Limits on Chapter 11 Debtors’ Use of Cash Collateral

In a Chapter 11 bankruptcy, the debtor is generally allowed to remain in control of their business as a debtor-in-possession. However, this control is subject to restrictions. One of these is prohibition of use of cash collateral, which refers to cash, securities, accounts receivable, inventory and other liquid assets that may be pledged as security for a loan. A Chapter 11 debtor often relies on cash collateral to cover operating expenses, including payroll, utility bills and other business-related costs. However, once a Chapter 11 case is filed, the debtor cannot use cash collateral to pay such expenses without first obtaining explicit approval from either the secured creditor or the bankruptcy court. This requirement is meant to ensure that the creditor’s interests in the collateral are adequately protected.

Motions for permission to use cash collateral are usually granted if doing so is found to be in the best interests of both the debtor and the creditors. Two primary reasons underpin this practice:

1. Preservation of business value — Allowing the debtor to continue operations helps maintain the value of the business. Shutting down operations could diminish the business’s worth, reducing the amount that creditors might ultimately recover.
2. Potential for a successful turnaround — Chapter 11 bankruptcy is designed to give businesses an opportunity to reorganize and return to profitability. Denying access to cash collateral could hinder this goal, making it very difficult for the debtor to recover and repay creditors over time.

Failing to obtain proper authorization to use cash collateral can have severe consequences for the debtor. Unauthorized use of cash collateral erodes trust between the debtor and creditors, which is essential for the successful progression of the bankruptcy case. A breakdown in trust can lead to the appointment of a Chapter 11 trustee, who would assume control of the business’s management. In more extreme cases, the court could deny the debtor access to any cash collateral, rendering the company incapable of functioning. This often results in the case being converted to a Chapter 7 liquidation, where the business is shut down, and its assets are sold to satisfy debts.

Dealing with the complexities of cash collateral motions and other critical aspects of a Chapter 11 case requires strategic planning and swift action. An experienced bankruptcy attorney can ensure that these motions are properly presented, with the twin goals of preserving the debtor’s ability to operate while protecting creditors’ interests.

At the Law Offices of Michael Jay Berger in Beverly Hills, California, our experienced lawyers act quickly and decisively on cash collateral motions and other applications to get Chapter 11 cases off on the right track. Call 310-271-6223 or contact us online for a free consultation.