What Is Cash Collateral?

Cash collateral is cash and equivalents collected and held for the benefit of creditors during Chapter 11 bankruptcy proceedings. Cash and cash equivalents include negotiable instruments, documents of title, securities, and deposit accounts. Unless a court orders otherwise, cash collateral is separated from other assets for the purposes of paying creditors.

Key Takeaways:

  • Cash collateral is cash and equivalents held for the benefit of creditors during Chapter 11 bankruptcy proceedings.
  • Cash and cash equivalents include negotiable instruments, documents of title, securities, and deposit accounts.
  • As assets are sold off during bankruptcy, the cash is placed in a cash collateral account, separate from other assets.

Understanding Cash Collateral

Collateral in the normal sense is property pledged to secure a loan; the lender then has a lien on that property. For example, a buyer secures a mortgage loan from a bank using their house as collateral.

When a bank or other lender provides a business loan, the business may have to pledge its inventory and accounts receivable as collateral to secure the loan. Unlike a house, accounts receivable and inventory changes every day: inventory is used, sold, and replaced, accounts receivable fluctuates as products are sold, or new accounts are opened if inventory is sold on credit.

According to 11 U.S. Code Section 363(a), the full definition of cash collateral is "cash, negotiable instruments, documents of title, securities, deposit accounts or other cash equivalents, whenever acquired, in which the estate and an entity other than the estate have an interest and includes the proceeds, products, offspring, rents, or profits of property and the fees, charges, accounts or other payments for the use or occupancy of rooms and other public facilities in hotels, motel, or other lodging properties subject to a security interest as provided in section 552(b) [of this title] whether existing or after the commencement of a case under this title."

Pledging cash collateral to secure a loan means that the business can continue to operate without having to pay off an entire loan whenever it sells inventory or collects an account receivable.

Cash Collateral and Bankruptcy

In the context of bankruptcy, when a creditor such as a bank or a supplier has a claim on a company's assets, any cash collected or generated from the sale of assets is considered cash collateral. As money is brought in from accounts receivable collections, sale of remaining inventory, or sale of property and equipment, the cash is placed in the cash collateral account.

The cash cannot be used by the debtor without the creditor's consent or by court order. In practice, a creditor may be amenable to the debtor using the cash to continue operations to relieve its financial distress. However, if a new piece of equipment is purchased with the cash, for example, the equipment takes the place of the cash as collateral. This type of substitution is governed by Section 361 of the Bankruptcy Code, which requires "adequate protection" for a secured creditor to "ensure against the decline of the value of its collateral." A debtor may be instructed by the court to provide a replacement lien, as in the preceding illustration, or make periodic cash payments if the value of the overall cash collateral account begins to decline.