Use of Cash Collateral in Bankruptcy

In a Chapter 11 case involving Delco Oil. Marathon, the federal court of appeals for the 11th Circuit forced Marathon Petroleum to return almost $2 million in cash paid to it by chapter 11 debtor. The case is persuasive authority for New York vendors dealing with a debtor in Chapter 11. To avoid credit risk when dealing with a Chapter 11 debtor in possession, verify that the debtor has court authority to use cash collateral before shipping goods or accepting payment.

In the case, Marathon sold petroleum to Delco Oil for cash in advance. It did not think it incurred any credit risk. The bankruptcy court never entered a requested order allowing Delco Oil to use its cash collateral. When the case was converted to a Chapter 7 liquidation, the bankruptcy court ordered Marathon to return the payments to the Chapter 7 trustee. The trustee argued the money was from the debtor’s secured lender’s collateral, which the debtor could not use without lender consent or bankruptcy court order. The 11th Circuit agreed with the bankruptcy court.

Under the Bankruptcy Code, a Chapter 11 debtor in possession cannot use pledged current assets, such as accounts receivable and the cash proceeds of inventory unless the secured creditor agrees or the bankruptcy court enters an order allowing the use of cash collateral. Most Chapter 11 debtors can only spend their money with the consent of the secured creditor or a court order when the debtors have pre-petition secured financing. The secured creditor usually does not consent without a court order.

A court order is usually required for a chapter 11 debtor to spend money. If there is no order in place, the debtor in possession cannot spend money. In Delco Oils case, the debtor asked the bankruptcy court to enter an order allowing the use of cash collateral, but the court did not enter an order. Even without the order, Delco Oil paid Marathon over $1.9 million for fuel.

A New York supplier dealing with a debtor in possession must verify a cash collateral order has been entered before delivering products or accepting payment from a Chapter 11 debtor. Otherwise, it risks supplying products without pay. Verification can be done by checking docket sheets on a bankruptcy court’s website through the federal court “PACER” system. A “PACER” ID and password is required. There is a per-page charge for access to the system.

Consult an experienced New York bankruptcy attorney on risks relating to unauthorized debtor payments.

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