Cash collateral: Overview, definition, and example
What is cash collateral?
Cash collateral refers to funds or cash equivalents provided by a borrower to secure a loan or credit facility, typically in a secured lending arrangement. Cash collateral is often used to back a loan or credit agreement as a form of security for the lender. This collateral may be held in a separate account or as part of a broader collateral package and serves as protection for the lender in case the borrower defaults on the loan or credit terms.
In the event that the borrower defaults, the lender has the right to seize the cash collateral to recover the outstanding debt. Cash collateral can also be used in bankruptcy proceedings, where it may help a borrower access credit while protecting creditors' interests.
Why is cash collateral important?
Cash collateral is important because it provides a lender with a higher level of security compared to unsecured loans, reducing the risk associated with lending. For the borrower, offering cash collateral may be necessary to obtain a loan, especially if they have a poor credit history or are seeking higher loan amounts.
In financial agreements, the use of cash collateral is a common practice to safeguard lenders, ensuring that they have assets available to mitigate potential losses if the borrower fails to meet their repayment obligations. For businesses, it can be a valuable way to access capital while demonstrating financial responsibility.
Understanding cash collateral through an example
Imagine a small business that needs a loan to expand its operations. The bank agrees to lend the business $100,000, but the business has limited assets to pledge as collateral. To mitigate the risk, the bank requires the business to provide cash collateral of $25,000, which is held in a separate account. This cash collateral secures the loan, giving the bank the right to seize the collateral if the business defaults on the loan.
In another example, a company that is undergoing a bankruptcy proceeding seeks additional financing to continue its operations. The lender agrees to provide a loan but requires cash collateral in the form of funds from the company’s reserves to secure the loan. This provides the lender with security while allowing the company to maintain operations and access credit during the bankruptcy process.
An example of a cash collateral clause
Here’s how a cash collateral clause might look in a loan or credit agreement:
“The Borrower agrees to deposit $[Insert Amount] in a designated cash collateral account, which shall be held as collateral for the Loan. The Lender shall have the right to access and apply the cash collateral to any outstanding obligations in the event of a default under the terms of this Agreement. The cash collateral shall remain in the account until the Loan is fully repaid, or the terms of this Agreement are otherwise satisfied.”
Conclusion
Cash collateral is a key component in secured lending, offering lenders a valuable form of protection in case the borrower defaults on their obligations. By providing cash or cash equivalents as collateral, borrowers can secure loans or credit facilities while giving lenders the assurance that they have assets to cover potential losses. Understanding how cash collateral works and including clear terms in lending agreements ensures that both parties are protected and helps facilitate access to credit in various business and financial situations.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.