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What is cash collateral?

Posted on May 13, 2009 in Chapter 11

When we file a chapter 11 case, one of the first questions our clients ask is whether they can use the cash they have in the bank and the cash they get when collecting their accounts receivable.

Usually, the client has a bank or other creditor which holds a lien on substantially all of their assets.  Property like inventory, machinery and equipment and the like is called “hard collateral”.  Such items can be used and sold in the ordinary course of business in chapter 11. 

Liquid assets, like cash, bank accounts, and accounts receivable, however, are a different matter.  These are called “cash collateral”.  And cash collateral may not be used over the objection of a secured party without a court order.  This order is called the “cash collateral order”.  Typically, in order to use cash collateral, the debtor must assure the creditor that the value of the collateral will not decline during the course of bankruptcy.  This is called “adequate protection”.  And in addition, if the creditor is fully secured, the creditor is entitled to interest for the use of collateral during bankruptcy.  The creditor is also entitled to attorneys fees to the extent provided by contract.  

Use of cash collateral in chapter 11 is typically conditioned upon following an agreed upon budget.  Any excess cash can be swept into an account for the benefit of the creditor to the extent necessary to provide the creditor with adequate protection.  The creditor can be given a replacement lien in post-petition accounts receivable to provide additional adequate protection for loss of pre-petition accounts receivable.

If there is debtor in possession financing, cash collateral issues can become more complicated.  But that is a topic for another entry at another time.

In the meantime, if you are a business debtor in chapter 11, don’t even think about using cash collateral without consent of the bank or a cash collateral order approved and entered by the Bankruptcy Court.

Watch for more information about chapter 11 and chapter 11 practice here at Lakelaw.

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