Vol 10 (2013) - Issue 2

Article preview

Debtor-In-Possession Financing in US Bankruptcy Cases

Given the financial difficulties around the world, many businesses have faced financial crises due to, among other things, declining customer demand which has created defaults under their existing credit facilities. Other businesses have been faced with maturing credit facilities during these difficult financial times in which refinancing is challenging, if not impossible. As U.S. businesses work through these issues with their lenders, they often must consider a possible Chapter 11 bankruptcy filing in order to, among other things, facilitate additional lending to the business in the form of a debtor-in-possession financing ('DIP financing' or 'DIP loan'). As discussed below, for various reasons, existing lenders, potential buyers or even third party lenders are willing to extend DIP financing to a troubled business. However, the typical source of DIP financing continues to be a company’s existing lender or a potential acquirer of the business. In addition, in most U.S. cases, the type of DIP financing extended is a 'priming' DIP loan.

Overview of financing a Chapter 11 case
The Chapter 11 bankruptcy process is designed to be a single, unified process to reorganise or liquidate a business. A company may file a Chapter 11 case in the United States if it has assets in the United States or is domiciled in the United States. Upon the filing of a Chapter 11 case, current management generally remains in place and continues to operate the business. Upon filing the Chapter 11 case, the company is referred to as the debtor or debtor-in-possession.
The objective of a company’s Chapter 11 case may be to restructure the balance sheet, conduct a going concern sale of the entire business, conduct a sale of non-core assets of the business, close and liquidate the business or a combination of these options. One of the main benefits of the Chapter 11 process is the automatic stay which prevents pre-filing creditors from enforcing their remedies or collecting their debts while the company pursues its Chapter 11 process.
Chapter 11 is a flexible process that is designed to be a consensus building process to achieve the company’s desired outcome. The Chapter 11 process and the company’s objectives in that process may be accomplished with or without the support of all creditors. Typically, a company will seek to gain the support of certain key creditors in an effort to facilitate the Chapter 11 process in an efficient, cost effective manner.
In order to continue operating the business during the Chapter 11 case and fund the costs of the restructuring process, the company (or debtor) must have access to cash and/or additional financing, depending upon the needs of the business. The company must have a way to pay its general operating expenses including employees, vendors and the like in addition to those costs of the Chapter 11 process. Therefore, to ensure the company’s ongoing viability and ensure implementation of the restructuring process, a company typically enters the Chapter 11 process with a pre-arranged agreement with its lender allowing for the use of 'cash collateral' and/or DIP financing.

What is 'cash collateral?'
Under the Bankruptcy Code, after commencement of a Chapter 11 case, a debtor cannot use cash collateral absent the consent of any creditor with a lien against cash collateral or a court order authorising the use of cash collateral. See 11 U.S.C. § 363(c)(2). Cash collateral generally includes the working capital of the business – cash in the bank, accounts receivables and their proceeds, and inventory and their proceeds of inventory. Many businesses have a working capital lender that provides a revolving line of credit. The line of credit typically provides financing to the company based upon advance rates tied to inventory and receivables and is secured by all of the company’s assets, in particular any assets that fall within the Bankruptcy Code’s definition of cash collateral. Therefore, the company must obtain the lender’s consent or a court order authorising the use of cash collateral during the Chapter 11 case.