DIP Financing Can Be Used to Maintain a Property During Bankruptcy
Debtor in possession financing (DIP financing) is a special form of financing granted to companies in financial trouble. Usually these companies are in a Chapter 11 bankruptcy. The unique feature of a DIP loan is that the bankruptcy court usually grants a super-priority status to the new loan. This means that the new loan gets to jump in front of any mezzanine financing and any senior mortgages in the debt stack.
"Gee, George, does this mean that if I have a first mortgage that some crazy bankruptcy judge can just push my loan back into a second mortgage position and allow the DIP lender to be the new first mortgage?"
Bankruptcy courts don't just approve debtor in possession loans willy-nilly. Usually the debtor has to obtain the permission of the existing lenders.
"Gee, George, why, if I had a first mortgage position, would I ever agree to be pushed back into a second mortgage position?"
Let's suppose that your bank had a $10 million first mortgage on a huge RV manufacturing facility in Elkhart, Indiana. As you know, the RV industry is in shambles and there are millions of square feet of empty industrial space in Elkhart right now. If you're the bank, you could easily be looking at seven years before you'll ever be able to sell or lease the property.
Now let's suppose that, right before the RV manufacturer went into bankruptcy, the company received an order from FEMA for 1,000 movable trailers that could be rushed to disaster areas as emergency housing. The RV company was poised to make millions of dollars on that order, but they didn't have the dough to order the parts and supplies. All of their suppliers had put them on a cash-only basis.
A DIP lender might come in and make the RV company a DIP loan of $1.5 million, secured by a first mortgage on the property. The company could then use this new money to fill the FEMA order and to restore itself to financial heath. The bank might very well agree to subordinate their $10 million first mortgage loan to this new debtor-in-possession financing because it would prevent the company from a total dissolution.
"But George, why wouldn't the bank just agree to increase the size of its first mortgage?"
There could easily exist at the bank an unwillingness to throw good money after bad. In addition, many banks are short of lendable funds right now because few of their existing loans are getting paid off at maturity.