Understanding & Protecting ‘Cash Collateral’ in Chapter 11 Bankruptcy

June 23, 2020

The storied American retail giant JCPenney filed for Chapter 11 bankruptcy in May 2020 as the COVID-19 pandemic finally crippled an already-struggling company. Days after filing, JCPenney obtained approval from the United States Bankruptcy Court for the Southern District of Texas to spend the $500 million in cash it had on hand. The Court authorized JCPenney to use this so-called “cash collateral” for certain ongoing business-critical functions. CEO of JCPenney, Jill Soltau, has expressed optimism that $500 million in cash collateral, plus $450 million in new financing, will enable the company to weather the bankruptcy process and ultimately emerge from it as a stronger retailer.

 

The United States Bankruptcy Code defines cash collateral as cash or its equivalents that must be held for the benefit of creditors during the reorganization process. Various sections of the Code do, however, allow a Chapter 11 debtor to spend cash collateral with court or creditor approval. Debtors in many Chapter 11 proceedings find it necessary to spend their cash collateral for the purpose of staying in business and emerging from bankruptcy in healthier operating condition. Bankruptcy courts are usually inclined – at least in the early stages of a Chapter 11 case – to allow a business to use its cash collateral to either maintain or improve its financial footing.

 

An important caveat to the use of cash collateral is the debtor’s obligation to take steps to ensure that the collateral will stay adequately protected. For obvious reasons, secured creditors have an interest in ensuring that cash collateral is protected against diminution during the automatic Chapter 11 debt-collection stay. Determining just what degree of protection is adequate is done on a case-by-case basis after the evaluation of many factors. It is often a very nuanced analysis that takes into account the severity of the risk to the creditor, what the cash collateral is being used for, and the specific measures the debtor promises to take to ensure protection. 

 

Adequate protection is essentially any reasonable means a debtor uses to make sure that a secured creditor’s cash collateral doesn’t drop in value after the start of the bankruptcy case. One way to achieve adequate protection is for the debtor to make periodic cash payments to the creditor, also referred to as adequate protection payments. The debtor could also grant a lien on its assets that the creditor would be able to exercise after the bankruptcy case is over. This is called a replacement lien and can be used either independently or in combination with the adequate protection payments just described. Section 361 of Chapter 11 codifies the various ways in which adequate protection can be provided as required under Sections 362, 363, and 364.

 

Using cash collateral and ensuring that it is adequately protected is mutually beneficial to the debtor and creditor in many Chapter 11 reorganizations. It allows the debtor to conduct business without having to spend time fighting off creditor collection actions. This, in turn, can lead to both better cash flow and improved operational efficiencies. For its part, the creditor will have a more-solvent borrower after the reorganization occurs.

 

For more information on this and related topics, consider speaking with a member of the legal team at Curran Antonelli, LLP. We proudly provide trusted counsel to midsize and large multinational companies in the United States and Western Europe with respect to a broad array of litigation and transactional matters.

The above information is brought to you by Curran Antonelli, LLP – a bankruptcy, litigation and transactional law firm that represents a broad range of businesses and corporate entities, private equity funds, as well as governmental agencies and other interested parties in all phases of the bankruptcy process and in bankruptcy related transactions and litigation.  As advocates and trusted business advisors, our well-established foundation of knowledge and understanding of our clients’ business interests, enables our attorneys to deliver unparalleled individualized attention to our clients of all sizes with their litigation and corporate transactional needs.

 

 

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