Adequate Protection: Why You Need It and What to Do When You Don’t Have It

In our article, “The Automatic Stay: Just their Latest Excuse?”, we discussed how the lack of adequate protection results in sufficient grounds to have the court lift the automatic stay to get your asset back if you are a secured creditor.  What exactly is adequate protection? And how do we know when something is adequately protected?

Adequate Protection

If you, as a creditor, have a security interest in one of your bankrupt debtor’s assets, it’s important to you that the asset in question is adequately protected. For an asset to be adequately protected, this means that it’s value won’t diminish over the course of the bankruptcy proceeding.  In other words, the debtor’s possession of the asset during the bankruptcy should not cause you to receive less money in exchange for the asset should the asset be returned into your possession after the bankruptcy.

For example, if the asset in question is a car and your debtor drives it frequently, the wear and tear as well as the constant mileage added to the car will diminish the car’s value over time. Typically a car lessee pays monthly lease payments to compensate for this wear and tear.   In a bankruptcy where no lease payments are being made, it would be appropriate grounds to request the court to lift the automatic stay and protect the value of the asset.  

If the asset in which you have a security interest is subject to being diminished in value, the debtor may compensate you for the diminution by providing you periodic cash payments, addition or replacement liens, or other agreed upon terms between you and your debtor. As defined in Bankruptcy Code Section 361, adequate protection may be provided through three different methods:

  1. requiring the debtor to make a cash payment or periodic cash payments to you if the debtor retains use of the asset or sells the asset or uses the asset as collateral for more indebtedness;
  2. provide you an additional or replacement lien on other assets to compensate for any diminution in value of your original security interest due to use, sale, lease, or other encumbrance on it; or
  3. Grant you other relief, such as compensation in the form of an administrative expense claim (which is higher priority than an ordinary unsecured claim), as will result in providing you the “indubitable equivalent” of your interest in the property securing your claim.

The short summary of the above forms of adequate protection is that you should be otherwise compensated or alternatively protected if you have a security interest in collateral that the debtor will not return to you and the debtor wishes to continue to use, sell, lease, or otherwise encumber the asset.

We always thought The Indubitable Equivalents would be a great name for Swing Band!

If you are a secured creditor and are unable to get your collateral back, drop us a note at Proxifile and we or Enumero Law, P.C. can help you secure your own adequate protection.

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