DIP financing

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Business Bankruptcy Issues

Cooley GO: A Great New Resource For Entrepreneurs And Their Companies

Cooley Go

Cooley GO

Earlier this month, Cooley LLP launched Cooley GO, a terrific new resource center for entrepreneurs with businesses at all stages of the growth cycle. Cooley GO is a mobile-friendly microsite that provides a wide range of free legal and business content covering formation, financing, building a team, working with directors and advisors, intellectual property, M&A, IPOs and more.

I have the pleasure of being a contributor to Cooley GO. A new post I wrote called “A Key Customer Filed for Bankruptcy: Should You Keep Doing Business With Them?” is now on the Cooley GO site. To read the article just follow the link in the prior sentence.

Be sure to explore the full Cooley GO site. Among other tools, Cooley GO provides entrepreneurs with the ability to:

I hope you find Cooley GO to be a helpful resource for your business.

Business Bankruptcy Issues The Financially Troubled Company

DIP Financing: How Chapter 11’s Bankruptcy Loan Rules Can Be Used To Help A Business Access Liquidity

Cash Is King. An army may march on its stomach, but for companies, it’s liquidity that keeps the business going. For many companies, typical sources of liquidity, beyond cash flow from sales or other revenue, are (1) financing from banks or other secured lenders, (2) credit from vendors that can reduce immediate liquidity needs, and (3) when needed, loans from owners, investors, or other insiders.

When A Liquidity Crisis Hits. Companies in financial distress often find that their need for liquidity goes up just as the availability of traditional financing goes down. The borrowing base may shrink, the ability to get further advances may be cut off, and loans may go into default. Worse, new lenders may be unwilling to make loans given the distress. For many distressed businesses, revenues may also be declining and insufficient to cover expenses without additional financing. A liquidity crunch can quickly snowball into a liquidity crisis.

Insider Loans. Even if an owner, investor, or other insider might be open to making a loan, the company’s distress may raise a red flag because of the extra scrutiny often given to insider loans to a distressed company. Insiders may be concerned that if they make the loan, creditors or a bankruptcy trustee could later challenge it (and any security interest granted) in an attempt to recharacterize the loan as an equity contribution or have the debt equitably subordinated — and therefore never repaid — in a bankruptcy. 

A Potential Solution: DIP Financing. A company in financial distress is probably already looking at a workout, restructuring, or sale of the business. Out-of-court workouts should be considered and may succeed. However, in the right situation a Chapter 11 bankruptcy can provide powerful options, including the ability to facilitate financing. If a company needs a loan but a potential lender is unwilling to make it, including because of concern about a legal challenge, the Bankruptcy Code offers a way to give the lender comfort that the loan will not be challenged, even if the lender is an insider or a potential purchaser.

  • To explore this further, we first need to review a little bankruptcy terminology. When a company files a Chapter 11 bankruptcy, the company’s management and board of directors remain in possession of its business (unless a trustee is later appointed). For that reason, the company in Chapter 11 is called a "debtor in possession" or a "DIP" for short. The special Chapter 11 bankruptcy financing is known by this acronym: DIP financing.
  • When the debtor company has lined up a lender, it files a motion seeking Bankruptcy Court approval of the DIP financing. Typical DIP financing terms include a first priority security interest, a market or even premium interest rate, an approved budget, and other lender protections. Creditors have a right to object to the DIP loan, and may do so if the proposed lender is an insider, and the Bankruptcy Court will ultimately decide whether to approve it.
  • If the company already has secured debt, to borrow funds secured by a lien equal or senior to the existing lender (often called "priming" the existing lender), the company either will need the existing lender to consent or will have to convince the Bankruptcy Court that the existing lender’s lien position will be "adequately protected" (essentially meaning that the existing lender will not be worse off if the DIP loan is approved).
  • An existing lender itself may be willing to make a DIP loan, even if it has refused to make further advances outside of bankruptcy. In fact, when DIP loans are made they often come from a company’s existing lender. That lender may have its own reasons to use the DIP financing process, for instance, to finance a sale process on specific timelines or otherwise to enhance its position.
  • Unlike a loan outside of bankruptcy, if the Bankruptcy Court gives final approval to a DIP loan and finds that the loan was made in good faith, the new DIP loan will no longer be subject to legal challenge. Put differently, with that approval in hand, a loan that could have been challenged outside of bankruptcy will not be subject to challenge inside of bankruptcy. That’s true even if the lender is an insider or a "stalking horse purchaser" seeking to buy the company’s assets. 
  • The takeaway is that while it isn’t easy, in the right case a distressed company may be able to use Chapter 11 bankruptcy’s DIP financing procedures to get the liquidity it needs, to run a sale process or finance a formal Chapter 11 restructuring, even if it could not get a new loan outside of bankruptcy.

Why Chapter 11? One of the key reasons companies file for Chapter 11 bankruptcy is because of the special legal protections it provides. For the company, those include the automatic stay and, in the right case, the ability to restructure its debts through a Chapter 11 plan of reorganization. Chapter 11’s protections for purchasers of assets can sometimes allow the seller to achieve through Chapter 11 a sale price that it never could have realized without bankruptcy. Likewise, Chapter 11’s DIP financing process for lenders may help the company generate liquidity — including from an existing lender, investor, or stalking horse purchaser — even if it could not do so outside of bankruptcy. 

Conclusion.  A company facing a liquidity crisis should get legal advice from an experienced restructuring and bankruptcy attorney to make sure it considers all options. A workout or other out-of-court restructuring may be able to solve the problem and get the business back on track. However, there are times when a Chapter 11 bankruptcy filing, despite its costs and disruptions, is the best tool in the toolkit. That’s especially true if Chapter 11’s DIP financing rules help a business access liquidity that it could not get outside of bankruptcy.

Business Bankruptcy Issues Recent Developments

The Credit Crisis And DIP Financing

The credit crisis has made it difficult for companies to borrow throughout the economy. It should come as little surprise then that the constriction in the credit markets is hitting Chapter 11 debtors in possession as well. According to an article entitled "Bankruptcy financing gets pricier and more elusive," debtor in possession financing (commonly known as "DIP financing") has recently become more costly for companies in Chapter 11 bankruptcy — when it’s available at all.

  • Adding to the challenge is the amount of prepetition secured financing, including second lien debt, that many companies took on over the past few years when financing was easier to get. A company that has already encumbered its assets with secured debt may have little or no unencumbered assets to offer a DIP lender as collateral.
  • The article predicts that fewer companies in Chapter 11 will be able to find new lenders to provide DIP financing, giving the DIP’s existing lenders the advantage in negotiating DIP financing terms such as interest rate and fees.
  • Alternative sources of DIP financing may be able to be found in certain circumstances. In some cases, the buyer in a Section 363 asset sale may provide DIP financing to bridge to the closing of the sale. However, such limited purpose financing is not a substitute for the type of DIP financing generally needed for a successful reorganization.

Cash is king in bankruptcy and DIP financing is often a key source of that cash. Until the credit crisis subsides and DIP financing becomes more available, companies may find it more difficult to reorganize in Chapter 11.

Business Bankruptcy Issues Recent Developments

Southern District Of New York Bankruptcy Court Proposes Amendments To Local Rules

The United States Bankruptcy Court for the Southern District of New York has announced proposed changes to its Local Bankruptcy Rules in light of the recent amendments to the Federal Rules of Bankruptcy Procedure that took effect on December 1, 2007. Many of the largest business bankruptcy cases are filed in the Southern District of New York, which includes Manhattan, making these proposed amendments to the Local Bankruptcy Rules of particular interest.

Cash Collateral And DIP Financing Disclosures. The most significant proposed changes for Chapter 11 bankruptcy cases address cash collateral and DIP financing motions and, if adopted, the local rule amendments would supplement the disclosures required by amended Federal Rule of Bankruptcy Procedure 4001. Proposed Local Bankruptcy Rule 4001-2 would require at least fifteen material provisions to be disclosed in cash collateral and DIP financing motions. These include the following:

  • the amount of cash to be used or borrowed, including any borrowing base formula and availability;
  • material conditions to closing, including budget provisions;
  • pricing and economic terms, including various fees;
  • any effect on existing liens;
  • any carve-outs from liens or superpriorities;
  • any cross-collateralization;
  • any roll-up provisions;
  • any provisions that would materially limit the Court’s power or discretion or the fiduciary duties of a trustee, debtor in possession, or committee;
  • any limitation on the lender’s obligation to fund activities of a trustee, debtor in possession, or committee;
  • termination or default provisions;
  • any change of control provisions;
  • any deadline for sale of property;
  • any prepayment penalty or other restriction on repayment;
  • terms governing joint liability of debtors; and
  • any funding of non-debtor affiliates.

Additional Proposed Financing Changes. Other provisions would require (1) disclosure regarding efforts to obtain financing, (2) adequate notice after an event of default and before a lender could exercise remedies, (3) disclosure regarding carve-outs and allocations of carve-outs, (4) investigation periods for committees, and (5) appearances at preliminary and final hearings. In addition, the proposed local rule would mandate certain provisions in proposed orders, including a reservation of the Court’s right to unwind roll-ups if a successful challenge is later made. 

Other Proposed Amendments. The remaining proposed amendments are mainly technical. They would repeal local rules that have become unnecessary, drop the requirement that attorneys use an identifier that includes the last four digits of their social security number, conform attorney signature rules to current practice, and dispense with the need for a separate memorandum of law if a discussion of the law is included in the motion itself.

Opportunity For Comments. The Bankruptcy Court has not yet promulgated these local rule amendments and it is accepting comments on the proposed changes until April 23, 2008. Information on how to submit comments is available on the Court’s website at the Local Rule page.