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Matter of SI Restructuring

United States Court of Appeals for the Fifth Circuit
532 F.3d 355 (2008)


Facts

John and Jeffrey Wooley (defendants) were officers and directors and the largest shareholders of Schlotzsky’s, Inc., a publicly traded franchise operation. In April 2003, after Schlotzsky’s was unable to obtain needed cash funding, the Wooleys loaned $1 million to the company. The loan was secured by franchise royalty payments to Schlotzsky’s, intellectual property rights, and other intangible property. The transaction was negotiated at arms’ length, approved by the audit committee and board of directors, and disclosed in SEC filings. When Schlotzsky’s continued to experience cash-flow issues, it approached the International Bank of Commerce (IBC) for a loan. IBC would not loan Schlotzsky’s money directly but agreed to make a loan to the Wooleys who could then loan the funds to Schlotzsky’s. On November 10, 2003, IBC formally approved a $2.5 million loan to the Wooleys. An emergency meeting of the Schlotzsky’s board was called, and relevant loan materials were distributed to board members. The meeting was held on November 13, 2003. The loan was approved by the audit committee and the board and disclosed in SEC filings. It was secured by the same collateral as the April loan. Separately, the Wooleys acted as personal guarantors of $4.3 million of preexisting Schlotzsky’s debt. In connection with the November loan, the Wooleys’ guarantees were secured by the same collateral as the April and November loans. Proceeds from the loans were used, among other things, to pay certain unsecured creditors. The Wooleys left their positions as officers and directors in 2004. The financial condition of Schlotzsky’s worsened; in August 2004, the company filed a Chapter 11 bankruptcy petition. The Wooleys filed secured claims for the April and November loans. The committee of unsecured creditors (the Committee) (plaintiff) sought to have the Wooleys’ claims equitably subordinated. The bankruptcy court decided in favor of the Committee, finding that the Wooleys violated their fiduciary duties by pressing the board to ratify the November loan on short notice, by receiving extremely valuable collateral in the form of franchisee payments, and by securing their personal guarantees. The district court affirmed. The Wooleys appealed.

Rule of Law

Issue

Holding and Reasoning (Davis, J.)

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