DIP Financing in Chapter 11 Offers a Lifeline, But With Strings Attached
Debtor-in-possession (DIP) financing is a special form of loan that may be available to a company going through Chapter 11 bankruptcy. Its purpose is to enable the company to meet operational needs, payroll, supplier payments and other critical expenses and eventually emerge as a viable entity. This financing is often necessary because traditional sources of capital are usually not attainable by firms in Chapter 11, given the high risk associated with their financial status.
DIP financing requires bankruptcy court approval. Before this will be granted, the DIP must seek unsecured credit — known as a priming loan — to fund normal business operations. This loan can be treated as an administrative expense, which must be paid under the Chapter 11 plan. The lender will likely be able to negotiate favorable terms, such as higher-than-normal interest rates. If it is not possible to obtain credit on those terms, the court may authorize DIP financing.
The terms of DIP loans are often stringent, reflecting the elevated risk to lenders. These terms include high interest rates, which compensate for the high risk of lending to companies in financial distress. Additionally, lenders may require liens on all available assets of the debtor, ensuring that they have a claim to these assets in case of default.
Other common conditions include exit and commitment fees, which are charges the debtor must pay upon the exit from DIP financing or for the commitment made by the lender to provide funds. Lenders may also negotiate for waivers of certain debtor rights, such as §506(c) surcharge waivers, which prevent the debtor from charging administrative expenses to secured creditors.
Strict budget adherence is another critical condition. It requires the debtor to adhere closely to a court-approved budget, ensuring that the funds are used prudently and that the debtor does not undertake expenditures that could jeopardize the restructuring process.
The Bankruptcy Code offers special protections to DIP lenders to encourage them to lend to bankrupt companies. These include the ability to receive periodic cash payments, the provision of replacement liens on unencumbered property, and super-priority status in repayment. Super-priority means that DIP debt is repaid before all administrative expenses and pre-bankruptcy debts, including secured debts in many cases. These protections are designed to mitigate the risks faced by DIP lenders.
Creditors may object to the terms of DIP financing, particularly if they feel that the terms are too favorable to the DIP lenders and detrimental to other creditors. Such objections can lead to contested bankruptcy proceedings. If no resolution can be reached, the bankruptcy court decides. The court must balance the need for DIP financing to keep the company operational with the interests of other creditors and stakeholders. An experienced DIP financing attorney can assist in overcoming creditors’ contests.
The Law Offices of Michael Jay Berger in Beverly Hills, California advises and represents debtors and creditors in Chapter 11s and other bankruptcy cases. Call 310-271-6223 or contact us online to schedule a consultation.
