Lending to an entity already in Chapter 11 bankruptcy and in possession of its assets (i.e., a debtor-in-possession, “DIP”) seems counterintuitive. Where is the benefit in rescuing a “sinking ship”? Certainly, DIP lending is dangerous and not for the faint hearted. A successful bankruptcy, in which secured lenders are made whole, is never guaranteed. On the other hand, DIP lending provides unique opportunities to lenders that only exist in bankruptcy. DIP loans typically have premium interest rates and high yields with a shorter maturity—often a year or less—with the added benefit of Bankruptcy Court oversight and approval. DIP loans should not be overlooked as a profitable, albeit risky, credit tool.
For a pre-petition lender the decision to lend additional funds to a customer that is now a debtor in bankruptcy is a defensive action designed to protect, if not maximize, a recovery on a pre-petition loan. The decision is also an aggressive offensive play for the opportunity to extend new credit on more profitable terms, while potentially controlling the destiny of the debtor and ownership of its assets. For example, it’s an opportunity to make a lucrative loan, one that may even prime—leap frog in priority over—existing secured lenders to their potential detriment.
