Several individuals, companies, and business owners need to know about the Debtor in Possession financing. As there are pros and cons to almost every existing thing in this world, the DIP Funding has some of it too.
Here, in this article, we will discuss several things about the Debtors in Possession process, such as the barriers of debtors in possession funding or the reasons why most of the companies as petitioners cannot utilize the DIP Funding to exit the proceedings of Chapter 11 successfully. But before that, we need to know what a debtor is in possession of, known as DIP.
The debtor in Possession - The Definition
A debtor in possession or DIP is an organization or an individual who has filed a Chapter 11 bankruptcy protection case. The DIP generally holds their properties as assets. The creditors have a claim to the assets of the debtors by the law under a security interest. The DIP can do business and use those assets for business purposes. There are no legal restrictions in that matter. But the debtor has to take the court's permission in order to take a step that is not a regular business activity. The DIP must keep all the necessary documents that are related to business, such as tax returns, financial records, property records, and many more.
Understanding the DIP Funding and Impact of it
DIP Funding is basically a transitional stage of salvaging the value from the assets after a bankruptcy as per the debtor's attempt. This funding actually rescues the debtors from liquidation and helps the creditors and the bankrupts both.
Let us see an example. Suppose there is a hotel that is bankrupt for many reasons. But still, the hotel has skilled staff, good customers. These factors are more precious to a buyer than things like a hotel's property, building, or equipment. But it may take a long time to get a buyer for the hotel. Here the Funding helps the debtor to run the hotel continuously until a buyer shows interest in the hotel and buys it.
Now, here is another angle. Suppose the owner does not want to sell the whole hotel. In that case, he can arrange a local investor who will buy the hotel building and give it to them on rent. By this process, the debtor can refund the creditors with the profit of the running hotel, and the hotel can be back in business.
The impact of DIP Funding says something bad. As history suggests, 30% of the companies that file a bankruptcy case as per Chapter 11 can successfully exit. The other 70% of companies cannot do it because of some dismissal or any conversion of the case. And then those companies face liquidation immediately. This takes place for a lot of reasons. But there are three big reasons for it. Here we will discuss the reasons behind the debtor's liquidation even after filing a Chapter 11 bankruptcy case.
There are mainly three barriers to DIP Funding. Those are:
Focus on Mega Deals:
Extended credit lines that are accessible through debtors in possession financing could be beneficial for smaller businesses. In spite of this fact, debtors in possession, funders do not provide a focus on that. They only focus on large corporations that can provide some mega deals. Research shows that in cases like this, less than two per cent of deals are done in less than ten million dollars. The largest deal that took place was worth 33 billion dollars.
Geographical Disbursement in Court's Approval:
The debtor in possession cases mainly takes place in two court districts, the Southern District of New York and the District of Delaware. Between 2006 and 2012, a total of 112 bankruptcy cases were filed. But 75 per cent of the case confirmations took place in the Southern District of New York and the District of Delaware. Because of these geographical preferences, those Chapter 11 cases that are filed elsewhere struggle in obtaining court confirmation.
Cost of Legal Counsel:
In simple words, bankruptcies are now more expensive than it ever was. Through the last two decades, the legal cost in bankruptcy has increased by almost 50 per cent. That simply means that if a company files a Chapter 11 bankruptcy case, they will have to spend a lot more on legal counsel than before. That is a matter of tension for small business owners.