Cash Collateral in Chapter 11: 5 Rules Before You Spend a Dollar of Receipts

The first deposit a business makes after filing chapter 11 may already carry someone else's name inside it. Nothing on the bank statement says so. The claim lives in a security agreement signed years earlier and a financing statement on file with a secretary of state, and it follows the money into the new case whether or not the owner remembers signing anything.

The Bankruptcy Code calls that money cash collateral, and it treats every dollar of it as spoken for until the creditor consents or a judge rules. What follows are the five rules that govern the interval between the petition and the first order, which is the interval in which most avoidable damage to a case is done.

1. The Lien Decides What Counts, and It Was Written Before the Case

Section 363(a) defines cash collateral as "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 it sweeps in the proceeds, products, offspring, rents, and profits of collateral, "whether existing before or after the commencement of a case." The words whenever acquired are the ones owners tend to read past.

A second statute pulls in the opposite direction. Under 11 U.S.C. 552, property the estate acquires after the filing "is not subject to any lien resulting from any security agreement" the debtor signed before it. That is the general rule, and it is a generous one. The exception in 552(b)(1) then restores the lien to postpetition "proceeds, products, offspring, or profits" of prepetition collateral, to the extent the security agreement and nonbankruptcy law provide, unless the court, "based on the equities of the case," orders otherwise.

Consider a hypothetical distributor with $90,000 in invoices outstanding on the petition date and a lender holding a perfected lien on accounts and their proceeds. When those customers pay in the second week of the case, the checks are proceeds of prepetition collateral, and the cash is very likely cash collateral. New sales made after the filing present a harder question, because the receivable itself was born inside the case, and whether the lien reaches it depends on the collateral description, on state law, and on how the court weighs the equities (a phrase that sounds soft and is not, since it is the textual opening the statute gives a debtor who wants to argue that the lender's claim to new revenue should be narrowed).

Merchant cash advance funders complicate the inventory. Some contracts purport to buy future receivables outright and back the purchase with a UCC filing; others read more like secured loans. Whether a given funder holds an interest in the deposit accounts at all is a question about that contract and that filing, and no general rule answers it in either direction. The owner who files without knowing which funders claim which receipts has, in effect, agreed to learn the answer from the funder's lawyer.

The lien search belongs before the petition, then.

2. Consent or an Order, and Nothing Between Them

Section 363(c)(1) lets an operating debtor use estate property in the ordinary course without notice or a hearing. Paragraph (c)(2) removes cash collateral from that permission. The debtor "may not use, sell, or lease cash collateral" unless each entity with an interest consents, or the court authorizes it once notice has gone out and a hearing has been held.

An agreement to use cash collateral has its own procedure. Bankruptcy Rule 4001(d) requires that a motion to approve an agreement to use cash collateral be filed with the agreement and a proposed order, and that notice give parties a period to object, fourteen days unless the court sets another. The statute accepts consent. The rule, once approval is sought, wants everyone else told.

There is no third route. A lender's loan officer who says on the telephone that the business may keep operating "for now" has not consented to anything the court will recognize, though owners in the first week of a case hear that sentence as permission, and it is a strange sort of comfort to rest a payroll on.

3. Until Then, the Money Waits Apart

Section 363(c)(4) directs the debtor to "segregate and account for any cash collateral" in its possession, custody, or control, except as consent or an order under (c)(2) allows.

Segregation means a place and a ledger. It does not mean a mental note.

4. The First Hearing Buys Only What Prevents Irreparable Harm

A business cannot wait weeks for its own money, and the rules concede as much, though grudgingly. Under Rule 4001(b), a motion to use cash collateral must begin with a concise statement, no longer than five pages, naming each entity with an interest, how the cash will be used, the material terms of its use including duration, and the adequate protection offered to each interested party (or an explanation of why none is needed). A final hearing may begin no earlier than 14 days after service. If the motion asks, the court may hold a preliminary hearing sooner, and after it the court may authorize only the cash collateral "necessary to avoid immediate and irreparable harm to the estate pending a final hearing."

The statute adds its own standard. Under section 363(c)(3), a preliminary authorization is available only if there is "a reasonable likelihood" that the debtor will prevail at the final hearing on adequate protection, and the court "shall act promptly" on the request.

Put the two together and the practical shape of the first fortnight appears. Suppose, hypothetically, a restaurant group with $28,000 in weekly payroll, $11,000 in weekly food costs, a $9,000 rent installment falling in the second week, and a $5,000 invoice from its point of sale vendor that could wait a month without anyone closing a door. An interim request built on irreparable harm has a coherent case for payroll, for food, and very likely for rent. The software invoice is harder to describe as irreparable, and a court asked to stretch that phrase over every line of a monthly budget may decline, which is why the motion's list of uses tends to read, if we are being honest about it, less like a request than like a budget written under oath.

The interim order does not ask what the business would like to spend. It asks what the business cannot survive not spending.

The fourteen days are also a clock for the creditor. Its objection, its valuation of the collateral, and its view of the debtor's projections all arrive before the final hearing, and the interim order may be the last moment at which the debtor frames the argument unopposed.

5. Adequate Protection Is the Price, and the Debtor Carries the Proof

Section 363(e) requires the court, on request of an entity with an interest, to "prohibit or condition" the use of its collateral as necessary to adequately protect that interest. Section 361 lists the forms protection may take: cash payments or periodic cash payments to the extent the use decreases the value of the creditor's interest; an additional or replacement lien to the same extent; or other relief that gives the creditor "the indubitable equivalent" of its interest, excluding a mere administrative expense claim.

The burdens are divided. Section 363(p) places the burden of proof on adequate protection on the debtor, and the burden on "the validity, priority, or extent" of the interest on the creditor. For an owner facing a funder whose filing is doubtful, that second clause matters. The funder must prove its interest before anyone asks the debtor to protect it.

A replacement lien on postpetition receivables is the form a business short of cash can most readily offer, because new collateral is easier to supply than new dollars. Its value depends on the business generating receivables at least as fast as it spends the old ones, and a debtor that cannot show that will find the court's patience measured in weeks. Section 1112(b)(4)(D) names unauthorized use of cash collateral that substantially harms a creditor as cause to convert or dismiss the case.

Owners rarely spend cash collateral out of defiance. They spend it because Friday arrived.

Where Settlement Fits, and Where It Does Not

A business that already sits in chapter 11, with a cash collateral motion pending or a funder objecting, needs its bankruptcy counsel making every one of these decisions. Delancey Street negotiates business debt outside the courthouse and is not a law firm, so petitions, hearings, and stipulations inside a case lie beyond its reach. Its work sits earlier, in a free and confidential review of whether funder balances and other business debts might be resolved by agreement before a petition becomes the only instrument left, with independently licensed attorneys handling any legal question that arises. Some businesses will learn from that review that the petition is the better tool. The lien search in the first rule is worth doing in either case, and it starts with financing statements already on file.