Table of Contents Hide
- What is DIP Financing?
- Understanding How Debtor-in-Possession (DIP) Financing Works
- What is the Process in Debtor-in-Possession (DIP) Financing?
- The Chapter 11 Proposal Process
- Factors Taken Into Account Before Funding Is Given
- What is the Difference Between Exit Financing and DIP financing?
- DIP Financing vs. Regular Financing
- Priming DIP Loan
- Bottom Line
- What is DIP financing Canada?
- What is a dip roll up?
- What is a prepetition lender?
- Related Articles
Businesses in dire financial distress usually have issues sourcing for funding when they need it the most. They may be cut off from potential lenders, and this is where Debtor-in-Possession (DIP) financing comes in.
Debtor-in-Possession (DIP) financing is a financing method for companies in bankruptcy situations.
It is associated with organizations that are experiencing Chapter 11 bankruptcies and need financial funding.
A DIP Financing will help these companies reverse course, gain stability, receive restructuring support, and return to profitability.
Continue reading as we discuss DIP financing in details in this article.
What is DIP Financing?
DIP Financing, known as Debtor-in-Possession financing is a special kind of financing that is meant for companies that have declared bankruptcy.
In other words, only companies that have filed for Chapter 11 bankruptcy protection have access to DIP financing, which mostly happens at the beginning of a filing.
As a means of restructuring, DIP financing provides capital funding for an organization facing bankruptcy. It is typically available to companies where lenders believe the company has a good chance of coming out of bankruptcy. However, it is not available to firms that want to liquidate the company.
The term “Debtor-in-Possession” describes the fact that the current management and board of directors remain in “Possession” of the business in line with its Chapter 11 bankruptcy filing.
DIP financing is unique from other financing methods because it has a higher priority over existing debts, equity and other factors.
More so, the lenders of DIP financing assume a senior position on the firm’s assets, ahead of previous lenders.
Unfortunately, most businesses are not aware that they can obtain financing to operate their company after declaring bankruptcy.
Understanding How Debtor-in-Possession (DIP) Financing Works
Chapter 11 favors corporate reorganization over liquidation of its assets. Hence, filing for protection can offer distressed companies in need of financing a vital lifeline.
In DIP financing, the court must check to ensure that the financial plan is consistent with the debt protection granted to the business before it is approved. The lender’s choice to oversight the loan is also subject to the court’s approval and protection.
If the financing is approved, the business will have the liquidity is needs to continue operating.
More so, DIP financing helps a business retain its position in the market. This is because, when a company is able to secure DIP financing, its customers, suppliers, and vendors know that they are still in business, and can offer services and make payments while reorganizing.
If the lender has found out that the company is worthy of credit, and has a high chance of making a come back, there’s a greater chance that the marketplace will have the same conclusion.
What is the Process in Debtor-in-Possession (DIP) Financing?
To obtain DIP financing, the assets pledged as collateral must be equivalent to the business bankruptcy loan. Here’s how the process works.
When a distressed company gets a lender that is willing to finance its comeback, the company seeks court approval from the Bankruptcy Court. Some terms and conditions for Standard DIP financing includes;
- a high-security interest in the collateral
- a market rate or even premium rate of interest
- an approved budget, and other related lender protections.
Lenders may object to the loan if the company has no potential of making a come back.
Regardless, the Bankruptcy Court retains the right to decide whether to approve the loan or not.
But if a company that has filed a chapter 11 bankruptcy has existing secured loans and wants to borrow on a secured basis that is equal to or higher than the existing loans, it will have to;
- Obtain the current lender(s) consent to the new loan
- Convince the Bankruptcy Court that the existing lender(s) will be adequately protected. In other words, they will not suffer from the new loan.
A current lender who provided financing to the firm before it declared bankruptcy may be willing to agree to a DIP business loan, even if it failed to make further advances before the bankruptcy proceeding.
In addition to the protection under the Bankruptcy Code, the lender may also have its own goals in creating the DIP loan. For example, it could be to stabilize the company so as to sell it to another party.
The Chapter 11 Proposal Process
The Debtor-in-Possession process is a long one. You must obtain approval from the court, judge, and U.S. trustee.
Below are the processes involved for DIP financing as stated by CFI.
- Filing Process: A company that wants 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, the company begins to work on a reorganization plan.
Chapter 11 Reorganization Plan and Confirmation
After Chapter 11 is filed and everything has been finalized, the debtor is given four months to come up with a reorganization plan. If the four-month deadline is missed, it can be extended if the debtor provides a solid reason.
In general, the reorganization plan is important 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 metrics needed to confirm 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.
In general, the bankruptcy court requires a large amount of evidence that shows that the organization can recover from its present state.
Factors Taken Into Account Before Funding Is Given
Once the restructuring and reorganization plan is confirmed, lenders consider a wide variety of factors before issuing funding.
- The structure of the reorganization plan must be stable, firm and possess a good degree of profitability.
- There must be thorough monitoring of the funds to ensure they are used effeciently.
- Protection of the newly subordinated creditors so that they don’t fall short if liquidation were to occur.
What is the Difference Between Exit Financing and DIP financing?
As we have established, Debtor-in-Possession (DIP) financing is part of a company’s Chapter 11 bankruptcy working strategy.
The fund is made available to aid the company in restructuring and reorganizing its operation, regain stability, come out of bankruptcy, and plan to move forward.
While, Exit financing on the other hand is the company’s post-bankruptcy financing package. In smaller deals, lenders often negotiate and commit to a debtor-in-possession and an exit facility at the same time. This is known as a “DIP rollover.”
DIP Financing vs. Regular Financing
DIP financing, as we’ve talked about is funding provided to companies in financial crisis, who are in need of bankruptcy relief. Simply put, the main purpose of DIP financing is to help a company out of bankruptcy.
While Regular Financing on the other hand provides capital funding to an organization for business purposes. It includes investing, manufacturing, making purchases, etc.
Priming DIP Loan
When every efforts fail,and the company cannot obtain DIP financing through any means, the bankruptcy court can issue a “priming DIP loan”
A priming DIP loan allows the debtor to borrow funds on a secured basis from other lenders.
Conversely, the bankruptcy court grants the lender a priming lien. This gives the creditor a legal right to sell the debtor’s collateral if they fail to meet their financial obligations.
If your organization is experiencing bankruptcy, it’s best to consult with an experienced bankruptcy attorney to determine all your viable options. You may be able to do other restructuring processes outside bankruptcy.
However, if it turns out that Chapter 11 bankruptcy is your best bet, then Debtor-in-Possession (DIP) financing is your best option in moving your company around.
What is DIP financing Canada?
In Canada, DIP financing refers to the debtor giving priority ranking security on assets in order to finance its ongoing operations during a restructuring. Generally, applications for DIP financing are made to the court while a company is undergoing a reorganization under the Company Creditors Arrangement Act (“CCAA”).
What is a dip roll up?
A roll-up usually requires that the debtor draws on the DIP loan to pay off some or all of the lender’s prepetition claims. The DIP lender arranges DIP financing in a way that effectively pays off its prepetition debt, “rolling up” its prepetition debt.
What is a prepetition lender?
Prepetition Lender means any lender providing the Prepetition Credit Facility Debt under the Prepetition Credit Facility (including the “Lenders” (as defined in the Prepetition Credit Facility)). Sample 2. Sample 3. Prepetition Lender means the lenders party to the Credit Agreement.