Chapter 11 Practice — Bankruptcy Nuts & Bolts: The Basics of Cash Collateral and DIP Financing  

Aug 15, 2010


A. Importance

In most chapter 11 bankruptcy cases, a debtor will need to use cash that is subject to a lien of a secured creditor and/or obtain postpetition financing to continue operating postpetition. Section 363 of the Bankruptcy Code permits a debtor to use such encumbered cash (and its proceeds, collectively “cash collateral”) to satisfy a debtor’s postpetition expenses. In most chapter 11 cases, however, a debtor cannot rely solely on its existing cash balance or postpetition accounts receivable to meet its postpetition obligations. As such, section 364 of the Bankruptcy Code permits the extension of postpetition credit to a debtor (DIP financing). In order for a debtor to be permitted to use cash collateral or receive DIP financing, however, a debtor may be obligated to satisfy several conditions.

B. Objectives of Different Parties

The Bankruptcy Code recognizes that, absent protection, some lenders may be reluctant to either consent to a debtor’s use of cash collateral or provide a debtor DIP financing because the debtor only recently chose to pursue bankruptcy protection, very often without the lender’s consent. Therefore, to encourage secured lenders to allow the use of cash collateral and the extension of DIP financing, the Bankruptcy Code provides lenders certain incentives and protections. Thus, a lender that is willing to consent to the use of its cash collateral or extend DIP financing will naturally want to receive as many protections and incentives as it can to protect its collateral to ensure repayment.

DIP financing may be provided by either a debtor’s existing (or prepetition) lender or a new lender. The prepetition lender's reasons for wanting to extend DIP financing will not necessarily coincide with the reasons why a new lender is willing to extend DIP financing. The postpetition lender, for example, may only be willing to extend DIP financing if the new lender perceives value in the debtor’s collateral and believes there is a high likelihood of full repayment. Whereas, the prepetition lender may be willing to extend additional financing for mere tactical reasons, such as: (i) preventing a new, postpetition lender from being granted liens superior to the prepetition liens; (ii) addressing defects in the perfection of its prepetition security interests; (iii) increasing or preserving the value of its prepetition collateral; (iv) cross-collateralizing prepetition and postpetition indebtedness (discussed in more detail below); or (v) gaining substantial leverage over the direction of the bankruptcy case, as a result of receiving a high priority claim. Regardless of its reasons for wanting to provide DIP financing, whichever lender provides the DIP financing will want to maximize the protections and incentives it receives in return.