Debtor-in-Possession Financing (DIP Financing)

Debtor-in-Possession (DIP) Financing

Debtor-in-possession (DIP) financing is short- to medium-term financing provided to companies that have filed for Chapter 11 bankruptcy protection. It supplies the working capital a distressed company needs to continue operations, pursue a reorganization, and preserve value for creditors while the bankruptcy case proceeds.

Key takeaways

• DIP financing is available only to debtors in Chapter 11 bankruptcy.
• Lenders of DIP loans receive priority liens and often “super-priority” status ahead of pre‑petition creditors.
• Courts must approve DIP financings, including the lender’s oversight and the debtor’s budget.
• Term loans are the most common form of DIP financing today; interest costs tend to be higher than pre‑bankruptcy debt.
• DIP financing aims to preserve value and improve creditor recoveries relative to liquidation.

Purpose

DIP financing’s main goals are to:
* Provide liquidity to keep the business operating (pay suppliers, employees, and ongoing expenses).
* Finance a turnaround or restructuring so the company can emerge from Chapter 11.
* Preserve going‑concern value to maximize recoveries for creditors compared with a fire sale or liquidation.

By enabling operations to continue, DIP financing also reassures customers, vendors, and employees that the business can meet its obligations during reorganization.

How DIP financing works

1. The debtor identifies a prospective lender and negotiates terms, including an authorized operating budget (the “DIP budget”).
2. The debtor files a motion with the bankruptcy court seeking approval of the financing and related protections for the lender.
3. The court evaluates the proposal—reviewing the budget, the debtor’s turnaround plan, and protections proposed for existing creditors—and either approves, modifies, or denies the financing.
4. If approved, the debtor draws funds according to the agreed budget and reporting requirements; the lender receives the agreed priority in the debtor’s assets and repayment waterfall.

Lenders typically require evidence of a viable reorganization plan and collateralized security. Existing secured creditors may need to consent or be subordinated to the new lien.

Typical terms and structures

• Seniority: DIP lenders are usually granted first priority liens or super‑priority claims under bankruptcy law, making them first in line in liquidation.
• Budget and reporting: A detailed DIP budget governs draws and requires frequent reporting and court oversight.
• Loan type: Term loans are common (fully funded at closing), though lines of credit or revolving facilities and invoice factoring can also be used.
• Cost: Interest rates and fees are usually higher than pre‑petition financing to compensate for risk and the administrative complexity.
• Covenants and controls: DIP agreements often include stringent covenants, milestones, and lender oversight of spending tied to the approved budget.

Who provides DIP financing?

DIP lenders can be banks, specialty finance firms, existing creditors, or a group of lenders. Sometimes the debtor’s pre‑petition lenders provide DIP financing; other times a new lender steps in, often seeking the protections and priority that bankruptcy provides.

DIP vs. exit financing

• DIP financing: Funding while the company is in Chapter 11 to operate and complete a reorganization.
• Exit financing: Funding secured as the company emerges from Chapter 11 to support the reorganized business going forward. Exit financing typically replaces DIP loans.

Benefits and risks

Benefits
* Keeps operations running and preserves going‑concern value.
* Increases the likelihood of better recoveries for creditors versus liquidation.
* Signals market confidence if a lender is willing to extend credit.

Risks and costs
* Higher interest and fees.
* New lender priority can subordinate pre‑petition creditors and dilute their recoveries.
* Court approval is required, and the process can be time‑consuming.
* Debtor may face restrictive covenants and close monitoring of operations.

When companies use DIP financing

DIP financing is most appropriate when a debtor has a viable path to reorganize or sell assets for greater value than liquidation, and when short-term liquidity constraints threaten ongoing operations. Notable historical examples include major restructurings where DIP funding enabled continued operations and orderly reorganizations.

Practical steps to obtain DIP financing

• Prepare a realistic DIP budget and credible reorganization plan.
• Identify potential lenders and negotiate preliminary terms.
• File a motion with the bankruptcy court seeking approval and provide required disclosures and hearings.
• Obtain court approval and adhere to the DIP budget and reporting requirements throughout the case.

Conclusion

DIP financing is a critical tool in Chapter 11 cases that allows distressed companies to maintain operations and pursue a reorganization. While it often comes at a higher cost and requires court oversight and concessions, DIP financing can preserve value and improve outcomes for both the debtor and creditors compared with immediate liquidation.