A Chapter 11 debtor filed a motion to use cash collateral. The key question was whether there was adequate protection of the lender’s interest in the cash collateral.
The court introduced its opinion as follows:
At first blush, this case presents a straightforward issue – can a debtor, who offers its major secured creditor adequate protection in the form of a post petition lien on assets that will increase in value at least $1 million and monthly payments, as well as usual conditions, use that creditor’s cash collateral? Normally, the answer is yes. In this case, however, the secured creditor sees failure and disaster for the Debtor within a year and asks this Court to deny Debtor’s Motion.
The debtor operated a dairy farm that had expanded over the years until it reached annual revenues of over $12 million. However, it lost $1.2 million in the year prior to bankruptcy and had aggregate losses of $5 million to $6 million over the five years preceding bankruptcy. Two primary contributing factors were identified: The expansion of a milking facility was done with improper concrete flooring that severely injured the debtor’s cows, causing it to lose 600 cows; and the price of milk dropped.
The debtor’s agricultural lender (two affiliated companies) was owed ~$20 million, with monthly interest of ~$89,000. It held a mortgage and security interests in virtually all of the debtor’s assets, which the debtor valued at a little over the value of the secured debt.
Cash collateral is defined as cash, deposits, etc. in which both the bankruptcy estate and another entity have an interest. Under section 363 of the Bankruptcy Code, the debtor may not use cash collateral unless either the third party consents or the court authorizes the use. On request of the third-party, the court shall prohibit or condition the use as necessary to provide adequate protection of the third party’s interest.
In this case the lender’s collateral included cash collateral. The focus of this opinion was ~$450,000 cash from the sale of milk held by the debtor. The debtor received two checks per month for milk sales which it needed to use to continue operations. Initially the debtor and lender had an agreement allowing use of cash collateral. After that agreement expired, the debtor sought court approval for continued use.
The debtor argued that it would provide adequate protection based on (1) monthly payments of $60,000 and (2) its projections that over the course of two months through harvesting haylage and corn silage it could increase the value of the lender’s asset base by ~$1.7 million while staying current with its trade creditors. It also intended to take steps to increase profitability by acquiring more milk cows to increase revenue.
The lender’s witness responded that “the Debtor has done everything possible to become economically feasible, including personal loans and capital infusions, but these efforts were not successful.” Focusing on the operating losses, he noted that the debtor should replace an average of 100 milk cows per month. A less productive cow that is being culled sells for around $615, while a replacement cow costs $1000-$1350, leaving a shortage of up to $73,500 per month that must be funded through milk revenue. The money was not there. The lender also forecast a drop in milk prices in the near future, so believed there was a small window of opportunity for the debtor to liquidate.
The court evaluated adequate protection by determining (1) the value of the lender’s interest, (2) the risk that the value would decline, and (3) whether the proposed adequate protection protected against the risks. The court considered the lender’s collateral interests as a whole, rather than just the cash collateral. It noted that all agreed that the most liquid assets (milk and cattle sale proceeds) should be used to fund day-to-day operations. So, the focus was on the value of the cattle, haylage and silage.
The court concluded that the projections in combination with the monthly payments demonstrated adequate protection. However, the court acknowledged the lender’s concerns about the debtor’s financial reporting. So, the court conditioned use of cash collateral on reporting requirements relating to the status of harvesting and retention of an accountant or financial expert.
The court specifically declined to impose a requirement that the debtor show that it would likely be able to accomplish an effective reorganization. Neither section 361 (adequate protection) nor section 363 (use of cash collateral) imposes that requirement, and in any event the parties would be addressing the issue within a couple of months in the context of a lender request for relief from the automatic stay.
It is not that unusual for a lender to see “failure and disaster” for a debtor that has filed bankruptcy. From the standpoint of a lender that has concluded the debtor is a lost cause, watching the dissipation of cash can be frustrating.
Note that in the context of a traditional real estate case involving an assignment of rents (as opposed to profits from a business), there can be the additional threshold question of whether the debtor retains any interest in the rents after there has been a default and perhaps an exercise of the assignment of rents. Some courts have held that under applicable state law only the mortgagee has an interest, which means that the rents are not cash collateral since they are not even part of the bankruptcy estate, and thus the debtor has no right to use rents.
Vicki R Harding, Esq.