Four Provisions to Watch for Before You Sign a Cash Collateral Order
When a business files Chapter 11, an emergency motion to use cash collateral is essential. Cash collateral is most often the accounts receivable that the business needs to fund its operations. Payroll, rent, and other operating expenses can’t wait to be paid. That urgency of the immediate need to use cash can create pressure to agree to terms in a cash collateral order that go beyond what the Bankruptcy Code actually requires. A debtor focused on simply "getting the order signed" can inadvertently agree to provisions that are unnecessary and harmful to reorganization efforts.
Below are four general areas where business owners should slow down and look closely before signing an agreed order on the use of cash collateral.
1. Budget Restrictions That Are Too Tight
Nearly every cash collateral order includes a requirement that the debtor propose a budget demonstrating the ability to make periodic payments to the secured cash collateral creditor during the pendency of the case. Cash collateral motions are submitted with that proposed budget, which, generally speaking, is for a short term of 3 months, or such other period as is necessary to reach a final cash collateral hearing or a confirmation hearing. Such budgets usually come with a cap on permissible deviations (commonly around 10-15%). In principle, this is reasonable, because lenders are entitled to know their collateral isn't being squandered. On the other hand, an unrealistically tight budget, or one that doesn't account for the genuine unpredictability of operating a distressed business, can set the debtor up for default. Before agreeing to budget terms, make sure the numbers reflect a realistic, achievable operating plan. And remember, the budget is there to prove the ability to make adequate protection payments. In an ideal world, the cash collateral budget becomes the budget for the Chapter 11 plan; however, formulating a Chapter 11 plan budget for a distressed business can depend on many variables that won’t be known until well into the case; thus, a cash collateral budget filed on the first days of the case should be viewed with its appropriate preliminary purpose.
2. Waiver of Section 506(c) Surcharge Rights
The Bankruptcy Code allows a debtor to recover the reasonable costs of preserving or disposing of a secured creditor's collateral from that same collateral. Think of it as reimbursement for expenses incurred after filing that specifically benefited the lender's position, such as repairing equipment to keep it operational. Lenders frequently ask debtors to waive this right as a condition of the cash collateral order.
3. Overly Broad Waivers of Claims Against the Lender
Some negotiated cash collateral motions ask the debtor (and any future trustee) to waive claims against the lender, including potential challenges to the validity, priority, or extent of its lien, often on a compressed timeline. Because these hearings happen so early in a case, before meaningful discovery has occurred, courts are often rightfully skeptical of sweeping waivers agreed to under time pressure. If a waiver is included, it should be limited to what's genuinely necessary, and any deadline for challenging the lender's position should run from a clear, fair triggering event, such as the filing of the lender's proof of claim and not from the signing of the order itself.
4. Cross-Collateralization and "Rollover" Provisions
Watch closely for language that effectively upgrades a lender's pre-petition, potentially under-secured position into a fully secured post-petition claim whether through cross-collateralization (pledging new collateral to cover old, unsecured exposure) or a "rollover" (using new post-petition financing to pay off old debt, converting it into a fully protected claim). These provisions can substantially disadvantage other creditors of the estate, and several courts have found them to exceed what the Bankruptcy Code actually authorizes. If your lender is asking for either, at least in the cash collateral context, you can just say, “no” and bring the matter before the court if necessary.
The Takeaway
Cash collateral is distinctly different from post-petition financing. A lender can choose to extend or not to extend credit. A bankruptcy judge determines what is and is not adequate protection for the use of cash collateral. The terms of a first-day cash collateral order can quietly shape the trajectory of a Chapter 11 case and a business owner who understands what's negotiable and what is actually required by law is in a far better position to protect the nascent reorganization effort.
Johnson Legal Services, PLLC represents debtors in Subchapter V and Chapter 11 reorganizations, including negotiation of first-day cash collateral orders. If your business is preparing to file and wants a careful, experienced eye on the terms you're being asked to sign, we're glad to help.
This post is intended for general informational purposes only and does not constitute legal advice. Every case is different, and you should consult with a qualified bankruptcy attorney about your specific circumstances.
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