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The sanction for Unauthorized Use of Cash Collateral Under American Bankruptcy Law

Section 363 (a) defines cash collateral as “cash, negotiable instruments, a document of title, securities, deposit account, or other cash equivalents. In a Chapter 11 case debtor’s bank account, which is held at the bank where the debtor borrows (and so subject to set against that borrowing), would be cash collateral.

One of the few specific questions associated with the debtor’s cash collateral use is the penalty the debtor will suffer for unauthorized use. We believe that we often used cash collateral without authority based on highly anecdotal evidence. In some cases, debtors have atoned by giving replacement collateral. But of course, giving additional collateral is no punishment, for that is what the debtor would have had to have done if that asked permission to use cash collateral.

A debtor in possession sells collateral under section 363 without the proper authority or where a lender makes a post-petition loan without court approval under section 364. In addition, the court can often punish the lender or the buyer for returning the asset or its value, for example, in re Krisle case, who withdrew 94.000 from the debtor in possession deposit.

The Krisle (hereafter debtors) filed a Chapter 11 petition for reorganization on June 1, 1984. The debtors are farmers. Raymond R.was the attorney at the time of filing. On September 25, 1984, John M. Fousek, another attorney, was approved by the Court to represent the debtors. He was subsequently allowed to withdraw, and, on January 9, 1985, Max A. Gors, Pierre, South Dakota, was approved as the debtors’ attorney. 

The Confirmation hearing on the debtors’ third amended plan was held on May 21, 1985, in Rapid City, South Dakota. Before this hearing, Mr. Gors, on behalf of his clients, made several attempts to negotiate with their major secured creditor, First Bank of South Dakota, Lemmon Branch. When these negotiations proved unsuccessful, the parties agreed to continue the hearing on plan confirmation.

On May 23, 1985, Attorney Haven L. Stuck also requested an expedited hearing on behalf of First Bank. Accompanied by a supporting Affidavit, and continue to file a second motion on June 3, 1985. It was a Motion for Issuance of Order to Show Cause Turnover of Property, Restraining Order, and an expedited hearing. Because the Court was in transit to Pierre, South Dakota, for its June court term before filing the second motion and affidavit, Mr. Stuck provided the Court a copy at June 4, 1985, hearing. In addition, the certificate of mailing attached to the pleadings indicated that Mr. Stuck had sent copies to both the debtors and their attorney, Mr. Gors, on May 29, 1985.

The Court reviewed the pleadings. The accompanying affidavit recited that they had informed  First Bank that the debtors had withdrawn all the funds from the debtor-in-possession account and closed it. Further, the amount withdrawn was approximately $100,000, which was cash proceeds from the sale of livestock secured to the bank. Accordingly, acting according to 11 U.S.C. § 362(f), the Court determined an emergency and that they should immediately hear it. Neither the debtors nor their attorney, Mr. James E. Carlon (Gors Law Firm), raised any objections.

Attorney Stuck called the debtor, Kenneth R. Krisle, as a witness. When asked his name, Mr. Krisle refused to answer, basing his refusal on the protection of the Fifth Amendment. The debtor continued to rely on the Fifth Amendment when asked who his attorney was and whether he had a debtor-in-possession account. Attorney Carlon requested that his client be granted immunity according. to 11 U.S.C. § 344 After confirming that Mr. Krisle would not answer any questions, the Court ordered that he turn over the cash collateral. When Mr. Krisle disobeyed this order, he was held in civil contempt. Following proper civil contempt procedures, the Court ordered the debtor into the custody of the United States Marshal until the proceeds of the debtor-in-possession account are made available to the Clerk of the Bankruptcy Court.

Upon reviewing the case file, the Court found adequate evidence showing that the debtors had closed a debtor-in-possession account at the West River State Bank in Hettinger and withdrawn all funds of not less than $94,207.00.Additionally, findings included that the First Bank of South Dakota, Lemmon, would be harmed if they did not turn over the cash collateral to the Court.

Court-ordered Krisle to turn over the cash collateral to the Clerk of the United States Bankruptcy Court; otherwise, Kenneth Krisle would stay in the custody of the United States Marshal until the proceeds are withdrawn from the debtor-in-possession account and disbursed to the Clerk of the Bankruptcy Court.