Cram Down in Bankruptcy Proceedings
February 12, 2025
In the previous few articles, we have come across the various types of risk which are present in an infrastructure project. We have discussed the risk of cost overruns as well as the risks of revenue delays and everything in between. However, all the risks we discussed were directly applicable to the infrastructure company or […]
Forecasts Spread Over a Period of Time Inflation is an ever persistent condition in today’s economy. The purchasing power of money has been reducing year after year for decades now. Apart from the occasional recession where money may gain real value, the usual case is a loss of value. Investors are investing money today. They […]
The Icelandic budget airline “Wow airline” became the latest airline to go bankrupt in Europe. Of late, Europe has seen a lot of airlines go bankrupt due to multiple reasons. No less than eight airlines have suspended their operations in Europe in the past year. Price wars, rise in fuel prices, and overcapacity have been […]
Corporate America is flush with cash! Collectively, the Amazons’, Apples’ and other such publicly traded mega corporations account for close to $2 trillion in cash. This excessive hoarding of cash in unparalleled in financial history and hence has left a lot of economists flummoxed. In this article, we will try to understand why American corporations […]
Whenever a company wants to sell its shares in the open market, it faces a very important question. The question is that what should the price of the shares being sold be? Over the years, investment bankers have tried multiple ways to find out the fair price at which the shares should be sold. Many […]
In the business world, Cash is King. Companies that do not have adequate cash cannot survive for very long. This is because of the fact that employees, vendors, tax authorities, and other creditors expect to be paid in order for the business to remain in operation.
When a company is not facing bankruptcy, it obtains funds using one of the following methods:
However, when a company is facing financial duress, two things happen. Firstly, the company needs more cash to run its operations i.e., the demand for financing goes up. At the same time, all traditional lenders are no longer willing to lend to the firm. Hence, the supply of cash also goes down. This simultaneous increase in demand and reduction in the supply of cash is called a cash crunch. This is a difficult situation for a company to be in and is capable of exacerbating the bankruptcy process.
When a company is in duress, outsiders i.e., external lenders, tend to withhold credit. This is because they do not have the visibility of the operations and the financial viability of the company. Hence, they have to make decisions in the absence of critical information, which makes it a risky bet for these companies.
However, insiders have access to this information. Sometimes, they may be confident about their ability to turn around the fortunes of their firm. Hence, they may offer to invest more money. However, it would not be prudent of them to do so without following proper procedures.
The fact of the matter is that insider loans are a subject of a lot of scrutiny in distressed companies. In many cases, loans made by insiders have later been challenged by other stakeholders. In many cases, the priority of the debt was reduced. In some other cases, the debt infusion was converted into equity, and the shareholders had to absorb the resultant losses.
Also, form a legal point of view, companies that seek Chapter 11 bankruptcy protection are supposed to get approvals from the court before they agree to any new financing arrangements.
DIP financing is an alternate way for companies that are under Chapter 11 bankruptcy to obtain finance. If the loan is given as a part of this arrangement, it is approved by the court, and hence its validity cannot be challenged by any party at a later date.
DIP financing is a boon for companies facing bankruptcy. The guarantee that this kind of financing provides attracts many potential investors. This is because the court guarantees that their interest will remain safe even if the financer is an insider or a potential acquirer.
The name DIP financing is short for “Debtor in Possession” financing. This is because an insolvent company is considered to be bankrupt. Hence, ideally, the debtors should no longer be in possession of the company. However, bankruptcy proceedings allow for a short period of time when they can still be in possession of the company. Hence, this state is called “Debtor in Possession” or DIP. This is the reason why the financing provided at this stage is called DIP financing.
In case a company wants to obtain DIP financing, it first needs to line up a lender. This means that all the details related to the loan like interest rates (which may be above market rates), fees, and repayment schedule needs to be planned. Also, the details about how the funds will be utilized, and the control plan also need to be decided. These documents are then submitted to the court for their approval.
It needs to be understood that the court will intimate all the existing creditors as well. Also, the court may consider objections raised by them, especially if the financing party is an insider or a potential acquires. After listening to both sides of the argument, the court will then decide whether or not to allow the company to obtain DIP financing.
Obtaining DIP financing is somewhat difficult. This is because the company needs to convince the court that the current position of the other creditors will not be negatively affected. Alternatively, the company can directly convince the other creditors and provide the court with written documents indicating their consent.
Many times, the existing lenders are the ones who agree to provide DIP financing. This is because, under the DIP financing laws, their interests are better protected. DIP financing carries security from an investor’s point of view. The validity of the terms and conditions of the loan granted under DIP financing is unquestionable!
The problem with DIP financing is that it takes a lot of time. Companies under the threat of bankruptcy need to reach quickly. Such long delays may not be in the best interest of all the stakeholders. The bottom line is that DIP financing is a valuable tool that needs to be used correctly. It has the potential to provide companies with critical cash flow that they need at the right time.
Your email address will not be published. Required fields are marked *