Legal Definitions - adequate care

Adequate Protection

In bankruptcy law, Adequate Protection refers to measures taken by a bankruptcy court to safeguard the financial interests of a secured creditor when a debtor files for bankruptcy.

When a debtor declares bankruptcy, an "automatic stay" goes into effect, which temporarily prevents creditors from taking action to collect debts or seize collateral. While this stay protects the debtor, it can put a secured creditor's interest at risk if the value of their collateral (the property securing the loan) decreases during the bankruptcy process, or if they are prevented from enforcing their rights. Adequate protection aims to prevent this harm by ensuring the secured creditor's interest in the collateral is not diminished while the bankruptcy case proceeds.

This protection can take various forms, such as:

• Regular cash payments from the debtor to the creditor.
• Granting the creditor an additional or replacement lien on other property.
• Providing other forms of security or compensation to offset any potential loss in value of the collateral.

Here are some examples illustrating Adequate Protection:

• Example 1: Depreciating Equipment

  A manufacturing company files for bankruptcy, and one of its key assets is a fleet of specialized delivery trucks, which are collateral for a loan from a bank. The trucks are essential for the company's operations and generating income to reorganize, but they are also rapidly depreciating in value due to heavy use. The bank is concerned that by the time the bankruptcy concludes, the trucks might be worth significantly less than the outstanding loan balance.

  To provide Adequate Protection, the bankruptcy court might order the manufacturing company to make monthly cash payments to the bank. These payments would compensate the bank for the depreciation of the trucks, ensuring that the bank's secured interest in the collateral is preserved even as the trucks lose value during the bankruptcy proceedings.

• Example 2: Unmaintained Real Estate

  A real estate developer files for Chapter 11 bankruptcy, and a commercial property it owns is subject to a mortgage held by a lender. The developer needs time to reorganize its finances, but during this period, it is not adequately maintaining the property, leading to deterioration and a potential decrease in its market value. The lender fears that its collateral is being devalued while the automatic stay prevents foreclosure.

  The bankruptcy court could require the developer to establish an escrow account specifically for property maintenance and repairs, funded by a portion of the property's rental income. Alternatively, the court might grant the lender a secondary lien on another unencumbered asset of the developer. Both measures serve as Adequate Protection, safeguarding the lender's interest in the property's value.

• Example 3: Use of Cash Collateral

  A small business in bankruptcy needs to use its operating cash, which is held in a bank account and pledged as collateral to a different lender, to pay employees and suppliers to keep the business running. The lender is concerned that allowing the business to use this "cash collateral" will deplete its security.

  The bankruptcy court might permit the business to use the cash but require it to grant the lender a "replacement lien" on future accounts receivable or inventory that the business generates. This new lien would replace the value lost from the original cash collateral, thereby providing the lender with Adequate Protection for its secured interest.