Dr Cornwell, the member for Charlestown, told the Independent Commission Against Corruption he knew Councillor McCloy - a property developer - was a prohibited campaign donor.
"It was just a huge mistake, I just froze," Dr Cornwell told the inquiry on Thursday.
He said Cr McCloy made no demands when he handed him the money in the mayor's luxury car shortly before the 2011 NSW election.
"He said 'I should be giving this to the Salvation Army'," Dr Cornwell said.
"That was the extent of the conversation."
Dr Cornwell - then a vet - returned to his practice to finish an operation on a dog before looking inside the bag, he said.
On Thursday, counsel assisting the commission Geoffrey Watson opened the day's hearings by formally withdrawing a comment he made on Wednesday that Dr Cornwell and fellow Liberal MP Tim Owen's inexperience may have seen them wrapped up in an alleged donation fraud.
"Those comments were only a statement of my opinion," Mr Watson said.
"I don't want to pull them here thinking there was nothing."
Mr Watson had said there was no evidence Dr Cornwell acted favourably towards Cr McCloy.
But on Thursday, he said an investigative journalist contacted the commission with fresh information but that information still needed to be verified.
"If it is verified, it could cast quite a different light on Mr Cornwell and Mr Owen," Mr Watson said.
He did not elaborate on the information.Dr Cornwell and Mr Owen spectacularly stood down from the Liberal Party on Wednesday, shortly after Mr Watson first aired the allegations in his two-hour-plus opening address.
ICAC has heard Dr Cornwell handed the $10,000 in cash to Bob Beaven, president and de facto treasurer of the Liberal Party's Charlestown branch.
Mr Beaven banked it into a business account for a company called Harmony Hill and the funds were subsequently "donated" by Mr Beaven to the NSW Liberal Party.
Political donations by property developers have been banned in NSW since 2009.
Operation Spicer is ICAC's investigation into allegations that NSW Liberal Party figures circumvented fundraising bans in the lead-up to the 2011 NSW election.
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