## Facts

- Schlotzsky’s, Inc. (later SI Restructuring, Inc.) suffered severe cash-flow distress in 2003 and later filed Chapter 11.
- John C. Wooley and Jeffrey J. Wooley were officers, directors, and the largest shareholders when two challenged insider loans were made.
- In April 2003, after other financing efforts failed, the Wooleys loaned the company $1 million secured by franchise royalty streams, intellectual property, and other intangibles.
- The April loan was negotiated with separate counsel, approved by the audit committee and board as a related-party transaction, and disclosed in SEC filings.
- In November 2003, after the company’s condition worsened, a bank declined to lend directly to the company but allowed the Wooleys to borrow and re-lend $2.5 million to the company.
- The November loan was secured by similar collateral and also protected the Wooleys’ exposure on $4.3 million of preexisting company debt they had personally guaranteed.
- In 2004, the Wooleys were removed/resigned; the company filed bankruptcy; the Wooleys filed secured proofs of claim for both loans.
- The unsecured creditors’ committee (later the plan administrator/trustee) sought equitable subordination of the Wooleys’ secured claims under 11 U.S.C. § 510(c).
- The bankruptcy court found inequitable conduct and subordinated the Wooleys’ secured claims to general unsecured status for distribution purposes; the district court affirmed.

## Issues

1. Whether the trustee established equitable subordination under 11 U.S.C. § 510(c) as to insiders’ secured claims, including proof that the conduct injured creditors or conferred an unfair advantage.
2. Whether insider rescue financing, including collateral that also protected insiders’ personal guarantee exposure, justified subordinating secured claims absent evidence of concrete harm to the debtor or general creditors.

## Decision

- The Fifth Circuit reversed the district court and the bankruptcy court’s equitable-subordination order and rendered judgment for the Wooleys.
- The court held the trustee failed to prove that the insider loans harmed the debtor or general creditors or otherwise conferred an unfair advantage warranting subordination.
- The Wooleys’ claims remained secured rather than being treated as unsecured for distributions.

## Legal Principles

- Equitable subordination under 11 U.S.C. § 510(c) requires: (1) inequitable conduct, (2) resulting injury to creditors or an unfair advantage to the claimant, and (3) consistency with the Bankruptcy Code.
- Insider status triggers heightened scrutiny but does not, by itself, justify subordinating an insider’s claim.
- Insider loans made to address liquidity crises are not inherently inequitable; absent proof of injury or unfair advantage, secured status is not subordinated.
- A trustee challenging insider collateralization (including protection of insiders’ guarantee exposure) must show actual injury to the debtor or creditors, not merely theoretical disadvantage.

## Conclusion

The Fifth Circuit rejected equitable subordination of insiders’ secured bankruptcy claims where the record showed emergency financing to a distressed debtor and the trustee did not prove creditor injury or an unfair advantage, despite the claimants’ insider status and the loans’ secured structure.


Wooley v. Faulkner (In re SI Restructuring, Inc.), 532 F.3d 355 (5th Cir. 2008)