Why You Should Consider DIP Loan – Insolvency / Bankruptcy / Restructuring


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Why should you consider the DIP loan

It may seem counterintuitive for banks and other lenders to grant loans to failed businesses, but they often do. All businesses, especially bankrupt ones, need cash flow to keep operating. Ensuring the availability of liquidity is one of the most important considerations in a Chapter 11 reorganization, as debtors are often unable to reorganize without adequate cash flow.

The market for debtor-in-charge (“DIP”) financing is important. In 2019, DIP’s financing volume was over $ 18 billion, up from around $ 10 billion in 2018. DIP lenders are typically secured creditors who have an interest in the outcome of the case. bankruptcy and lend to improve their own collection. There has, however, been an increase in the number of DIP facilities financed by third parties for investment purposes and for more strategic purposes, such as acquiring the assets of a debtor as part of a “loan” transaction. to own ”. Regardless of a lender’s goals, DIP lenders continue to receive very favorable treatment in the event of bankruptcy.

Types of DIP funding

Congress predicted that lenders might be nervous when granting credit to failed businesses, and as a result, the Bankruptcy Code offers DIP lenders powerful protections. These protections include:

  1. If the trustee or DIP is otherwise unable to obtain an unsecured debt, the court may authorize the trustee or DIP to obtain such debt and may:
    1. Treat this debt as an administrative claim with priority over most other administrative claims [11
      U.S.C. § 364(c)(1)];
    2. Grant a lien on unencumbered assets
      [11 U.S.C. § 364(c)(2)]; Where
    3. Grant a junior lien on collateral [11 U.S.C. § 364(c)(3)].
  2. If the trustee or DIP is still unable to obtain a debt, the court may grant a lender a lien greater than or equal to the existing liens on the assets of the estate. [11 U.S.C. §
    364(d)].

The strongest of these protections is “bootstrapping privilege” under section 364 (d). A seed lien is generally only available as a last resort and will only be granted if the existing lien holders consent to it or if the trustee or DIP can demonstrate that it has equity in its assets that is greater than the debt. existing collateral, or whether existing lien holders are adequately protected from the decrease in the value of their collateral. Existing lenders will often insist on top priority seed privilege and administrative claims, providing the maximum possible protection to their DIP financing facility.

Benefits of being a DIP lender

DIP lenders can receive an excellent premium over their normal interest rates. DIP loans are often significantly larger (sometimes 25-50%) than the debtor’s projected needs. DIP lenders benefit from large loans as they earn facilities, ongoing commitment and other fees depending on the loan amount.

DIP loans with seed privileges are usually paid before any other stakeholder, unless they agree to draw funds from their collateral for the payment of certain estate or court-approved professional expenses. DIP lenders have an excellent chance of realizing a return on their investment for several reasons, including:

  • DIP loans are usually secured by sufficient collateral to pay off the balance in full;
  • The DIP Lender’s Seed Privilege and Superpriority Claim ensures that it gets paid first;
  • The privileges granted to DIP lenders are generally not challenged once approved by the court;
  • DIP lenders may require covenants and other protections that borrowers may not accept outside of bankruptcy, including:
    • frequent and detailed financial reports;
    • maintaining guarantee ratios;
    • approval by the lender of the use of the loan proceeds;
    • additional influx of capital from sponsors and third parties;
    • strict milestones for the sale of real estate assets or the implementation of a reorganization plan; and
    • close control of the reorganization process, approval or veto right over a reorganization or liquidation plan.
  • The provisions of the DIP Funding Order generally grant the DIP Lender immediate relief from the automatic stay (to the extent applicable) to pursue remedies without court approval in the event of default.

The DIP loan also gives secured creditors a unique ability to protect their pre-bankruptcy claims. Although controversial, some bankruptcy courts allow secured creditors to obtain additional protections not contemplated by the Bankruptcy Code. For example, some courts allow DIP lenders to “bundle” their existing secured receivables into the DIP loan, providing pre and post-petition credit with the additional protections described above. DIP lenders also often condition these loans on order entry finding that their existing privileges are valid and unassailable. And many courts will even allow DIP lenders to obtain liens on collateral that would not otherwise be available to them, such as proceeds from claims arising solely from the Bankruptcy Code (such as annulment actions, fraudulent transfer claims, etc. .).

Sometimes lenders provide DIP financing as part of a “loan-to-own” strategy. DIP loans can include clauses allowing lenders, in the event of default or as part of a plan (which must be submitted for approval), to “swap” senior secured debt for newly issued shares, giving the lender a controlling stake in the business after the emergence of bankruptcy. Alternatively, the DIP lender’s control over a debtor’s asset sale process may give it an advantage over other potential bidders at an auction of the debtor’s assets. If the lender does not win the auction, and depending on how the transaction is documented, lenders may charge termination fees and expense reimbursements, and insist that the loan be repaid upon the sale of assets to a third.

Ultimately, DIP financing provides willing lenders with a variety of options that creditors should consider when the right opportunity presents itself. If you have any questions regarding DIP funding, please contact the Ice Miller Distressed Investments Group. Ice Miller represents both for-profit and not-for-profit businesses in financial difficulty and restructuring due to insolvency and regularly advises individuals and corporations as creditors, investors, lenders and debtors on financial matters. corporate, governance and tax for tax exempt entities, such as as well as gifts, estates, tax trusts, estate planning, administration of estates and trusts and charitable giving for organizations to non-profit.

Originally posted by Ice Miller, December 2020

The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.

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