Law Offices of Nicholas Gebelt

Cash Collateral In Chapter 11

What is cash collateral?  Perhaps the best starting point to understanding the concept is with a relatively common example.  Suppose the debtor has a rental property encumbered by a mortgage.  The note undoubtedly has an assignment of rents provision.  This means that the creditor has a lien against the debtor’s stream of rent payments.  That stream of payments belongs to the creditor and is called cash collateral because it serves as partial collateral for the debt — the real property is the other portion of the collateral.  As long as the debtor makes the monthly payments, the creditor will take no action.  However, if the debtor stops making the payments and uses the cash collateral for personal or business purposes, the debtor violates the terms of the note.  This is a form of fraud.

Prior to filing the bankruptcy petition, the debtor has assets and debts.  When the debtor files the petition, the assets go into a bankruptcy estate, and the debts become claims against that estate.  In the case of an individual debtor, the debtor can remove assets from the estate using the appropriate exemption table.  The nonexempt assets remain in the estate.

One thing that the debtor cannot exempt is the cash collateral because that money is not one of the debtor’s prepetition assets.  It belongs to the creditor.

Suppose the debtor has been faithfully remitting payments to the creditor prepetition, while using the rest of the rental income for personal and business purposes.  After the debtor files the petition, can the debtor continue this practice?  The answer is no, unless the creditor agrees to it, or the Court grants the debtor permission to use the cash collateral.  11 U.S.C. § 363(c)(2).  See Fed, R. Bankr. P. 4001(b) and LBR 4001-2 for the mechanics.  You can either use Form F 2081-2.1, or prepare your own motion in standard pleading format.

Therefore, a standard first-day[1] motion is a motion to use cash collateral.  It is especially important to get the motion granted right away if the cash collateral is necessary to pay employees.  Otherwise, the employees will quit and the case will burst into flames.  Therefore, you should concurrently file an application for hearing on shortened notice to speed up the process.

Ideally, it’s best to get the cash collateral motion granted on a final, rather than an interim, basis.  Otherwise, you will have to prosecute future cash collateral motions.  However, if your judge will only grant the motion on an interim basis, then take what you can get.

Make sure you tell your client not to use any cash collateral until the judge enters the order authorizing its use.  Otherwise, the Court may either convert the case to one under Chapter 7, or appoint a trustee, or dismiss the case — whichever is in the best interests of the creditors.

Finally, before the judge enters the order, the debtor must segregate the cash collateral in a separate DIP account.  No comingling.  § 363(c)(4).  This isn’t much of an issue if the motion is granted within a couple of days after the petition date, but it is essential otherwise.


[1] In spite of the term, the motion does not have to be filed on the petition date.  However, it should be filed as soon as possible after the petition date.

The post Cash Collateral In Chapter 11 appeared first on Southern California Bankruptcy Law Blog.

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