In business bankruptcy, cash collateral is a frequently used term. According to lawyers of Dallas based law firm, collateral is a property against which you get a loan. Thus, the lender has a lien on the property. Examples of collateral include house which secures the mortgage, car that secures the vehicle loan, and jewelry that secures loan received from the pawnbroker.
In case of a secured loan, when you pay back the amount owed, the lender releases the lien on the property. However, if you default on it, the lender can take the property and sell it to recover the money owed. Thus, home loans, car loans or pawnshop loans are collaterals that exist for the entire duration of the loan. You cannot sell or trade any of those properties unless you pay off the loan.
Know more about cash collateral
In case of a business loan, any lender (including banks) ask for the inventory and accounts receivable as collateral for the loan. However, business inventory or accounts can change daily. As per bankruptcy laws, cash collateral includes cash, negotiable instruments, securities, documents of title, deposit accounts, products, rent, etc. This includes money received, new accounts created due to the sale of inventory as well as money from accounts receivable.
Need for cash collateral for loans
The advantage of pledging cash collateral for a business loan is that it works as an added security. Thanks to it,the business can continue operations without the need to pay off the entire loan whenever they sell inventory or collect any account receivable.
What is special about cash collateral?
Cash collateral is different from other collaterals as it changes frequently and can include cash or account which were not present when the original loan was sanctioned. It finds use in bankruptcy as well as outside it. If the business is making timely loan payments as per the agreement, it can continue operation without any interruptions. This is because the lien on the loan shifts from inventory to sale proceeds and then to new inventory and accounts.
However, when the reorganization of business takes place due to bankruptcy, in case of cash collaterals additional steps are required. The business needs permission from the court to use cash collateral in bankruptcy proceedings. This is because bankruptcy laws prevent an agreement made before bankruptcy from forming a lien on income generated or assets acquired once the bankruptcy is filed.
Apart from this, you need to provide sufficient protection to the secured creditor before the court approves the use of cash collateral in bankruptcy. For providing protection to lenders, you need to guarantee a safeguard that ensures that the lender’s security interest is not reduced by your actions. This can be done by either providing them with a replacement lien on the proceeds from the sale of inventory and new accounts or having a separate cash collateral bank account. Additionally, you could also pay the lender in cash or agree to a budget that specifies the amount and way the business could use cash collateral.