2009 Chapter 11 Recent Developments (Part I)

has been abandoned contains a typographical error - the case was referring to § 506(a), not § 502(a)

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and the argument is denied. Section 502(b)(3) originally granted tax authorities' claims priority and prohibited distribution for a tax assessed against a bankrupt's property (ultimately, both real and personal) when the assessment exceeded the value of the estate's interests. When it was abandoned, the Holyoke Property was appraised at $0.00 (it had previously been appraised at $290,000) and therefore did not represent a source from which the Holyoke claims could be paid. This is a rare case where a strict application of the bankruptcy code would produce a result demonstrably at odds with Congressional intent: a windfall in this case is not possible since the Holyoke Property is worth nothing and, because the Holyoke Property is un-saleable, there is no successor owner who would benefit. Moreover, keeping in mind Congressional intent that tax liabilities have priority, the court will not disallow or reclassify the proofs of claim despite the plain language of § 502(b)(3).

d. Priority, Subordination, and Setoff

Faulkner v. SRI Restructuring, Inc., et. al. (In re SRI Restructuring, Inc.), 532 F.3d 355 (5th Cir. 2008)

Facts: John and Jeffrey Wooley (the "Wooleys") made two loans (the "Loans") - one in April 2003 in the amount of $1 million and one in November 2003 in the amount of $2.5 million - to Schlotzsky's, Inc. ("Schlotzsky's"). At the time of the Loans, the Wooleys were officers and directors of Schlotzsky's. The April loan was made after other financing fell through, and the November loan was made after IBC Bank would only agree to make the loan through the Wooleys. Schlotzsky's experienced severe cash flow problems and needed the Loans to survive. The Loans were secured by Schlotzsky's rights to the royalty streams from franchises, intellectual property rights, and general intangibles.

Additionally, when the Loans were made, the Wooleys had in place personal guarantees which guaranteed pre-existing Schlotzsky's debt in the amount of $4.3 million. As part of the November loan, the Wooleys secured their potential liability under the guarantees with the same collateral that secured the Loans. Both Loans were approved by Schlotzsky's board of directors and Schlotzsky's audit committee and the Loans were publicly disclosed in SEC filings. In mid-2004, the Wooleys were removed as D&Os of the company and, later, the company declared bankruptcy. The Wooleys filed two proofs of claim relating to the Loans. The committee of unsecured creditors filed a lawsuit against the Wooleys seeking to equitably subordinate the Loans. The bankruptcy court found that the proofs of claim should be equitably subordinated because the Wooleys had, as fiduciaries, engaged in inequitable conduct with regard to the November loan.

Issues: whether the Wooleys proofs of claim should be equitably subordinated.

Holding: Reversed and remanded.

Rules:

(1)

Section 510(c) of the Bankruptcy Code allows for the equitable subordination of claims. A fourprong test has emerged for equitable subordination and specific findings and conclusions must be made to each requirement: (a) the claimant engaged in inequitable conduct; (b) the misconduct must have resulted in injury to the creditors of the bankruptcy or conferred an unfair advantage on the claimant; (c) equitable subordination of the claim must not be inconsistent with the provisions of the Bankruptcy Code; and (d) a claim should be subordinated only to the extent necessary to offset the harm which the debtor or its creditors have suffered as a result of the inequitable conduct.

(2)

Equitable subordination is remedial, not penal, and in the absence of actual harm, equitable subordination is inappropriate.