When Is (and Isn’t) Debtor-in-Possession Financing a Good Option?

For companies with more debt than they can afford, reorganizing through the Chapter 11 bankruptcy process can help them regain financial stability and build toward a profitable future. When necessary, debtor-in-possession (DIP) financing can serve as a financial bridge between a company’s pre-bankruptcy financial struggles and the end of the reorganization process. So, when (and isn’t) debtor-in-possession financing a good option? Learn about some key considerations from a Miami business bankruptcy attorney at Edelboim Lieberman:

What is Debtor-in-Possession Financing?

Debtor-in-possession financing is a special type of loan that companies can use to manage their costs during a business bankruptcy. This includes not only the costs of the bankruptcy process itself, but also payroll, rent, and other business expenses.

Even when businesses cannot secure additional financing outside the Chapter 11 bankruptcy process, they may be able to obtain debtor-in-possession financing. Lenders willing often be willing to extend DIP financing to insolvent businesses for three main reasons: (i) the terms of DIP financing are subject to court approval (and therefore less likely to be challenged by the business’s other creditors); (ii) lenders that extend DIP financing are entitled to special protections during the bankruptcy process; and, (iii) there are restrictions on how insolvent businesses can use DIP funds.

But even if a business has access to DIP financing, that does not necessarily mean taking on additional debt is the business’s best option. Despite the protections afforded to DIP lenders, debtor-in-possession financing is still considered high-risk, and lenders calculate DIP interest rates accordingly. The fact that DIP lenders are entitled to additional protections means that businesses taking on debtor-in-possession financing are in a less advantageous position vis-à-vis these lenders. As with all aspects of the business bankruptcy process, informed decision-making is required.

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

Broadly speaking, debtor-in-possession financing can be a good option for businesses that have a clear path (or, at least, a relatively clear path) toward a solid financial future. If reorganizing a business’s debts under Chapter 11 is likely to provide the financial relief the business needs to continue operating over the long term, then pursuing reorganization could be the best approach. If the business does not have the financial resources to get through the reorganization process, DIP financing could be the solution.

With this in mind, securing debtor-in-possession financing can be a good option if:

1. Reorganizing Under Chapter 11 is a Viable Path Toward Financial Stability

Businesses can seek (and lenders will be willing to offer) debtor-in-possession financing when reorganizing under Chapter 11 is a viable path toward financial stability. Reorganizing under Chapter 11 involves developing a payment plan that allows the business to meet its debt obligations while also managing its other operating expenses. In many cases, a Subchapter V bankruptcy under Chapter 11 will be the most cost-effective path forward.

2. The Business is Dealing with a Short-Term Cash Shortage

Debtor-in-possession financing is intended to manage short-term cash shortages during the Chapter 11 reorganization process. Generally speaking, it is not a tool for making additional capital investments, and businesses that have taken out DIP loans must strictly comply with the limitations on authorized expenditures. If a business does not need additional access to capital in order to get through the reorganization process, then seeking DIP financing generally won’t be a suitable option.

3. The Business Has a Clear Plan for Moving Forward

Beyond having a viable path toward financial stability, businesses that pursue reorganization under Chapter 11 should also have a clear plan for moving forward. Reorganizing a business’s debts will not solve the business’s financial problems on its own. For seeking debtor-in-possession financing (and going through the reorganization process) to make sense, a business must have a well-formed plan not only to meet its new post-bankruptcy payment obligations but also to regain—and maintain—its financial stability.

When Isn’t Debtor-in-Possession Financing a Good Option?

Based on these considerations, we can see when debtor-in-possession financing is not a practicable solution for businesses experiencing financial distress. Specifically, securing DIP financing may not be a good option if:

1. Reorganizing Under Chapter 11 Is Not a Long-Term Solution

Debtor-in-possession financing is a short-term solution to facilitating the Chapter 11 reorganization process. As a result, if reorganizing a business’s debts under Chapter 11 is not a long-term solution to the business’s current financial circumstances, then seeking DIP financing will not make sense. For struggling businesses, reorganizing under Chapter 11 might not be the best path forward if either: (i) the business has less-restrictive and less-costly alternatives available; or, (ii) the business’s financial circumstances are such that it needs to pursue liquidation under Chapter 7 or an assignment for the benefit of creditors.

2. The Business Has Other Means of Meeting Its Short-Term Financial Needs

Due to the high interest rates and restrictions that apply to debtor-in-possession loans, seeking DIP financing is generally not a good option if a business has other means of meeting its short-term financial needs. For example, if the business can liquidate certain assets, streamline its operations, or reject executory contracts through the Chapter 11 process, taking on additional debt may not be necessary.

3. The Business Won’t Be Treated as a Debtor-in-Possession

Finally, in order to be eligible for DIP financing, a business must be treated as a debtor-in-possession during the Chapter 11 bankruptcy process. If a business will not be treated as a debtor-in-possession for any reason, then securing DIP financing will not be an option, and the business may need to address various other potential risks and concerns as it prepares for the bankruptcy process as well.

Schedule a Call with a Miami Business Bankruptcy Attorney at Edelboim Lieberman

If you would like to know more about debtor-in-possession financing or any other aspect of the Chapter 11 reorganization process, we invite you to get in touch. To schedule a call with a Miami business bankruptcy attorney at Edelboim Lieberman, give us a call at 305-768-9909 or request a free consultation online today.