January 09, 2024

Subscription Finance: Commingling Collateral Accounts


For loans primarily secured by a cash flow stream, subscription facility lenders heavily depend on collateral accounts as a key element of the security package. In this Legal Update, we delve into why subscription facilities usually prohibit depositing anything other than capital contributions into the collateral account – often referred to as commingling.

The Potential to Commingle Funds - Automatic and Indefinite Perfection of Cash Proceeds

Under the Uniform Commercial Code (“UCC”), a secured creditor’s perfected security interest in collateral continues and is automatically perfected in the proceeds of such collateral if that collateral is disposed of by the pledgor without authorization from the secured creditor. While this outcome under the UCC is beneficial to a secured creditor because it preserves the creditor’s claim on the proceeds of the original collateral, it can also generate uncertainty because cash credited to a collateral account could consist of the proceeds of another secured creditor’s unauthorized sale of the underlying collateral. For most forms of collateral proceeds, the automatic perfection is generally limited to 20 days, but when it comes to cash proceeds, automatic perfection can survive indefinitely if the proceeds are identifiable.

Considering this fact, subscription facility lenders usually require that the credit parties maintain single-purpose collateral accounts that are contractually limited to hold only capital contributions. Through this limitation, subscription facility lenders safeguard against the risk that a third-party creditor could validly claim credit balances held in the subscription facility’s collateral account as its collateral.

For operational ease, however, many private equity funds (“Funds”) bristle at opening dedicated capital contribution accounts to serve as collateral accounts. Instead, they would prefer to use a single account for multiple purposes, such as to receive capital contributions from investors, hold distributions from underlying assets, and make distributions back to investors. Many Funds push their subscription facility lenders for the general account approach on the theory that the lender benefits from having a single account because they are gaining more collateral (i.e., amounts deposited more than the traditional subline collateral, namely capital contributions). While subline lenders could, in one sense, benefit from these additional credit balances, they could also be harmed by the potential uncertainty arising from a single general purpose account because most Funds use asset-level secured leverage, which raises concerns that an asset-level secured creditor might have a valid, first-priority secured claim on amounts credited to the single, general purpose account as proceeds of portfolio level collateral. Most subline lenders favor the certainty that a dedicated capital contribution account provides versus the benefits of this “boot” collateral.

Allocation of Commingled Cash Proceeds is Uncertain

To the extent that amounts in a single account represent commingled funds, the UCC deploys equitable principles in evaluating a continuing claim to cash proceeds.1 If an asset-level creditor can satisfy the requirement of identifiability (i.e. that cash proceeds arose from the disposition of such creditor’s collateral in which it had a perfected security interest), the UCC maintains the creditor’s claim of perfection in the cash proceeds. The issue, however, is that cash is fungible and tracing specific cash proceeds to a prior disposition may be challenging, especially over a period of time. The UCC permits the use of whatever tracing methods are legally permissible for the type of commingled property involved and, in the case of cash proceeds, the equitable principle of the lowest intermediate balance rule is often used.

The lowest intermediate balance rule protects a creditor’s claim in cash proceeds that was automatically perfected under the UCC by deeming the relevant cash proceeds to be the “last dollars out” of an account. If a balance of $100 in a deposit account consisted of $20 of an automatically perfected claim of an asset-level creditor in cash proceeds and the other $80 was capital contributions, the balance of the account could potentially be drawn down by the Fund to $20 before the asset-level creditor’s claim on the account would start to be diminished. If the account were drawn down to $10 and then new capital contributions were deposited by the customer to take the account back to $100, the asset-level creditor’s claim would be limited to $10 because that amount would represent the lowest intermediate balance. If the account balance dropped to zero at any point, the asset-level creditor’s claim would be completely wiped out. While applying the lowest intermediate balance rule is straightforward when a claim is between a secured creditor and an account customer or another unsecured creditor, it would be less predictable if two or more secured creditors had a claim to the credit balance in a deposit account.

In a situation where the competing claims in a credit balance maintained in a deposit account are between two or more secured creditors (i.e., an asset-level creditor and a subline lender), it is less likely that a court would deem either secured creditor to have a claim to the last dollars out of the account. It is possible that a court might try to evaluate each creditor’s relative percentage claim to the credit balance based on the traceable cash proceeds (perhaps a 60%/40% split, for example) and then deem each creditor’s claim to any remaining balance in the account be lined up with such percentages – although, if the account balance ever went to zero, the analysis would likely reset. Ultimately, all that can be said with absolute certainty is that a court’s approach to allocating cash proceeds between competing claims of two secured creditors will not be certain.

The Solution

To avoid potential problems (including “secret liens” or competing secured claims), secured creditors in subscription facilities usually limit the source of funds that can be credited to collateral accounts to capital contributions that are the core collateral securing such subscription facility. To the extent that this limitation is satisfied, lenders will have a heightened level of confidence that their claim to the balances in such collateral accounts will not be subject to competing claims. This solution is simple in its scope and concept; however, in practice, it might not always be entirely effective because errors could occur.

Other Relevant Concepts Relating to Claims in Cash Proceeds

While equitable principles are available to resolve circumstances in which cash proceeds become commingled with other cash assets under the UCC, other provisions of the UCC might be called upon to guide the allocation of commingled funds among the relevant parties. Article 9 of the UCC is a system of rules that, among other things, governs the priority of claims of potentially competing creditors. Consequently, in a world where two or more creditors have valid competing claims in a credit balance maintained in a single deposit account, a court might weigh the relevance of other UCC provisions in allocating the relevant assets:

Priority in Deposit Accounts

A secured creditor having “control” of a deposit account has priority over a conflicting security interest held by a secured creditor that does not have control.2 Accordingly, a court might find that in a dispute between two sets of lenders, the lenders having “control” would prevail with respect to the full amount of the cash collateral, but that outcome would not be certain and other equitable principles might play an important role in such a dispute. If two creditors each had control of a deposit account, the creditor that first obtained control would have priority under the UCC.

Where the Road Ends for Perfected Interests in Cash Proceeds

The UCC provides that a transferee (other than the debtor) of funds from a deposit account takes these funds free of a security interest in those funds unless acting in collusion with the debtor in violation of the rights of a secured party.3 This rule is necessary to ensure that security interests in deposit accounts or any portion of a credit balance credited thereto do not impair the free flow of funds. For example, if a borrower wrote a check to a third party drawn on a capital call lenders’ account, the capital call lenders would not have a security interest in the cash proceeds of such check when funded to the third party’s account.


To avoid the uncertainty that can arise from funds being commingled in a deposit account, secured lenders in a subscription facility should consider including a covenant in the loan documents that requires the credit parties to only deposit capital contributions in their collateral account. This simple covenant, if satisfied, would help avoid the potential reliance of a subscription facility lender on funds that may be subject to a competing creditor’s valid claim and could help avoid unanticipated delays and costs of litigating claims against competing creditors claiming an interest of the credit balance of a subscription facility lender’s collateral account.



1 See UCC Section 9-315.

2 See UCC Section 9-327.

3 See UCC Section 9-332.

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