Using DIP Loans For Higher Returns, Less Risk



Bankruptcy lending is very profitable
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* The views expressed herein are those of the authors only and are not necessarily shared by others at Lowenstein Sandler LLP. Each case is unique and the law is subject to interpretation.

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Historically low interest rate environment where can you find double digits? Surprisingly, the answer is found in Chapter 11 Bankruptcy Cases as a DIP creditor.

DIP Credits Can Be Profitable

DIP lending has grown into big business. With sufficient business diligence and adequate collateral, coupled with sound documentation and ongoing monitoring of the borrower’s performance, DIP loans can be relatively safe and profitable.

Potential Chapter 11 debtors usually lack working capital and need a life buoy. They often work at problem levels for a period of time and seek funding for bailouts when shareholders are no longer willing or able to fund them. By then, stocks could be depleted, suppliers could stop supplying, and shipments to customers slowed down. After the start Chapter 11 bankruptcy case, the debtor must act quickly to restore the confidence of customers and suppliers. Thus, DIP funding is critical to getting debtor’s business up and running quickly and increasing the likelihood of a successful reorganization achieved by confirming a reorganization plan or selling the business in a competitive environment.

Traditional creditors facing bankruptcy may not understand Chapter 11, including the benefits (and some of the hardships) it entails. Some of them may be inconvenient when lending to problem clients or borrowers in bankruptcy. Those who continue to make loans often do so by burdening the debtor with unreasonably short runways within which a reorganization plan can be made public or a sale completed. In other cases, creditors before bankruptcy may have ulterior motives, such as obtaining their collateral (and the debtor’s business) in exchange for the secured debt, while subjecting the debtor to tough milestones and deadlines. Such requirements can be too onerous for managers seeking to maintain the business, retain employees, and maximize value.

The high cost of DIP financing is not objectionable by management when combined with other terms that are beneficial and meet other important needs of the borrower. For example, a financing package that provides the debtor with sufficient working capital (as opposed to the minimum or insufficient capital usually offered by pre-existing creditors) for reorganization and gives the debtor more time to strategize and more flexibility to operate and restructure its business. more than compensates for the cost of the loan. In addition, the ability of the DIP lender to provide more than necessary DIP loan will build the trust of suppliers and customers, further justifying management’s desire to obtain a DIP loan at a higher cost. From the debtor’s perspective, the increased cost of borrowing from a new DIP lender is outweighed by the projected additional cost of the debtor’s business as a result of the financing and flexibility provided by the DIP lender.

The DIP lender is compensated for their efforts throughout the entire process. BUT debtor usually required to finance the professional fees and costs of a potential DIP lender related to the verification and processing of a loan by the DIP lender. In addition to striving for higher interest rates, DIP lenders often ask for a variety of fees ranging from upfront loan disbursement fees, unused credit line fees, monitoring fees, and prepayment fees to exit fees at maturity, i.e. restructuring commission or any other specified initial fee. These fees actually increase the value of money for the debtor and, likewise, the yield for the creditor. They also ensure that the lender’s stated interest rate is not diluted with administrative costs.

Key to being a DIP lender

Considering that DIP loans are often requested with expedited time frames, the DIP lender must be agile and able to act quickly. The key to becoming a DIP lender is understanding the real residual value of the collateral offered, as well as potential liquidation costs (including administrative costs, indirect costs and professional fees) and litigation if the borrower’s restructuring strategy fails. The ability of the DIP lender to ensure that the debtor’s management lives up to their confidence and to limit lending to the borrower’s net liquidation value is also a prerequisite for a successful DIP loan. DIP’s new lender avoids excessive risk by requiring the borrower to adhere to adequate basic borrowing formulas and by ensuring a controlled and expedited liquidation of its collateral in the event that the debtor defaults on its loan obligations.

DIP financing often provides a safer and more reliable lending environment than what can be available outside of bankruptcy. To begin with, the DIP lender does not provide any money until the bankruptcy court orders the DIP loan to be approved. Thus, a new loan after approval is not subject to potential future problems. A DIP loan usually has a shorter maturity and is secured by virtually all of the debtor’s assets. The granted security interests and security interests obtained in virtually all of the debtor’s assets can be improved by simply signing a DIP funding order by a judge (even though many creditors nevertheless register their security interests in accordance with applicable law) … Further bankruptcy The court order usually dictates the priority of the DIP loan over all other obligations of the debtor, which additionally ensures that the DIP’s creditor will be in the highest position over virtually all other creditors and equity holders.

On the other hand, lending outside of bankruptcy leaves the lender potentially vulnerable to defects or other deficiencies in its collateral package (whether due to errors in documentation or errors in perfection), delays in defaults, and disruption of remedial efforts. … Unlike a Chapter 11 debtor loan, which must adhere to court-approved budgets and provide complete information about its business operations and assets, the typical business lender is more reliant on and dependent on the reliability of management and their disclosures.

DIP lenders can also protect their loans in other ways. They may insist on agreements and other safeguards that would be unacceptable to borrowers except in bankruptcy cases. DIP lenders often dictate the terms of the DIP lending, such as the need for the lender to approve the reorganization plan in advance, or liquidation, the sale transaction, as well as the use and application of proceeds from the sale of assets, setting milestones to achieve specific bankruptcy goals (from the sale stages to the deadlines for filing a plan or a disclosure statement or reviewing important contracts or leases), prohibition of the future loans with a priority higher than the DIP lender and requiring detailed financial reporting. Breach of conditions on a DIP loan usually results in default, allowing the lender to act quickly.

Chapter 11 should be transparent. Close monitoring of the debtor’s transactions by the DIP lender (paid by the borrower as additional borrowing costs) is standard. There are also frequent (often weekly) financial reporting requirements. And all actions outside the normal business of the debtor require the approval of the bankruptcy court, which, in turn, informs the creditor of the DIP throughout the process.

DIP lenders who are ready to act quickly and are able to thoroughly screen the transaction (and the borrower) and closely monitor the borrower can minimize the risk associated with DIP loans. DIP loans, discussed in Chapter 11, provide a unique opportunity for higher yields not available to lenders outside of bankruptcy.


Kenneth A. Rosen is a partner and honorary chairman of the Bankruptcy and Restructuring Department of Lowenstein Sandler LLP. Ken has over 35 years of experience advising on a full range of restructuring solutions, including Chapter 11 restructuring, out-of-court decisions, and financial restructuring.

Wojciech F. Jung is a partner in the Bankruptcy and Restructuring Department of Lowenstein Sandler LLP. Wojciech represents enterprises, unions, pension funds, buyers and creditors in all aspects of corporate restructuring and restructuring, liquidation, debtor and creditors’ rights, bankruptcy and commercial litigation.



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