Debtor in Possession (DIP)
A form of financing that is provided to companies that filed for Chapter 11 bankruptcy
What is Debtor in Possession (DIP)?
Debtor in Possession (DIP) is a form of financing that is provided to companies that filed for Chapter 11 bankruptcy. Used to restructure, DIP financing provides capital funding for an organization while bankruptcy runs its course.
Summary
- Debtor in Possession (DIP) financing is associated with organizations that are experiencing Chapter 11 bankruptcies and need financial funding.
- DIP financing is an attempt to bail out organizations during bankruptcy.
- DIP financing and regular financing differ in the use of capital.
DIP Financing vs. Regular Financing
Debtor in Possession Financing: A form of financing that is provided to companies facing financial distress and who are in need of bankruptcy relief. In other words, the main purpose of DIP financing is to help fund an organization out of bankruptcy.
Regular Financing: The process of providing capital funding to an organization for business activities such as investing, making purchases, merchandising, and manufacturing.
Before the Chapter 11 Plan is Proposed
The Debtor in Possession process is lengthy. You must obtain approval from the court, judge, and U.S. trustee. Several legal activities must also be met under Chapter 11.
- Filing Process: A company that wishes to receive DIP financing must first file for a Chapter 11 petition in bankruptcy court.
- Debtor Continues Business Operations: The term “Debtor in Possession” is given to the person who files for bankruptcy on behalf of the organization. The name implies that the actual debtor of the capital funding is still given majority possession.
- Major Decisions: Major decisions such as business default, mortgage, and financing agreements, any sale of assets, lease agreements, and attorney expenses of the organization are given to the bankruptcy court.
- Creditors: People associated with the organization can support or oppose the actions of the bankruptcy court. They include creditors, stakeholders, and shareholders.
- Constructing a Plan: Before funding, a reorganization plan must be completed. It must include a streamlined plan on how the firm will use the funding to get out of bankruptcy.
Once everything is agreed upon, the construction of a reorganization plan begins.
Chapter 11 Reorganization Plan and Confirmation
After Chapter 11 is filed and everything is agreed upon, the debtor is given four months to propose a reorganization plan. If the four-month deadline is missed, it can be extended if the debtor provides a sufficient reason.
As a whole, the reorganization plan is crucial because it shows creditors how the company will operate after bankruptcy and how they will pay their obligations in the future.
Below are some of the key features needed for confirmation of a reorganization plan:
- Creditor Voting: Once the reorganization plan is submitted, creditors can vote on whether or not they approve of the proposed Chapter 11 plan.
- Feasibility: The bankruptcy court must find the reorganization plan feasible. Specifically, the debtor must prove that their company will be able to raise enough revenue to cover expenses.
- Fair and Equitable: The reorganization plan must be fair and equitable. It means that secured creditors must be paid the value of their collateral (at least). The debtor is unable to retain any equity interest they’ve received until obligations are paid in full.
- Good Faith: The reorganization plan must follow the law.
- Best Interest of Creditors: In the case of “best interest,” the debtor must pay the creditor as much as they would if the plan were converted to a Chapter 7 liquidation.
Overall, the bankruptcy court requires a large amount of reasonable proof that can guarantee organizational recovery.
Factors Taken Into Account Before Funding Is Granted
Once the reorganization plan is confirmed, lenders consider several factors before issuing capital funding:
- Protection of the newly subordinated creditors so that they are not under-protected if liquidation were to occur.
- Attentive monitoring of the funds so that they are being used efficiently.
- The structure of the reorganization plan must be firm and possess a degree of profitability.
As a lender, you want to ensure that the business exits Chapter 11 bankruptcy quickly and efficiently. Many factors must be looked at before funding to guarantee a return.
Priming DIP Loan
When all else fails and financing cannot be obtained through any means, the bankruptcy court can authorize a “priming DIP loan.”
- Priming DIP Loan: Authorized by the bankruptcy court, a priming DIP loan allows the debtor to borrow funds on a secured basis.
- Lenders Rights: Conversely, the bankruptcy court grants the lender a priming lien. It gives the creditor a legal right to sell the debtor’s collateral if they do not live up to financial obligations.
Related Readings
CFI offers the Commercial Banking & Credit Analyst (CBCA)™ certification program for those looking to take their careers to the next level. To keep learning and developing your knowledge base, please explore the additional relevant resources below:
