The Use of DIP Financing as a Mechanism to Control the Corporate Restructuring Process

Lenders routinely use debtor-in-possession (“DIP”) financing agreements to gain substantial control over debtors in Chapter 11 and the bankruptcy reorganization process.  However, the currently accepted degree of lender control over the Chapter 11 process has evolved into a major de facto change in the bankruptcy process that inhibits rehabilitation of distressed companies. This evolution has been accelerated by the overleveraging of debtors, the proliferation of secured financing, restrictions on the time for debtors to assume or reject leases, the exorbitant cost of DIP financing, and the availability of forms of DIP financing documents on the Internet. Whether this change is bad policy, or merely an economically efficient reallocation of capital, is an issue that courts, scholars, and practitioners are struggling to address.

Lenders legitimately contend that if the lender is under-collateralized, then the lender experiences all of the downside of the reorganization process and should be able to maintain a high degree of control over the operations of the debtor during the Chapter 11 reorganization.  Lenders also contend that increased risk will result in higher credit cost and limited availability of DIP credit to debtors. These considerations must be balanced with the overall objective of reorganization.  On the other hand, the premature liquidation of a viable business without providing the opportunities that Chapter 11 was designed to afford, has serious negative consequences.