Objecting to a Debtor’s Use of Cash Collateral in Bankruptcy

When a produce company files a chapter 11 bankruptcy case, one of the first questions my PACA trust creditor clients ask is whether the debtor will be able to keep any cash it may have in the bank or any cash it receives from collecting its accounts receivable.

The answer is that the debtor almost always has a bank or other secured creditor which holds a lien on substantially all of its assets.  Property like inventory, machinery and equipment and the like is called hard collateral.  Such items can be used and sold in the ordinary course of business in a chapter 11 case.

Liquid assets, like cash, bank accounts, and accounts receivable, however, are a different matter.  These are called “cash collateral.”  And cash collateral may not be used over the objection of a secured party without a court order.  This order is called the “cash collateral order.”   Simply put, the purpose of a cash collateral order is to allow the debtor to utilize its cash collateral even though the cash collateral is subject to the liens of a secured party.  To do this, the debtor must provide its secured lenders with adequate protection (e.g. replacement liens in post-petition assets, super-priority administrative claims, etc.) necessary to facilitate the use of the cash collateral.  Because the debtor’s ability to use its cash collateral is critical to its ability to successfully emerge from a chapter 11 filing, debtor’s counsel often seek court approval of a cash collateral order on the very first day of the bankruptcy filing.

If you are a PACA trust creditor, you must be mindful of the cash collateral order process because there are almost never any provisions included in a cash collateral order that protect the rights of the PACA trust creditors.  As a result, a savvy PACA trust creditor will immediately object to the debtor’s use of cash collateral and create a seat at the negotiating table for the PACA trust creditors.  A well advised PACA trust creditor understands the debtor’s obligations under PACA and will generally make the following objections to debtor’s use of cash collateral:

1. The scope of the PACA trust covers the debtor’s cash collateral as a matter of law
2. PACA trust assets are not property of the debtor’s estate
3. The debtor cannot use non-estate property as cash collateral
4. The debtor cannot use PACA trust assets as collateral for post-petition financing

A timely filed objection to a debtor’s attempt to obtain a cash collateral order will often result in the full and immediate payment of the PACA trust claim.  When that is not possible, the objecting PACA trust creditor will have the ability to either seek adequate protection (just like a secured party) from both the debtor and its secured creditors or force the case to convert to a chapter 7 liquidation case.  Remember, a chapter 11 case will not stand if there are no estate assets to administer.

Key Point: If the PACA trust creditors do not act quickly when they are notified of a produce buyer’s insolvency, the debtor will obtain a cash collateral order that does not include any protections for PACA trust creditors.  If that happens, the cash collateral order will allow the debtor to use trust assets (the Court won’t know unless someone speaks up) to administer its estate, obtain DIP financing, and otherwise place trust assets out of the PACA trust creditors reach (e.g. paying pre-petition wages, etc.)

Bissett Produce Bankruptcy

On February 4, 2013, Bissett Produce Company, which is a 17-year-old company that owns and operates a sweet potato distribution company in Spring Hope, NC, filed for Chapter 11 bankruptcy protection.

The bankruptcy court entered an order on March 1, 2013  authorizing Bissett Produce to utilize its cash collateral in order to incur certain operating expenses anticipated in relation to a wind down of its operations.  According to court documents, at the time of its Chapter 11 filing, Bissett Produce said it owed liabilities of nearly $5.5 million, with $2.1 million of that amount due to secured creditors and the remaining $3.4 million owed to unsecured creditors, including claims held by several farms located in North Carolina.

Importantly, Bissett Produce has neither established any type of carve out to pay PACA trust creditors nor filed any motion seeking to establish a PACA trust claims procedure.  Rather, Bissett Produce simply asked the Court to allow it to use its cash collateral to pay pre-petition wages and to fund the wind down of the business.  In essence, the defunct entity seeks to use assets, which most likely include PACA trust assets, to pay professionals, employee wages and other operating expenses without regard to any trust obligations that may exist.  This is exactly the type of situation that requires an immediate objection to the Debtor’s continued use of cash collateral so that the PACA trust may be protected.  Until the PACA trust is preserved and the unpaid suppliers of produce paid in full, there may not be an estate to administer.

Industry Note: Bankruptcy cases often move quickly with numerous motions filed on the very first day the case is open.  Because of this, produce companies would be well advised to get involved in these types of cases early and take the steps needed to ensure trust assets are not placed out of the reach.