The Basics of DIP Financing During a Chapter 11

In a Chapter 11 bankruptcy, the person or corporation under bankruptcy protection is usually designated a debtor-in-possession (DIP), which means they can continue to manage the business freely though subject to obtaining court approval for major decisions. But a successful reorganization of the business requires infusion of additional capital. DIP financing is a remedy for raising that capital despite the company’s weakened credit standing. 

DIP financing typically begins just before the filing of a Chapter 11 case. The debtor in possession must first seek unsecured credit, one that doesn’t give the lender a lien on the debtor’s property. This is known as a priming loan, the purpose of which is to fund 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 is not 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 repaid 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 or even agree to lend the money themselves. Their incentive to do so is that if the debtor company stays in business, the 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.

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.