Debtor-in-Possession Financing and Chapter 11: What Florida Business Owners Need to Know

Filing for bankruptcy under Chapter 11 of the U.S. Bankruptcy Code provides a way for companies to reorganize their debts and overcome short-term financial strain. But, for some businesses, the Chapter 11 bankruptcy process itself can prove prohibitively expensive. While this is less common today due to the enactment of Subchapter V (which provides streamlined bankruptcy procedures for small businesses), seeking financing for the bankruptcy process will still be necessary in some cases. This involves working closely with a Chapter 11 bankruptcy lawyer to seek debtor-in-possession financing.

What is Debtor-in-Possession Financing?

In most cases, companies that file for bankruptcy under Chapter 11 are classified as debtors in possession. This means that they remain in possession of their assets during the bankruptcy process, and they remain able to use these assets in the ordinary course of their business operations.

Debtor-in-possession financing is simply financing that is extended to a company during a Chapter 11 bankruptcy. If a company could benefit from going through a Chapter 11 bankruptcy but does not have the resources needed to fund the bankruptcy process, debtor-in-possession financing serves as a short-term bridge that allows the company to reorganize its debts and move toward financial stability.

How Does Debtor-in-Possession Financing Work?

So, how does debtor-in-possession financing work? Typically, the business will secure debtor-in-possession financing before initiating its Chapter 11 bankruptcy proceeding. That way, the business’s owners will know that they have the resources they need to navigate the bankruptcy process without foregoing any potential benefits or opportunities due to lack of funding.

Debtor-in-possession financing can be either secured or unsecured, and, in many cases, it will be unsecured. While the primary purpose of debtor-in-possession financing is to facilitate a Chapter 11 filing, the business may also be able to use a portion of its loan for ordinary operating expenses if necessary. However, unsecured debtor-in-possession financing generally comes at a cost (in the form of an increased interest rate), so business owners will want to be careful to ensure that they do not take on more additional debt than they need to get through the bankruptcy process.

If no lenders are willing to extend unsecured debtor-in-possession financing, then a secured short-term loan may be necessary. Alternatively, it may be possible to secure protections that convince a lender to extend unsecured financing, such as priority over unsecured debts. In all cases, debtor-in-possession loan payment obligations will generally be classified as an “administrative expense,” which means they will be prioritized under the debtor’s Chapter 11 repayment plan.

When is Debtor-in-Possession Financing a Good Option?

Debtor-in-possession financing is a good option for companies that can benefit from the Chapter 11 reorganization process but that cannot fund the process themselves. While it is a niche market, the market for debtor-in-possession financing is well-established, and companies will generally be able to find a lender that is willing to work with them. With that said, the terms that lenders are willing to extend vary case-by-case, and it will be well worth shopping around in most circumstances. Once you engage a Chapter 11 bankruptcy lawyer, your lawyer may be able to assist with finding a lender that will work with your business as well.

Of course, for debtor-in-possession financing to be worth it, this means that going through a Chapter 11 bankruptcy needs to be worth it as well. If you cannot see a viable path toward profitability, then reorganizing your company’s debts under Chapter 11 may simply delay the inevitable—and this may not be the best approach. Conversely, if you have better alternatives to a Chapter 11 filing, then you should avoid incurring the additional expense of securing debtor-in-possession financing and going through the formal reorganization process.

When is Debtor-in-Possession Financing Not a Good Option?

While securing debtor-in-possession financing can be a good option in appropriate cases, taking on additional debt in order to file for bankruptcy isn’t always the best approach. For example, seeking debtor-in-possession financing may not be in your company’s best interests if:

• Filing Under Chapter 11 Isn’t Your Company’s Best Option – As we mentioned above, filing under Chapter 11 isn’t the best option for struggling companies in all cases. If your company can regain its financial stability without filing under Chapter 11, this will most likely be the best approach.
• You Can’t See a Path Toward Profitability – As we also mentioned above, if you can’t see a path toward profitability, then filing under Chapter 11 simply might not make sense. Instead, your company may be better off filing under Chapter 7, pursuing an assignment for the benefit of creditors, or winding up its affairs through other means.
• Your Company Can Fund Its Chapter 11 Case Through Other Means – If your company can fund its Chapter 11 case through other means, debtor-in-possession may be the most costly of the options that are available. For example, selling assets your company no longer needs (if possible) will be more cost-effective in most cases.
• Your Company Qualifies as a “Small Business” Under Subchapter V – Subchapter V of Chapter 11 establishes streamlined (and significantly less costly) filing procedures for small businesses. For purposes of Subchapter V, a “small business” is defined as a company that “has aggregate noncontingent liquidated secured and unsecured debts . . . in an amount not more than $7,500,000 (excluding debts owed to 1 or more affiliates or insiders) not less than 50 percent of which arose from [its] commercial or business activities.”

Ultimately, as with all aspects of contemplating a Chapter 11 bankruptcy, informed and strategic decision-making is required. If you would like to know more about the benefits and drawbacks of seeking debtor-in-possession financing, you should consult with a Miami Chapter 11 bankruptcy lawyer promptly.

Speak with a Miami Chapter 11 Bankruptcy Lawyer at Edelboim Lieberman

Our lawyers have extensive experience representing distressed companies in Chapter 11 bankruptcy proceedings and other bankruptcy-related matters. To discuss your options with an experienced Miami Chapter 11 bankruptcy lawyer in confidence, call us at 305-768-9909 or request a complimentary consultation online today.