Using DIP Financing to Fund a Chapter 11 Reorganization
When a business struggles to generate profit and exhausts available financing options, a Chapter 11 bankruptcy might be a viable solution to continue operations while restructuring debt. Chapter 11 can also unlock new financing opportunities that are essential for the reorganization process.
Under Chapter 11 bankruptcy, the debtor, whether an individual or a corporation, typically retains control over the business operations as a debtor-in-possession (DIP). This status allows the debtor to manage the business but requires court approval for significant decisions. One key aspect of Chapter 11 is DIP financing, governed by Bankruptcy Code § 364, which enables the debtor to secure capital to sustain business activities during the reorganization phase.
The process of obtaining DIP financing usually commences shortly before the Chapter 11 filing. Initially, the DIP seeks unsecured credit, in which the lender does not receive any liens on the debtor’s assets. Known as a priming loan, this credit is intended to keep the business running smoothly. With court approval, such loans can be classified as administrative expenses, which must be prioritized in the repayment plan. Lenders often negotiate favorable terms, including higher interest rates, due to the elevated risk.
If obtaining unsecured credit proves unfeasible, the court may authorize DIP financing with additional security measures. This can include loans that have priority over all other unsecured debts, including administrative expenses, or loans secured by liens on unencumbered property. Alternatively, the court might approve loans secured by liens on already encumbered property, but with a lower repayment priority compared to existing liens. Like administrative expenses, these secured debts must be addressed in the reorganization plan.
The court can also permit new credit to be secured by property liens that match or exceed the priority of existing liens. However, to obtain such credit, the debtor must demonstrate that other lienholders are adequately protected, ensuring they receive compensation for any loss in lien value due to the new financing arrangement.
Existing creditors, although entitled to object to certain DIP financing arrangements, might actually support these loans. In some cases, they may even offer to provide the financing themselves. This is because enabling the debtor company to continue operations through new financing often results in creditors receiving a more favorable outcome through the reorganization plan compared to the liquidation scenario that would occur if the debtor couldn’t secure additional funding.
An attorney skilled in DIP financing can analyze your situation and determine the optimal means for securing the funding you need to complete your Chapter 11 efficiently.
The Law Offices of Michael Jay Berger in Beverly Hills is one of Southern California’s most experienced Chapter 11 bankruptcy law firms, with 12 locations across the region. If your company is struggling with debt, contact us online or call 310-271-6223 to schedule a consultation.
