What is Cash Collateral?
By Nicholas Ortiz, Boston Bankruptcy Attorney on Apr 11, 2008 in General Bankruptcy Information
Cash collateral is usually only an issue in business bankruptcy cases. Cash collateral is defined as “cash, negotiable instruments, documents of title, securities, deposit accounts, or other cash equivalents,” 11 U.S.C. § 363(a), in which a creditor has a lien.
An example is when a creditor has a security interest in inventories and their proceeds. The cash generated from sale of these inventories, even from sales after the bankruptcy case is filed, would be cash collateral. This cash collateral cannot be used by the debtor even in the ordinary course of business to, for example, pay workers or buy new inventories, without the consent of the creditor or by order of the Court.
Because this cash is often the lifeblood of the business, motions to use cash collateral must be brought early, and are often brought on the same day a case is filed. If an agreement cannot be reached with the creditor, the debtor has the burden of proving that the creditor is adequately protected from diminution of value of its lien despite the spending of its cash collateral. There are various ways to do this, but a common one is the granting of a replacement lien in favor of the creditor other property (for example, new inventories purchased with the cash collateral).
In any event, this issue must be addressed and resolved early in a Chapter 11 case so that the business can continue to operate. There are significant penalties for the unauthorized use of cash collateral.
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