What is Cash Collateral?

Cash collateral is cash, negotiable instruments, documents of title, securities, deposit accounts, and other cash equivalents in which a bankrupt estate and its creditors have an interest. In the absence of a court order to the contrary, cash collateral must be segregated from other assets. When the court orders that cash collateral can be used, creditors are typically protected with new liens on other debtor assets, to the extent that the debtor’s use of the cash collateral will otherwise decrease the value of the collateral held by creditors. Creditors may be amenable to a debtor using this cash, if doing so will improve its financial position to the point where the creditors are more likely to be paid back a larger proportion of what they are owed.

Examples of Cash Collateral

Here are several examples of cash collateral situations:

Security interest in inventory. A creditor of Failed Corporation has a security interest in the firm’s finished goods. The cash generated from the eventual sale of these finished goods is considered to be cash collateral. Failed Corporation is not allowed to use this cash collateral without the prior consent of the creditor, or by order of the bankruptcy court.
Security interest in accounts receivable. Questionable Corporation files for Chapter 11 bankruptcy. Before filing, the company borrowed money from Sponge Bank, securing the loan with a lien on its accounts receivable, including any proceeds (cash collateral). The company files for Chapter 11 bankruptcy, and needs immediate cash to pay suppliers, employee wages, and utility bills to keep the business running. Since the cash in the company’s bank account and ongoing accounts receivable collections are pledged as collateral for Sponge Bank’s loan, the company cannot use the funds without court approval or Sponge Bank's consent.