Filings for commercial Chapter 11 bankruptcy protection in the US totaled 2,167 in the first half of 2021.
Are you considering Chapter 11 for your business? Would you like to continue your regular business activities during a restructuring?
Debtor in possession financing could be the solution you’re looking for. Find out here how debtor in possession financing works. You can decide if it’s the best choice for your business.
What Is a Debtor in Possession?
A debtor in possession (DIP) is a person or corporation that filed for Chapter 11 bankruptcy protection. The DIP still holds property that creditors have a lien or other security interest on. The DIP can continue running their business using that property.
The DIP can continue running their business. The bankruptcy court must approve anything beyond regular business activities, though.
The DIP must keep detailed financial records. They must insure their property and file the right tax returns.
What Is Debtor in Possession Financing?
Debtor in possession financing is special financing for corporations that are going through Chapter 11 bankruptcy. A company must have filed for Chapter 11 bankruptcy protection to be eligible for DIP financing.
DIP financing helps companies that would otherwise run out of cash. It helps fund payroll, rent, and other operating expenses. It lets vendors, suppliers, and customers know that the debtor has the means to stay in business during its bankruptcy reorganization.
DIP Financing Process
The debtor in possession financing application should occur at the beginning of the bankruptcy procedure. The debtor needs to file a motion with the bankruptcy court for authorization to get financing.
The filing should include the loan documents and the proposed order for the court to approve. It should also include affidavits by the debtor explaining the need for financing and how they got it.
This means that the debtor company must find a lender before submitting the motion to the court.
Due to the short timeline, the parties are often still negotiating the loan agreement when the debtor files the motion. They may attach a commitment letter or drafts of the loan agreement instead of the final version.
Court Approval of DIP Financing
Approval of DIP financing is often a multi-step process. The debtor often files the DIP motion on the first day of the bankruptcy case. This doesn’t give their other creditors enough notice.
The bankruptcy judge can decide to grant interim approval of the financing. The judge will hold a hearing a few days later to consider whether the DIP lender can disburse some of the financing on an interim basis. The judge will then give notice to all the debtor’s creditors.
A hearing for final approval of the DIP financing takes place at least 14 days later. This gives the debtor’s other creditors time to file any objections.
The court hears both sides of the argument. Then the judge decides whether to grant final approval for the financing.
Types of DIP Loans
A debtor in possession facility can be a term loan or revolving credit. The debtor and the lender will negotiate which type of facility the financing will provide.
Term loans have a specified repayment schedule. Revolving credit facilities let the borrower draw down and repay the loan as needed. Revolving credit gives the borrower more flexibility.
Unsecured or Secured Financing
The debtor company must first try to get unsecured financing. An unsecured loan doesn’t require collateral.
The lender of an unsecured DIP loan gets administrative expense priority. They have priority over all other preexisting (pre-petition) unsecured claims.
If the debtor can’t find a lender for unsecured financing, the court can authorize them to get secured financing. Secured loans have collateral.
A lender who agrees to provide secured DIP financing gets superpriority over all other administrative expenses. The lender also gets a security interest in any assets not already used as collateral or a junior lien on collateral assets.
If the debtor can’t get unsecured or secured financing, the court can authorize a priming lien. A priming DIP loan gives the lender priority over pre-petition secured creditors. They get a superpriority over all other claims.
A priming lien on assets already used as collateral isn’t an option outside of DIP financing.
Finding a Lender
It may seem surprising that a lender would want to offer DIP financing. However, a debtor in possession loan has several features that make it more appealing for lenders.
First, DIP financing usually has a higher interest rate than the lender would get otherwise.
Second, the Bankruptcy Code protects a lender who offers unsecured or secured financing. The lender can also benefit from a priming lien.
Third, the debtor company’s existing lenders can use a new DIP financing agreement to protect their collateral. They prevent an outside lender from coming in and taking priority over the collateral that is already securing their loans.
In addition, lenders usually have some control over the debtor. The court grants this authority by approving the terms of the DIP financing.
The terms of the DIP loan can require the debtor company to comply with a variety of conditions. The debtor may need to follow a weekly budget and give frequent reports.
Roll-Up and Cross-Collateralization
Pre-petition lenders that offer debtor in possession financing can negotiate for other protections like a roll-up or cross-collateralization. A roll-up provision requires the debtor to use some of the DIP financing to pay down the pre-petition debt. A roll-up protects the lender from having the court restructure their preexisting claim without their consent.
Cross-collateralization lets the lender get a security interest in new collateral. The new property secures the DIP financing as well as the pre-petition loan.
The Bankruptcy Code doesn’t specifically authorize roll-ups and cross-collateralization. However, if the debtor doesn’t have any other financing options, bankruptcy courts often approve these provisions.
Benefiting From DIP Financing
Debtor in possession financing gives businesses going through Chapter 11 bankruptcy the funding they need to keep day-to-day operations running. The process can be lengthy. However, a DIP loan can make the difference in successfully emerging from bankruptcy.
Do your research, get professional advice, and take the first step toward saving your company.
Check out our other business finance articles for more timely information like this.