DIP Financing

1
Southern District of Texas Bankruptcy Bench Bar
Conference
DIP Financing Common Features and Pitfalls
John Melko, Gardere Wynne Sewell LLP Bruce
Ruzinsky, Jackson Walker LLP David Zdunkewicz,
Andrews Kurth LLP
2
What is a DIP Loan?

• Section 364(c) and (d) provide for different
  levels of DIP loans
• (c) If the trustee is unable to obtain
  unsecured credit allowable under section
  503(b)(1) of this title as an administrative
  expense, the court, after notice and a hearing,
  may authorize the obtaining of credit or the
  incurring of debt
• (1)   with priority over any or all
  administrative expenses of the kind specified in
  section 503(b) or 507(b) of this title
• (2)   secured by a lien on property of the
  estate that is not otherwise subject to a lien
  or
• (3)   secured by a junior lien on property
  of the estate that is subject to a
  lien.          
• (d)
• (1) The court, after notice and a hearing,
  may authorize the obtaining of credit or the
  incurring of debt secured by a senior or equal
  lien on property of the estate that is subject to
  a lien only if
• (A)   the trustee is unable to obtain such
  credit otherwise and
• (B)   there is adequate protection of the
  interest of the holder of the lien on the
  property of the estate on which such senior or
  equal lien is proposed to be granted.
• (2)   In any hearing under this
  subsection, the trustee has the burden of proof
  on the issue of adequate protection.
•             Few DIP lenders are willing to make a
  loan on anything other than a priming basis,
  i.e., 364(d).

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Does the Company Need a DIP Loan?

•  DIP Loans are intended to be used when cash
  collateral is insufficient and management or the
  trustee cannot obtain additional credit on any
  other basis.  However
•  Commonality of DIP Loans
•  DIP loans are becoming a regular feature of
  Chapter 11 cases
• Current cash flow will not support
  operations and costs of administration at current
  levels
•   Significant capital expenditures are
  required for the continuation/reorganization of
  the debtor
• Prepetition lender is interested in
  upgrading its existing loan.
• Defensive vs. Strategic or Third Party DIP
•   Defensive DIP loan made by existing lender
  to prevent its collateral from being primed and
  for other purposes as explained below
• Strategic DIP loan made by a lender with a
  view toward purchasing assets at 363 sale where
  DIP will be credit bid or made for other
  reasons.

4
Common Features of DIP Loans

• Priming Liens even existing  lender may prime
  its own loan or part of its own loan.  Third
  party lenders will want to prime all existing
  lenders
•  Confirmation of prepetition liens for existing
  lenders
•  Releases for existing lenders with respect to
  sins of the past
•  Releases for new lender for any claims arising
  from negotiations or anything prior
•  Releases are normally subject to a Challenge
  Period during which some party can
  examine/challenge liens or conduct of lender
•  Collateral package
•  Typically, first lien on all existing
  collateral
•  May include liens on causes of action, including
  Chapter 5 causes of action

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Common Features of DIP Loans (Contd)

• Subject to carve out for UST fees also subject
  to agreed basket of administrative expenses of
  debtor and committee professionals, after
  default, up to a maximum amount
•  Budget review and approval
• Covenants varies widely.  Range from tight
  covenants if the case is a continuation of an
  operating company to covenant lite for bridge
  loans to sale
• Rollup of prepetition debt of existing lender. 
  Consider effect on admin expense claims
• Interest rates vary widely.  Some DIP loans are
  subject to bidding
• Findings of good faith, best interests of estate,
  reasonableness of loan, etc. all with view toward
  364(e) protection
• (e)  The reversal or modification on appeal of
  an authorization under this section to obtain
  credit or incur debt, or of a grant under this
  section of a priority or a lien, does not affect
  the validity of any debt so incurred, or any
  priority or lien so granted, to an entity that
  extended such credit in good faith, whether or
  not such entity knew of the pendency of the
  appeal, unless such authorization and the
  incurring of such debt, or the granting of such
  priority or lien, were stayed pending appeal.