Understanding Debtor-in-Possession Financing
Debtor-in-possession (DIP) financing is the financing for a business that seeks to retain control of its assets and operations during Chapter 11 bankruptcy reorganization.
Chapter 11 Bankruptcy
During a Chapter 11 bankruptcy a company works to restructure its debts in order to pay them off.
How DIP Financing Works
During Chapter 11 bankruptcy a business will file to be protected from creditors while it works to reorganize and restructure its business. Additionally, during this process, a bankruptcy court will also allow the business to secure any additional financing from lenders in efforts to continue its operations. These post-bankruptcy lenders, under the bankruptcy court’s jurisdiction, assume a senior position on liens and security interests of the business assets. Typically, this is done with consent of the pre-bankruptcy senior lenders. The theory behind this process is that through the continued operation of the business, the debtor is able to achieve enough funds to reorganize and get itself into a position to be able to repay all the debts it owes.
Importance of DIP Financing
DIP Financing is crucial to the company during a Chapter 11 bankruptcy, because it essentially extends help to a business to be able to maintain payroll and suppliers, stabilize the current operations, and restructure itself for the future, so that it can repay creditors and hopefully emerge from bankruptcy. Usually, a business going through bankruptcy can obtain DIP financing only through giving its post-bankruptcy lenders protection senior lien positions. This ensures the lender will be fully repaid, even if the company needs to be liquidated. The senior lien position also limits the business to strict payment terms. Sometimes this can hinder a businesses’ reorganization process. DIP financing lenders are additionally protected through strict oversight by a bankruptcy court. The court’s role is to assure that new credit can be extended to a business in the middle of bankruptcy.
Source: Investing Answers, Debtor-in-Possession (DIP) Financing, 2014