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Debtor in Possession (DIP) financing is used to fund operating activities during Chapter 11 bankruptcy. In the context of commercial real estate, DIP financing often provides the money needed to fund additional capital improvements, marketing costs, and other expenses needed to enhance the value of a project to a point of profitability. Chapter 11 affords the debtor in possession a number of mechanisms to restructure its business. Debtors are also protected from other litigation against the business through the imposition of an automatic stay.
For example, a Chapter 11-protected commercial real-estate debtor cannot be subject to the filing or continuation of a lawsuit for claims that existed prior to the bankruptcy. Also, the DIP is shielded from actions that would create, perfect, or enforce a lien against property of the debtor’s bankruptcy estate. DIP financing traditionally takes a senior position over the existing debt, equity and other securities in place at the time of the Chapter 11 filing. It is also important to note that while DIP loans are used to provide new operating capital, they are not intended to pay off any current debt.
A priming loan is one type of funding that may be used for DIP financing. This type of loan may only be used to pay for core functions of the company’s operations (repairs, payroll, etc.). Priming loans must satisfy requirements for the existing creditors, which usually entails setting aside portions of the proceeds to pay interest on the ailing debtor’s outstanding debt. Although this type of loan charges high interest rates, it will provide the necessary capital required to work through the reorganization.
Another type of DIP loan is factoring. Factoring provides the debtor with an immediate advance upon invoicing, which provides necessary liquidity to meet current expenses. Factoring financing is also relatively easy to qualify for. The most significant requirement is that the debtor must sell products or services to credit worthy businesses (or government entities) at a profit. Factoring may also be used for purposes outside of Chapter 11 bankruptcy or DIP financing.
The availability of DIP financing may depend on several factors, most notably: the perceived viability of the company during the bankruptcy proceedings, and its ability to successfully complete a Plan of Reorganization (POR). The Plan of Reorganization must specify how the debtor intends to pay its overdue creditors. DIP financing gives distressed organizations the funding they need to continue operations through at least the planning stages of their POR. . DIP lenders are frequently Opportunity Funds, Hedge Funds, and recently formed Debt Funds that are willing to risk investing in a bankrupt project due to the super-senior position and high returns.
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