Obtaining Credit in a Chapter 11 Bankruptcy
If your company is unable to turn a profit and has run out of lenders willing to finance it further, Chapter 11 bankruptcy could be the best way to allow the company to stay in business. A Chapter 11 also can open up other sources of credit for you. This might seem counterintuitive, because your company must continue to make payments on at least some of its existing loans under a court-approved plan. However, the bankruptcy laws provide a mechanism for additional financing to assist with the reorganization.
In a Chapter 11, the person or corporation under bankruptcy protection is usually designated a debtor-in-possession (DIP), which means they can continue to manage the business subject to obtaining court approval for major decisions. DIP financing, as provided in Section 364 of the U.S. Bankruptcy Code, is a process for raising capital to fund the business’s operations during the reorganization.
DIP financing typically begins just before the filing of a Chapter 11 case. The debtor in possession must first seek unsecured credit, which doesn’t give the lender any liens on the debtor’s property. This is known as a priming loan, whose purpose is to maintain the debtor’s normal business operations. With the court’s approval, this loan can be treated as an administrative expense of the bankruptcy estate, which must be paid under the repayment plan. The lender will likely be able to negotiate favorable terms, such as higher than normal interest rates.
If it isn’t possible to obtain credit on those terms, the court may authorize DIP financing that either:
- Has priority over all other unsecured debts, including administrative expenses
- Is secured by a lien on property unencumbered by other liens
- Is secured by a lien on already encumbered property but with less priority of repayment from the sale of the property than the existing liens
These debts, like administrative expenses, must be paid under the reorganization plan.
The court may even authorize new credit to be secured by a property lien that has equal or greater priority than the existing ones. However, obtaining this credit requires proof that those other lienholders have adequate protection, meaning that they will receive compensation for any loss of value of their liens as a result of the new one.
Although existing creditors have the right to object to certain DIP financing, they might actually approve of such loans and might even agree to lend the money themselves. This makes sense because if the debtor company can stay in business, these creditors will likely receive at least as much, if not more, through the reorganization plan than they would if the debtor was forced to liquidate because it couldn’t obtain new financing.
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 me online to schedule a consultation.