Debtor in Possession Financing
What is Debt Financing?
Debtor in possession (DIP) financing, also called Debt Financing, refers to a type of loan for a business operating under the Chapter 11 bankruptcy reorganization process It allows the company to retain control of its assets through the restructuring period.
How Debtor in Possession Financing Works (Example):
Under Chapter 11 bankruptcy, a business files for protection from creditors while it reorganizes. During the reorganization process, the bankruptcy court allows the business to secure additional operational capital from lenders. Under the jurisdiction of the bankruptcy court, these post-bankruptcy lenders assume a senior position on liens and security interests in the business assets, normally by consent of the pre-bankruptcy senior lenders. In practice, the continued operation of the business allows the debtor in possession to reorganize, reposition itself, and improve its chances of repaying its debts.
Why Debt Financing Matters:
DIP financing can be an important lifeline for any business in Chapter 11 bankruptcy. It allows a business to maintain payroll and suppliers, stabilize operations, and restructure its balance sheet so that it can repay creditors and emerge from bankruptcy. A business in bankruptcy can usually only obtain DIP financing by giving its post-bankruptcy lenders protection in the form of a senior lien position. While a senior lien position guarantees that the lender will be repaid in full even in liquidation, it also limits the business with strict payment terms. This can hinder the reorganization process. Strict oversight by the bankruptcy court serves as an additional protection to DIP financing lenders to ensure that new credit sources are available to businesses in bankruptcy.
In many cases, sufficient capital dictates whether a company trying to emerge from bankruptcy will succeed or fail. Without funds to cover their operating expenses, companies cannot restructure their debt and execute a reorganization plan. However, as a “debtor in possession” (DIP), as defined by federal bankruptcy law, companies filing for bankruptcy are eligible for special financing while they are restructuring. For companies otherwise unable to raise or borrow capital, Debt Financing can provide the critical bridge to financial recovery.
DIP lenders can be any of the existing lenders for a business or any lender that wants to participate. They are given a senior lien position that protects their downside risk. They are also protected by the assets of the company, which are pledged as collateral. The bankruptcy loan can be converted into a long-term credit facility or into equity when the company emerges from bankruptcy.
Why Use DIP Financing?
- Obtain Positive Cash Flow
- Keep Operations Up & Running
- Gain Time to Address Challenges
- Leverage Market Opportunities