A Secured Creditor's Checklist of Responses to a Bankruptcy Petition

• Publication year: 1986
• Pages: 25
• Citation: Vol. 15 No. 1 Pg. 25

15 Colo.Law. 25 Colorado Lawyer 1986.

1986, January, Pg. 25. A Secured Creditor's Checklist of Responses to a Bankruptcy Petition

Vol. 15, No. 1, Pg. 25

A Secured Creditor's Checklist of Responses to a Bankruptcy Petition

by Mark L. Fulford

This article surveys some of the principal issues a secured creditor should consider when first learning that a Chapter 11 bankruptcy petition has been filed, as well as during the first months of a bankruptcy proceeding.(fn1)

Cash Collateral, Reclamation of Goods and Automatic Stay

There are some short fuses that may already be burning when the secured creditor first learns of a bankruptcy petition. These include cash collateral, reclamation of goods and the automatic stay. They all must be considered immediately

Cash Collateral:

Under the Bankruptcy Reform Act of 1978 ("Code"), it is presumed that the debtor will stay in possession in the absence of "fraud, dishonesty, incompetence, or gross mismanagement."(fn2) Generally, the debtor-in-possession:

may enter into transactions, including the sale or lease of property of the estate, in the ordinary course of business, without notice or a hearing, and may use property of the estate in the ordinary course of business without notice or hearing.(fn3)

The notable exception to this general rule is that the debtor may not use "cash collateral" without either the consent of the secured creditor or court authorization.(fn4) Cash collateral is defined in the Code and, in addition to cash, it includes negotiable instruments, bank accounts, rents from property subject to a security interest and proceeds.(fn5)

The danger to a secured creditor is that cash collateral may be lost if not protected, particularly cash collateral from sale of inventory and other assets subject to sale and replacement in the ordinary course of business. Pre-petition security interests continue in effect after the bankruptcy petition in collateral that is "proceeds, product, offspring, rent or profits."(fn6) However, despite the express terms of the pre-petition security agreement, inventory and other assets acquired after the petition would not be covered by the pre-petition security interest absent a post-petition agreement with the debtor. This probably requires notice and court approval (see discussion below).

The Code forbids the debtor to use the secured creditor's cash collateral without consent or court authorization. Thus, unauthorized use of cash collateral to purchase new assets not subject to the security interest would be a violation of the Code. It might be part of the basis for appointment of a trustee to dispossess the debtor(fn7) and, perhaps, for denial of confirmation of the debtor's plan.(fn8)

However, the debtor is not required by the Code nor by most security agreements to refrain from commingling cash collateral. Once cash collateral is commingled, the secured creditor's interest is limited to the greater of any uncommingled funds (such as identifiable cash proceeds or separate deposit accounts) or cash receipts for the ten days before the petition.(fn9)

Therefore, the secured creditor's immediate response should be to give the debtor written notice that the debtor does not have permission to use cash collateral and to request assurance that cash collateral is not being used and is being segregated. If immediate assurance is not obtained, the secured creditor should immediately and, if necessary, ex parte, seek an order from the bankruptcy court forbidding use of cash collateral until the debtor obtains consent or court authorization. The creditor also should request an order requiring segregation and accounting of the cash collateral.

Upon the debtor's application, the bankruptcy court will authorize use of cash collateral if the debtor can show the court that the creditor's interest in collateral is adequately protected. The secured creditor and the debtor must try to reach an agreement by which the secured creditor will consent to the use of cash collateral and the debtor will offer adequate protection, such as by a post-petition security interest, periodic payments and an agreement on how the cash collateral is to be used in...