DIP financing is a special type of loan for a debtor-in-possession (DIP), which is the term used for a company that has filed for Chapter 11 bankruptcy protection under the U.S. bankruptcy code, but is still operational and in possession of the property to which creditors have a legal claim.
Debtor-in-possession financing is a good solution for a business that is not only in financial distress, but also:
Is considering insolvency or who has actually filed for Chapter 11 bankruptcy already,
Has a viable restructuring/workout plan, and
Needs cash to continue operating as the bankruptcy proceedings go on.
When considering whether a DIP loan is a good idea, here are some benefits to consider:
DIP financing allows the company to meet payroll, continue delivering goods and services, avoid falling into further default, and otherwise maintain its business operations.
DIP financing also stabilizes the company’s situation, by maintaining its reputation and restoring public confidence.
Ultimately, the company is able to restructure and emerge from bankruptcy in a stronger and more profitable position.
In short, companies need to line up a bankruptcy loan because once the financial community finds out they are experiencing difficulties, their traditional sources of credit can quickly dry up.
DIP financing is the much-needed solution to provide the company with the cash it needs to make payroll, buy inventory and supplies, pay vendors, keep the lights on and the water running, and otherwise continue to operate throughout the bankruptcy case.
DIP financing typically takes the form of a bridge loan – a short-term loan designed to see the company through to the end of the bankruptcy process.
DIP financing usually takes a first-priority, senior position above all equity and debt financing – even senior secured creditors. The implications are as follows:
As the company generates cash, the company must pay its obligations to the DIP lender first, before all other secured and unsecured debts, and before paying dividends to shareholders.
The borrower must also obtain bankruptcy court permission before taking the loan.
If the company must eventually be liquidated, the proceeds pay off the DIP lending first, before all other claims.
This requires the approval of the board, and of all the subordinate lienholders.
The approval is normally granted because the DIP financing usually goes to protect their collateral, and to keep the company functioning so it can continue to make some payments to the other debtholders.
In a DIP financing situation, a complete collapse of the company would potentially cost these existing lenders more than a DIP loan that can prevent it.
When a company goes through bankruptcy, it can cause a domino effect potentially leading to a devastating collapse:
Existing equity holders may refuse to commit additional cash.
Vendors may stop shipping.
Lines of credit are closed up.
Retailers may cease ordering products.
Consumers may stop purchasing, fearful that the company won’t be around to service them, honor warranties, provide upgrades, etc.
DIP financing can provide a desperately needed shot in the arm, reassuring internal and external stakeholders and the public at large that the company will continue operations and provide promised support.
For example, a timely announcement that a troubled company has received a large debtor-in-possession loan, or a substantial line of credit, can help restore confidence in the company’s ability to operate.
Sometimes DIP financing is provided by a troubled company’s existing lenders (defensive lenders).
In other cases, companies going through bankruptcy may receive DIP financing from an entirely new lender, or even a group of financial institutions (offensive lenders).
When existing DIP financing lenders make a DIP loan, they’re called defensive lenders:
That is, they’re making the loan in order to defend their original loans because if the company collapses, it would also take the value of their original collateral down with it.
They make the loan to defend against a worse outcome if the company doesn’t receive DIP financing to stay afloat.
Defensive lenders typically don’t want to be in the DIP lending business. But they see the alternative as even worse.
New lenders are considered offensive lenders:
They engage in DIP financing because they are attracted to the above-market interest rates in these markets.
They are sometimes called debtor-in-possession asset-based lenders, or DIP ABL lenders, for short.
The term asset-based refers to the fact that these loans are secured by company assets – most typically commercial real estate.
Offensive lenders relish the opportunity and see DIP financing as a way to generate above-market yields.
With careful underwriting and adequate collateral, offensive DIP financing companies regard the rewards as more than adequate to balance out the risks.
On behalf of a swimming pool company that recently filed for Chapter 11 bankruptcy in Florida, DAK Mortgage helped obtain $1.25 million in much-needed DIP financing in a very short period of time.
As background:
The DIP was one of two tenants of a mixed-use property and needed financing for its cash-flow needs.
The initial lender offered only $836,000, and the process was taking too long. The trustee then called us to step in and speed up the process.
In less than 24 hours, we were able to secure a term sheet for $1.25 million (or $414,000 more than the initial lender’s offer).
We also kept the process streamlined, including by using the appraisal and the majority of the other documents that had already been submitted to the initial lender.
In short, the loan was closed quickly, the DIP received the financing it needed to stay afloat, and the trustee thanked us for making it look good in front of its client.
The DIP financing process can be complicated, as DIP loans are amongst the trickiest types of commercial real estate loans, but here are some general parameters to keep in mind regarding DIP financing terms.
Lenders that operate in the DIP space know that their borrowers need to close and get funded quickly. In most cases, a DIP loan can be closed within two to four weeks, pending court approval.
Loan amounts are chiefly determined by the amount of available collateral, and by the cash flow still available in the business. However, they range from as low as $250,000 up to $20 million and more. If the collateral is there, there is no limit to DIP financing.
DIP lenders will typically consider lending up to 65% to 80% of the value of pledged real estate collateral.
Debtor-in-possession financing comes with shorter loan terms than are customary with pre-bankruptcy bank lender senior secured debt.
DIP lenders will consider lending against any type of commercial property.
There are also lenders out there who will consider other forms of collateral. For example, debtor-in-possession financing for equipment is common. Additionally, accounts receivable (factoring), and/or inventory can be used as a security interest.
LTVs may vary based on the lender and the asset.
DIP lenders know that the companies that come to them for debtor-in-possession financing are already distressed, and have few other options. Most ordinary traditional lenders won’t touch this market. Traditional banks stay away from DIP financing, though they are often pre-petition lenders and lienholders.
Therefore, DIP loan interest rates are higher than ordinary senior secured debts issued under normal circumstances. This is necessary to attract lenders, and compensate them for the elevated level of risk in lending to a company that is already facing or going through bankruptcy.
While DIP lenders don’t normally need to impose as many covenants as bank lenders that rely on conventional cash flow underwriting, they still frequently impose some restrictions. Here are some examples of conditions that may apply with a DIP loan:
Lender must authorize any changes in reorganization plans.
Lender must approve liquidation.
Borrower may not take on new debt with a priority equal to or senior to the lender.
Borrower must submit detailed financial reports to lender at regular intervals.
Lender may impose deadlines for various filings, milestones, and bankruptcy completion.
If borrowers fail to meet these requirements, the lender can find them in default and quickly obtain a judgment allowing them to seize collateral. In many cases, this will effectively force liquidation.
Normally, borrowers pay DIP lenders fees to compensate them for the cost of due diligence and originating the loan. Because DIP lenders require detailed financial reporting from borrowers going through bankruptcy, they’ll probably impose a fee of some sort to cover the cost of going through these reports.
There may be other fees with various names such as unused line of credit fees, restructuring fees, monitoring fees, prepayment fees, exit fees paid upon repayment, or others.
To go through a few real-world examples of recent prominent DIP financing cases:
Debtor | Interest | Fees |
Town Sports, International | 10% per annum | Closing fee: 1% of the DIP commitment Commitment fee: 1.5% of the daily unused amount of the DIP commitment Exit premium: 2% |
24-Hour Fitness Worldwide, Inc. | 6% backstop commitment fee 4% upfront equity investment right | 3% commitment fee Term: Base rate (w. a 1% floor) + 900 b.p. |
GNC Holdings, Inc. | Alternate base rate + 8% | Fee equal to 1% of daily amount outstanding |
Exide Holdings, Inc. | LIBOR + 10% (with a 2% LIBOR floor) | Upfront fee: 3.5% of the credit facility initial amount Exit fee: 3.5% of the credit facility initial amount |
Brooks Brothers Group, Inc. | 11% per annum | Closing fee: 3.5% of the DIP facility $7,500 per month |
Source: Husch Blackwell, LLC
DIP loans and business bankruptcy loans get priced in a variety of ways.
In general, DIP financing interest rates can either be:
A straight-level interest rate; or
An adjustable rate that is a function of another reference rate.
The ongoing Revlon Chapter 11 bankruptcy serves as an example:
Revlon’s recent large DIP financing deal included a $575 million term loan priced at SOFR (Secured Overnight Financing Rate) +775 basis points.
In other words, it’s an adjustable rate: If the SOFR goes up or down, Revlon’s interest rate goes up or down with it. Revlon retains the interest rate risk.
Revlon also secured an additional $400 million in ABL (asset-based lending) financing. This portion of the loan package had a more complex interest rate determination: The loan is priced at an alternative base rate (ABR) + 250 basis points, with an ABR floor of 1.5%.
In this case, loan documents defined the ABR as the highest of these three possible references: The highest of the prime rate, the federal funds effective rate plus 0.5%, or the adjusted term SOFR rate plus 1%).
The financing was contingent on Revlon completing a Chapter 11 bankruptcy filing by June 15, 2022, which was in the cards, anyway, completing a restructuring support agreement (RSA) with an acceptable reorganization plan by November 1, plan confirmation by April 1, 2023, and with emergence from bankruptcy completed by April 15, 2023.
Revlon will additionally pay a 1% origination fee, a 1% payment fee, and a 1.5% “backstop fee.” There’s also an “arrangement fee,” the amount of which was undisclosed.
DIP financing is perhaps one of the most complicated forms of financing given the complexity of bankruptcy law and having to deal with the creditors’ committee and a web of secured lenders and unsecured creditors alike.
However, here’s how to get debtor-in-possession financing, broken down into 4 steps:
At this stage, you already know a Chapter 11 bankruptcy is a possibility. It’s time to get your ducks in a row:
Put together all the information you can, including bonds, leases, mortgages, lines of credit, judgments, mortgages, tax payments, and anything else.
Add up your total liabilities, and create a cash flow schedule with your required payments.
Additionally, list all your assets.
This allows you to define the problem.
Specifically, by adding up your total assets and liabilities and creating a cash flow schedule at the beginning of the process, you know how much money you need to request from the DIP financing company.
As a rule, it’s better to ask for more than you need at this stage, rather than risking having to go back to lenders later, after having run out of money.
It’s a good idea to contact a DIP financing broker at this stage, prior to announcing anything in public, and prior to filing for Chapter 11, which is a public filing.
Having DIP financing lined up in advance has multiple advantages:
It allows the DIP lender to come in right behind you in bankruptcy court, immediately after your initial filing, for court approval for their financing package.
In turn, this allows you to publicly announce your DIP financing arrangement at the same time the public learns about your bankruptcy filing.
This also enables the lender to fund the DIP loan immediately upon court approval.
In most cases, the most effective way to line up DIP financing in advance is to work with a mortgage broker who is already familiar with the DIP lending industry:
They can help match you with lenders whose terms and lending criteria best match your situation.
When time is of the essence, an experienced broker can also help ‘shop’ your application to multiple lenders, so you can get financed for the full amount you need, and have a choice of competitive offers. A good broker can do this much more efficiently than most business principals can do on their own.
At this stage of the process, you and your attorney will be communicating with your DIP lender(s) about the workout plan, timelines, and milestones, including not just what the lender requires but also what other lenders and lienholders and what the courts will likely require to approve the plan.
This includes filing the required balance sheet information. The DIP lender’s attorney will work with your attorney to assemble all the required schedule information and draft the proposed order before you commit to the filing.
At this point, you will have already hammered out the details of a realistic and feasible workout plan with your attorney and the DIP finance company. If you’ve done a good job, there’s an excellent chance that other creditors and the court will quickly approve the workout plan and your proposed order.
Once the court approves, your DIP lender will normally immediately fund the loan, or make the line of credit available to you. At this point, you can go back to serving your clients and customers, reassuring your employees, executing your workout plan, and making the internal changes you need to bring your business back to profitability.
Some companies take their creditors by surprise when filing bankruptcy, without informing creditors.
This often backfires, because as soon as they learn about your filing, lenders can quickly file a notice of non-consent with the bankruptcy court and formally seek adequate protection.
This, in turn, allows the lender to freeze the business’s bank accounts, and file a motion for relief from the automatic stay on collection efforts.
Pre-bankruptcy lenders are often an important source of DIP financing.
It’s much better to work with your creditors ahead of time, reassure them you have a workout plan, and get an agreement for some flexibility with your cash collateral that allows you to continue to operate as you go through bankruptcy.
We have the expertise to help you get the best DIP funding for your situation.
DIP financing is a specialized market. The business situation is fraught by its very nature. There are a lot of procedural and legal considerations and technicalities that the lender needs to understand to make the deal go through.
Traditional lenders who don’t ordinarily focus on bankruptcy and restructuring situations, for example, sometimes impose unrealistic deadlines on companies to complete a restructuring or sale.
Furthermore, an existing defensive lender may act contrary to your company’s interests. For example, they could potentially manipulate the restructuring process to capture their own collateral in the deal, while pushing management into unreasonable deadlines.
Business leaders with limited experience or understanding of the bankruptcy process may not even see it coming until it’s too late.
Companies that specialize in DIP lending may also help with legal, technical, and operational expertise to help your company get back on its feet.
While it’s most efficient to line up a DIP facility early in the bankruptcy process – pre-filing, if possible, we are able to arrange this type of credit facility at any stage of bankruptcy.
Even if you’re well into the bankruptcy workout plan, or looking for an exit, we can help you find the bankruptcy loan you need to keep your company operating as you put your bankruptcy behind you.
At DAK Mortgage, we’ve helped many businesses line up DIP financing to see them through Chapter 11 bankruptcy.
Our firm specializes in challenging situations, including credit-challenged, pre-bankruptcy, and bankruptcy situations.
Our goal is the same as yours: Preserve your firm as an operating entity, keep workers employed, and get your company back on its feet on a more sustainable profitable basis.
Sometimes all companies need is a short-term bridge loan or simple refinancing to help them avoid having to file Chapter 11 in the first place. We’re here to help you with that, too.
Whether you need debtor-in-possession financing, refinancing assistance, a bridge loan, or any other type of financing, we can work with you to find you a lender and terms that fit your particular situation.
For a confidential consultation, contact us today.
