Using Cash Collateral to Pay Expenses During a Chapter 11 Case
Most Chapter 11 bankruptcies involve a number of “first day” motions, which are applications made to the court at the very start of the case to give some immediate relief to the debtor. These motions might seek approval of financing for the debtor, preference of certain creditors over others and other changes in how the debtor does business. The debtor’s cash collateral motion is one of the most common first day motions heard.
In Chapter 11, debtors are allowed to remain in charge of their business. But in return, debtors have the legal obligation to avoid using cash collateral without permission of the creditor or a court order. “Cash collateral” includes cash and cash equivalents like securities, accounts receivable, inventory and various other liquid assets. For example, imagine a debtor has a rental property with a mortgage. The building itself is collateral, but so is the stream of rental income. The income is cash, but it is also collateral. If the debtor stops paying the mortgage, the creditor can take the building and the stream of income.
The reason why the cash collateral motion is so important is that the debtor may be using the cash to pay other costs of running the business — for example, to pay employees or cover other expenses. Once the debtor files for Chapter 11, he or she is no longer free to use the rental income for anything other than repaying the mortgage company. Instead, the debtor must get permission from the creditor or the court.
Permission to use cash collateral to pay expenses is commonly granted by the courts. There are several reasons for this, two of which are these:
- It is in both the debtor’s and creditors’ interests for the debtor to remain in operation to preserve the value of the business.
- Filing for Chapter 11 implies that the business can be turned around. Preventing the business from using cash would hurt its chance of success.
A debtor who doesn’t obtain permission to use cash collateral will quickly earn the mistrust of creditors. This lack of trust can make the whole case break down. Debtors who use cash collateral without approval run the risk of having the Chapter 11 trustee come in and take over management of the company. In the worst case, the court could bar the debtor from accessing cash, thereby inhibiting the company from operating. This eventually forces the company to convert to Chapter 7 liquidation and go out of business.
At the Law Offices of Michael Jay Berger in Beverly Hills, our Chapter 11 lawyers act quickly and decisively on cash collateral motions and other first day motions as needed. If you are considering reorganizing your California business through bankruptcy, call 310-271-6223 or contact us online for a free consultation where we’ll educate you about your options.