2003. The loans were secured by the company’s franchise income and other rights. At the time, Schlotzsky’s had been in financial trouble and unable to obtain other financing. By the time of the November loan, the company’s financial situation had deteriorated, necessitating the Wooleys’ loan to be arranged and approved in a matter of days. The board approved the loans and subjected the loans to independent audits. In addition to being secured by the company’s franchise income, the November loan also secured personal guarantees the Wooleys had for $4,300,000 in pre-existing company debt. In 2004, the Wooleys were removed as officers of the company and resigned from the board. Schlotzsky’s filed for bankruptcy later that year. The Wooleys filed secured claims with the bankruptcy court for both loans. The committee of unsecured creditors challenged the Wooleys’ right to be treated as secured creditors. The bankruptcy court held that the Wooleys had engaged in inequitable conduct and ordered that their claims for both the April and November loans be equitably subordinated and converted from secured to unsecured claims. The district court upheld the bankruptcy court’s ruling, and the Wooleys appealed.