Cross-Collateralization Clauses in Bankruptcy: Enforcement Challenges for Lenders

Description

Cross-collateralization clauses are common in consumer loans and are used in commercial financing as well, particularly commercial real estate mortgages. These clauses can wreak havoc in a borrower’s bankruptcy, as secured creditors compete for the priority of their liens. 

A recent Seventh Circuit Court of Appeals case upheld a cross-collateralization clause against a junior lienholder in a bankruptcy involving commercial real estate loans, based on the fact that the junior lender had actual notice of the provision in the senior loan documents.

Counsel to junior lenders should look into whether there is a cross-collateralization provision in the senior loan. If so, counsel must consider protecting the junior lender with an intercreditor agreement—and inquiring about other loans the borrower may have.

Cross-collateralization is also a key tool for lenders in providing bankruptcy financing. Courts tend to disfavor or heavily scrutinize future cross-collateralization involving pre-petition debt secured by post-petition collateral. Backward cross-collateralization is far less controversial.

Listen as our authoritative panel of attorneys discusses the enforceability of cross-collateralization provisions in bankruptcy, recent bankruptcy case law regarding dragnet clauses in borrower loans as well as DIP financing, and best practices for both senior and junior lenders to protect their priority in the event of the borrower's bankruptcy.