Bankruptcy and Cash Collateral

Bankruptcy and Cash Collateral



Section 362(c)(2) states as follows:

The trustee may not use, sell or lease cash collateral under paragraph 1 of this subsection unless:

  1. each entity that has an interest in such cash collateral consents
  2. the court after notice and a hearing, authorizes such use, sale or lease in accordance with the provisions of this section.

The definition of “cash collateral” is that which is readily converted into cash such as inventory and accounts receivable. Inventory is sold and the bankrupt has obtained cash or accounts receivable have been collected and converted into cash. The court takes the position that before the bankrupt can utilize this cash in a Chapter 11 proceeding to continue to operate the business, the bankrupt has two options: either obtain the consent of the secured creditor or obtain a hearing before the court on notice to the secured creditor. No other option exists. If the cash is utilized without obtaining consent and without a hearing, the bankrupt has violated Section 363(c)(2).

The bankrupt normally will contact the secured creditor or in the alternative will send out a notice for a hearing before the court. The creditor at that point can negotiate for adequate protection payments or some other adequate form of security so that the secured creditor will be protected. If the secured creditor and the debtor cannot reach an agreement, the court will design a solution usually not as favorable to the secured creditor as a negotiated agreement.

A secured creditor should take action where a creditor has a lien which can be converted into cash. The creditor should negotiate directly with the bankrupt to arrange for adequate security in the event the bankrupt intends to use the cash to operate the business. On the other hand, the secured creditor may take the position that Chapter 11 will not succeed and on proper grounds may oppose any use of the cash collateral. Harvis Trien & Beck, P.C. v. Federal Home Loan Mortg. Corp., 153 F. 3d 61 (2nd Cir., 1998)

What occasionally happens is that the bankrupt utilizes the cash collateral without consent of the secured creditor or without serving a notice of a hearing. Several cases have addressed this issue and all of them seem to agree that a remedy should be afforded to the creditor. They do not agree on the type of remedy since the statute is silent as to an available remedy where the bankrupt fails to comply with Section 363(c)(2).

It appears that in the event the cash collateral is used without the consent of the secured creditor or without a hearing, the court will craft some type of remedy such as a replacement lien or a payment plan or to hold an officer of the debtor, or perhaps the trustee, liable. One court did not agree with holding the trustee liable, but the court acknowledged that where the debtor misused the cash collateral, a fair and just remedy must be available to the creditor. The courts do not seem to accept, imply or infer consent of the creditor – the consent must be in writing.

Nevertheless, at this point of the bankruptcy proceeding, whatever remedy is developed by the court will not be adequate to satisfy the secured party. Accordingly, it is recommended that the secured party act quickly when cash collateral is involved.

Credit & Collection Tip: If the secured party is of the opinion that the cash collateral will be used in the business, the secured party should take some affirmative action to bring this fact to the attention of the court and seek protection immediately. Waiting for a bankrupt to act may result in serious harm.  In addition, the secured party will be faced with Section 552(a) which denies a security interest in after-acquired inventory.

Freightliner Market Dev. Corp., v. Silver Wheel Freightlines, Inc., 823 F. 2d 362 (9th Cir., 1987).

Cargocaire Eng’g Corp., v. Dwyer (In Re Gemel Int’l), 190 B.R. 4 (Bkrtcy. D. Mass., 1995)

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Revised: July 29, 2003