Adequate Protection

Adequate protection is relief, described in Bankruptcy Code section 361, that a debtor provides to a secured creditor. What is protected? The value of the secured creditor’s lien during the bankruptcy case. How is it protected? By the debtor making periodic payments or interest payments to the secured creditor; by the debtor granting secured creditor a replacement lien on other property; or by any other form determined by the court to be “adequate.” How can we tell that the protection is adequate? When it takes account of risks to the continued value of the lien.

Where the primary collateral is accounts receivable, a lender may be granted a “replacement lien” on the same or other receivables generated post-petition (the lender’s lien on accounts receivable is cut off as of the petition date – see section 552). Assuming that the replacement lien is on other receivables, the debtor then gets to spend the proceeds of the original receivables. If the debtor continues to generate replacement receivables at the same rate or higher as it spends the proceeds of original receivables, then the lender would be adequately protected.

Where the collateral is rental real property, the protection of the debtor using some of rents to preserve the real property may be deemed adequate, because the maintenance and upkeep of the building benefits the lender as mortgagee. Where the value of the real property substantially exceeds the amount of the secured debt, the lender is considered to have an “equity cushion” that by itself constitutes adequate protection, without further provision of anything by the debtor.

If the value of the collateral diminishes during the case, and the debtor is unable to provide adequate protection, the secured creditor may have grounds on which to lift the automatic stay and pursue its non-bankruptcy remedies with respect to the collateral. Note: to contend over adequate protection requires that the secured creditor have some measurement of value as of the beginning of the case. Determining that (by appraisal, by expert testimony, or by other means) should probably be on any secured creditor’s “to do” list with a troubled borrower even before a case is filed.

« Back to Glossary