DIP Financing: a Review of Best Practices and Recent Developments - Or - the Skinny on Dips1

DIP Financing: A Review of Best Practices and Recent Developments - or - The Skinny on DIPs1

Presented at the 43rd Annual Seminar on Bankruptcy Law and Rules, Atlanta, Georgia March 30 –April 1, 2017

Manuscript:

David L. Eades Glenn Huether Moore & Van Allen, PLLC

Discussion Panel:

Hon. Frank J. Santoro U.S. Bankruptcy Judge Eastern District of Virginia

Corali Lopez-Castro Kozyak Tropin & Throckmorton

David L. Eades Moore & Van Allen PLLC

1 Sorry.

Introduction.

If you actually read this manuscript (and, hey, you got this far), you will notice very quickly that it does not qualify as a particularly scholarly treatment of debtor in possession financing issues. I’ve cited a few cases, but only when I think they touch on an interesting or unresolved issue. On the other hand, I’ve also tried not to insult your intelligence or experience with a manuscript that assumes you’ve never seen a DIP loan before.

If I drafted this with anyone particular in mind, it was the lawyer who has been involved in several DIP lending situations and knows he/she will be again, but who also is capable at times of forgetting some basic points and of missing some recent developments. In other words, I drafted it for lawyers like me. I hope it helps.2

The Statutory Framework.

In the previous millennium, when I was a young lawyer, one old partner at our firm had one constant mantra: Re-read the statute, and re-read the rules - every time. He was didactic, maybe even a little bit batty about it (he said it pretty much every day), but he was right. Knowing exactly what the Bankruptcy Code, the Bankruptcy Rules and the applicable local rules require in connection with any proposed DIP financing package is critical.

Section 364.

Bankruptcy Code Section 364 lays out the roadmap for approval of any DIP facility. I say roadmap, but a better metaphor is probably a ladder. The rungs of the ladder work like this:

2 One thing is for sure, I could not have drafted it without the help of my colleague, Glenn Huether. Thanks, Glenn!

Rung 1. Is the prospective DIP lender willing to provide unsecured

financing with mere garden variety administrative priority? If yes,

(1) wow! and (2) congratulations, you don’t need court approval for

the facility. See § 364(a). If no,3 proceed to Rung 2:

Rung 2. Is the best prospective DIP lender willing to provide unsecured

financing with, and only with, priority over all other claims with 503(b)(1)

or 507(b) priority?4 If yes, simply demonstrate this to the satisfaction of

the court and, if the court also approves of all of the other terms of

the financing package (potentially a big “if”, as we shall see), off you go.

See §§ 364(b) and (c)(1). If no, keep climbing:

Rung 3. Is the prospective DIP lender willing to provide financing with

senior liens on unencumbered property and/or with liens junior to

prepetition liens (with super-priority administrative status almost always

thrown in). If yes, it’s the same “show and go” as above. See

§§ 364(c)(2) and (3). This is the most common priority package in

chapter 11 cases requiring DIP financing, at least when the DIP loan is

coming from a lender who was not a prepetition lender. But it’s not the

last rung of the ladder:

3 Each of the next three successive “rungs” require a showing that sufficient postpetition credit at the previous rung was not, under the debtor’s particular circumstances, practicably available. 4 Except, in most cases, as pertains to avoidance action proceeds. More on this later.

Rung 4. If the debtor can show that it is unable to find financing unless it grants liens that are senior or equal to existing prepetition liens, it may be able to procure court approval of such a loan package. This can be a very tall order, however. Section 346(d)(1)(B) requires that the debtor must show that the interests of the prepetition lender whose liens are impaired by the DIP financing are adequately protected. Priming facilities that achieve this goal usually do it in one three ways:

Consent. In many instances, the prepetition lender will consent to

the priming in exchange for a negotiated set of protections for its

primed security interest. This can often occur in syndicated

credits, where a subset of lenders in the prepetition secured credit

facility provide the DIP financing. Many, if not most, syndicated

credit agreements allow lenders holding a majority (or super-

majority) of the loan commitments to direct the agent who holds

liens for the benefit of all the lenders in the facility to voluntarily

subordinate those liens to another lender or set of lenders.

Equity Cushion. If the prepetition lienholder will not consent to

subordination of its liens in favor of a DIP facility lender, the court

may nonetheless allow a lien priming based on a showing that the

value of the collateral securing the prepetition debt is large enough

to fully secure both the DIP facility and the prepetition secured

loan. Of course, if the court turns out to be wrong about this, the

primed lender usually has only the cold comfort of Section 507(b) to – hopefully – make it whole. For this reason, courts tend to err on the side of caution when asked to find that a prepetition lien is adequately protected by excess collateral value. In part because potential DIP lenders tend to not want to invest the necessary underwriting diligence in loans they may never be allowed to make, full-blown “priming fights” are not particularly common.

Value Preservation. In rare instances, a court may allow a DIP facility to prime an under-secured prepetition lender upon a finding that the facility is likely to achieve a better recovery for the prepetition lender than the lender would realize in an immediate liquidation. The rationale in these instances is that the undersecured creditor whose lien is primed by a DIP loan is adequately protected because the DIP facility means the primed lender’s collateral remains part of a going concern and thereby maintains its fair market value. The problem here, of course, is that the DIP loan may only delay and impair an inevitable liquidation, leaving the prepetition lender with a worse collateral position than it had on the petition date, without so much as an apology note.

Case Example. In Binder & Binder – The National Social

Security Disability Advocates (NY), LLC, et al., the

Bankruptcy Court for the Southern District of New York

approved a priming DIP facility provided by the debtors’ prepetition mezzanine lender. (See Case No. 14-23728,

Bankr. S.D.N.Y. Mar. 20, 2015). Binder & Binder was a company that provided advocacy services to disability claimants across the country. In Binder & Binder, the debtors initially entered into a DIP facility offered by their senior secured lenders. This initial DIP facility contained, among other things, very tight covenants and a requirement to file a liquidating plan within six months of the petition date. It also included the requirement of a first- day rollup (more on these below), which various parties objected to and the court declined to approve. The debtors defaulted under the facility in less than a month.

Against a backdrop of a likely immediate liquidation, the debtors sought alternative financing. Their prepetition mezzanine lender responded and offered an alternative DIP facility on much more favorable terms and conditions for the debtors. As security for the alternative DIP credit facility, the mezzanine lender was granted a priming first lien on all of the estates’ assets (other than chapter 5 causes of action). Part of the proceeds from the alternative DIP

facility was used to repay the senior lenders in full for all

amounts extended under the initial DIP facility.

The mezzanine lender’s priming alternative DIP facility

was approved by the court. The court found that the senior

secured lenders were adequately protected because

the business would continue as a going concern via the

priming DIP facility and that the senior secured lenders

who were pushing for a liquidation would, if successful,

likely have received a much smaller recovery on their

claims.

Practical 364 Considerations.

Demonstration of Need. While Section 364 doesn’t say anything about having to prove an actual need for DIP financing (defaulting, presumably, to the debtor’s business judgment), as a practical matter demonstrating need is often critically important. For one thing, if you are seeking approval of the financing before the final hearing, Rule

4001(c)(2) requires a showing of need (more on this below). For another, the more dire the need for postpetition financing, the greater the ability able to push the envelope in terms of getting the more controversial provisions of a DIP financing package approved.

Keep in mind that “need” can encompass more than just filling a potentially fatal cash flow “hole”. A suitably sized DIP facility can be critical to convincing vendors, customers and employees to continue to engage with the debtor.

Early Preparation. Within the bounds of expense and client willingness to consider “downside” options, it is important to negotiate and prepare DIP financing packages and concomitant filings well before the petition date. Leaving key issues such as DIP facility sizing, pricing and budgeting to be resolved on the eve of filing may imperil the entire reorganization, Section 363 sale or orderly liquidation. While the cases are clear that Section 364 does not require that the search for the best possible financing package be exhaustive, there must be some showing that better options weren’t practically available. Also, unprepared witnesses can be a nightmare. That’s what I’ve heard, anyway.

Bankruptcy Rule 4001(c).

You’ve read the applicable Bankruptcy Code section. Are you done? C’mon, you know you aren’t done. You still need to read the applicable Bankruptcy Rule. In this case, it’s 4001(c). The rule answers the proverbial who, what, when, where and how of getting a DIP facility approved (alas, not in that order though).

How. Rule 4001(c)(1)(A) makes clear that a request to approve

postpetition financing must be made as a motion in accordance with

Rule 9014, which governs contested matters generally. (I never said there

was only one applicable rule.)

What. Rule 4001(c)(1)(B) states exactly what the motion for approval

must contain. The subsection was substantially revised in 2007 to address

the problem of key and potentially objectionable proposed financing terms

and conditions being hidden in endless pages of motion, proposed

approval order and proposed loan documents. The watchwords of

Rule 4001(c)(1)(B) are conciseness and clarity. I decided when I sat down to write this manuscript that I wasn’t going to clutter it up with cut and pasted material (unless I needed to do so to achieve a respectable length – as with my high school term papers). But Rule 4001(c)(1)(B) is not only extremely important, it touches on a large percentage of the other topics I intend to cover. So here it is in toto (that’s Latin):

The motion shall consist of or (if the motion is more than

five pages in length) begin with a concise statement of the relief

requested, not to exceed five pages, that lists or summarizes, and

sets out the location within the relevant documents of, all material

provisions of the proposed credit agreement and form of order,

including interest rate, maturity, events of default, liens, borrowing

limits, and borrowing conditions. If the proposed credit agreement

or form of order includes any of the provisions listed below,

the concise statement shall also: briefly list or summarize each

one; identify its specific location in the proposed agreement and

form of order; and identify any such provision that is proposed to

remain in effect if interim approval is granted, but final relief is

denied, as provided under Rule 4001(c)(2). In addition, the motion

shall describe the nature and extent of each provision listed below:

(i) a grant of priority or a lien on property of the estate

under §364(c) or (d);

(ii) the providing of adequate protection or priority for a claim that arose before the commencement of the case, including the granting of a lien on property of the estate to secure the claim, or the use of property of the estate or credit obtained under §364 to make cash payments on account of the claim;

(iii) a determination of the validity, enforceability, priority, or amount of a claim that arose before the commencement of the case, or of any lien securing the claim;

(iv) a waiver or modification of Code provisions or applicable rules relating to the automatic stay;

(v) a waiver or modification of any entity's authority or right to file a plan, seek an extension of time in which the debtor has the exclusive right to file a plan, request the use of cash collateral under §363(c), or request authority to obtain credit under §364;

(vi) the establishment of deadlines for filing a plan of reorganization, for approval of a disclosure statement, for a hearing on confirmation, or for entry of a confirmation order;

(vii) a waiver or modification of the applicability of nonbankruptcy law relating to the perfection of a lien on property of the estate, or on the foreclosure or other enforcement of the lien;

(viii) a release, waiver, or limitation on any claim or other

cause of action belonging to the estate or the trustee, including any

modification of the statute of limitations or other deadline to

commence an action;

(ix) the indemnification of any entity;

(x) a release, waiver, or limitation of any right under

§506(c); or

(xi) the granting of a lien on any claim or cause of action

arising under §§544, 545, 547, 548, 549, 553(b), 723(a), or

724(a).

Who. Rule 4001(c)(1)(C) sets forth who’s entitled to receive service of the full 4001(c)(2)(B)-compliant motion. Read it. But realize that it’s incomplete, because Rule 9034(f) also requires service of the full motion on the U.S. Trustee. Rule 4001(c)(3) states that parties who are entitled to be served with the DIP financing motion pursuant to Rule 4001(c)(1)(C) are also entitled to notice of hearings on the motion, which makes a lot of sense.

When. Rule 4001(c)(2) states that the final hearing to approve a DIP facility can occur no earlier than 14 days after service. As a practical matter, final hearings usually do not occur that soon. Also as a practical matter, however, the debtor often needs an infusion of debt capital immediately upon filing to stave off collapse. Recognizing this,

Rule 4001(c)(2) allows a court to approve financing on an interim basis

“only to the extent necessary to prevent immediate and irreparable harm to the estate pending a final hearing.” So that’s another thing you’ll need your witnesses to demonstrate.

In many chapter 11 cases, there is more than one interim DIP financing order leading up to a final order. As a general rule, the shorter the notice, the smaller and less aggressively pro-lender the interim facility. Interim

DIP orders often approve limited financing based on a mere term sheet.

Aren’t DIP lenders fearful that these interim orders may be overturned on appeal and that they’ll lose the benefit of the liens and priority they negotiated? Not if they know that they unassailably extended the interim financing in good faith. Section 364(e) protects them even in the event of a reversal of the financing order on appeal. It’s on the debtor’s lawyers to make sure that the bankruptcy court specifically finds — based on actual testimony — that the interim loan is made in good faith. It’s on the lender’s lawyers to make sure that the lender’s obligation to lend the first nickel is conditioned on the approval order containing such a finding.

Where. I overstated things above a bit for literary effect. Section 4001(c) doesn’t actually spell out where the hearing must be. Look at the case caption for clues.

Local Rules. You are of course generally familiar with the applicable bankruptcy

court’s local rules. Otherwise, you would never have signed that affidavit saying

that you were, right? If you are representing a party who is involved in a

proposed DIP credit facility, however, you need to be specifically familiar with

the local rules that address postpetition financing. For example, Rule 4001-2 of

the Southern District of New York’s local bankruptcy rules provides a set of rules

governing proposed DIP financing that robustly augment the requirements of

Bankruptcy Rule 4001(c), particularly Bankruptcy Rule 4001(c)(1)(B) set forth in

full above. Rule 4001-2 of Delaware’s local bankruptcy rules provides similar

augmentation.

The DIP Lender.

There are two fundamental types of DIP lenders: (1) those without a prior lending relationship with the debtor who lend the debtor money for fun and profit and (2) those whose primary motivation for providing postpetition financing is to protect their prepetition exposure.

Free-Standing DIP Facilities. “Free-standing” or “offensive” DIP credit

facilities (i.e., those without a corresponding adequate protection package for

the DIP lender’s prepetition exposure) tend to be provided by nonbank entities

like hedge funds and specialty finance companies. The most important issues that

must be resolved are usually the ones you would expect to see in a non-bankrupt

setting, such as tenor, collateral coverage, covenants and pricing, including in

some cases equity “kickers”.5 As we shall see, however, the application of

the Bankruptcy Code and the oversight of the bankruptcy court mean that

a regime of special bankruptcy provisions make their way into every postpetition

credit agreement.

Protective DIP Facilities. Around 60 percent of all DIP loans are “protective” or

“defensive” loans. Banks that don’t normally seek out distressed lending

opportunities make protective DIP loans all the time. Debtors often will have an

incentive to trade favorable adequate protection terms to a prepetition lender in

exchange for new loans that contain terms that are less onerous and more flexible

than might be offered by a free-standing DIP lender. For its part, a prepetition

secured lender often is eager to offer a fractional amount of new credit on

comparatively favorable terms to the bankrupt enterprise in order to buttress

the lender’s prepetition position and enhance the lender’s overall recovery

prospects. Everybody wins, right?

Well, no. As discussed below, the postpetition liquidity and flexibility purchased

by the DIP with a generous adequate protection package may come not at

the expense of the business enterprise (and its management) but at the expense of

5 The distressed lending market is where most loan-to-own lenders play, and DIP facilities can lead to an exit from chapter 11 in which the DIP lender ends up owning all or part of the enterprise. For example, in In re Magnum Hunter, the oil and gas company converted a $200 million DIP loan to 28.8% of the reorganized company’s equity pursuant to a consensual debt-to-equity exchange. (See In re Magnum Hunter, Case No. 15-12533, Bankr. D. Del. Jan. 11, 2016). Similarly, in In re American Gilsonite, a group of the hydrocarbon resin supplier’s noteholders provided a $30 million DIP loan in exchange for having $270 million in secured 11.5% notes converted into 98% of the new equity of the reorganized company. The court approved the DIP loan, and then later confirmed the pre-packaged plan. (See In re Am. Gilsonite Co., et al., Case No. 16-12316, Bankr. D. Del. Nov. 22, 2016 (DIP loan approval); Dec. 12, 2016 (plan confirmation)).

its unsecured prepetition creditors. That, of course, is why we have to have a

hearing.

Regulatory Concerns. One thing to keep in mind if you are representing

a bank making a protective DIP loan: Your client is making a new loan,

not just extending, expanding or restating the prepetition credit. This

means that it likely will face the same regulatory headaches that lenders to

non-bankrupt borrowers do (think flood certification requirements, “know

your customer” regulations, the Patriot Act, etc., etc.).6

DIP Loan Terms and Conditions.

As noted above, any DIP loan is going to present most of the same issues that arise in non-bankrupt lending.7 There also will be, however, many terms and conditions that are exclusively (or in some cases almost exclusively) found in DIP financing.

Special Chapter 11 Provisions. Certain issues arise in virtually every DIP credit

facility, regardless of whether the facility is a free-standing or a protective one.

Milestones. DIP lenders almost never offer a maturity date for their loans

that is shorter than 20 months from the petition date, which represents

the longest period that Section 1121(d) will allow the DIP to maintain

exclusive control over the plan process. Within the stated tenor of the

loan, however, DIP lenders may require certain case milestones, such as

6 The BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM, FEDERAL DEPOSIT AGENCY & OFFICE OF THE COMPTROLLER OF THE CURRENCY, INTERAGENCY GUIDANCE ON LEVERAGED LENDING (2013) helpfully provides that its regulations are not designed “to discourage providing financing to borrowers involved in workout negotiations, or as part of pre-packaged financing under the bankruptcy code”, but doesn’t offer the DIP lender any actual relief from those regulations. 7 One plus to DIP lending, though: Thanks to the Supremacy Clause, the court can grant the DIP lender automatic universal perfection of its security interests without the need to file UCCs and mortgages, which is nice. Best practices require filing these at some point anyway, however, just to stave of potential confusion.

the filing of a disclosure statement or a Section 363 sale motion, that are

designed to ensure a timely exit from the proceeding and repayment of

the DIP loan. Failure to timely meet an agreed milestone typically will

constitute an event of default under the DIP loan.

Control Caveat. Beware of situations when the DIP lender presses

for provisions that are designed less to ensure repayment of

the DIP loan and more to ensure a particular plan or Section 363

sale outcome. (Note that these provisions are not always expressed

as milestones. They can take the form of specific outcome-driven

budgets and financial covenants.) With the advent of loan-to-own

lenders, “control” provisions are not limited to protective DIP

loans. Control provisions are not verboten, but they justify

heightened scrutiny by the debtor, the unsecured creditors’

committee, the U.S. Trustee and the court. Some of them are

aggressive indeed.8

Bankruptcy-Related Events of Default. In addition to the standard set

of defaults delineated in any note or loan agreement, DIP loans usually

will include as events of default several occurrences that are unique to

8 For example, in In re Landsource Communities Dev., LLC, the court approved a DIP loan, which contained a requirement that, upon pain of default, the debtors file an application to retain a chief restructuring officer upon minimum terms acceptable to the DIP lenders. The DIP lenders also were permitted to require that the debtors file a plan and disclosure statement acceptable to the DIP lenders within 120 days of the petition date and that the plan be confirmed within 90 days after it was filed. Another control provision required that any change in the executive management of the debtors, including the termination or resignation of the CRO, occur only with the prior written consent of the DIP lenders. See In re Landsource Communities Dev. LLC, Case No. 08-11111 (Bankr. D. Del. July 21, 2008).

bankruptcy cases. Several of these are anticipated in the specific disclosures required by LR 4001-2(a)(10) of the Southern District of New

York’s local bankruptcy rules:

(i) the filing of a challenge to the lender's pre-petition lien or

the lender's pre-petition claim based on the lender's pre-petition

conduct; (ii) entry of an order granting relief from the automatic

stay other than an order granting relief from the stay with respect

to material assets; (iii) the grant of a change of venue with respect

to the case or any adversary proceeding; (iv) management changes

or the departure, from the debtor, of any identified employees;

(v) the expiration of a specified time for filing a plan; or

(vi) the making of a motion by a party in interest seeking any relief

(as distinct from an order granting such relief);

This is not an exhaustive list, of course. Bankruptcy-related events of default are limited only by the DIP lender’s imagination and goals, the competing interests of other interested parties and the obligingness of the court.

Post-Default Exercise of Remedies. A DIP lender will want not only the immediate right to stop lending upon the occurrence of an event of default, it will want the ability to realize upon its collateral without having

to appear before the bankruptcy court for permission. It generally won’t get the latter, but it usually will get the right to appear before the court on an expedited basis to address the issue. The rub is what is at issue at the hearing. The debtor and other interested parties will want more than the right to refute the allegation that an event of default has occurred.

They also will want the ability to argue that an exercise of remedies by the DIP Lender is not appropriate notwithstanding the default. As DIP lender counsel, I try to hold the line here and assert that allowing potential

“changed circumstances” and “the lender is still protected” defenses to the

DIP lender’s post-default exercise of remedies amount to unfair “do- overs”. (I honed my arguments here playing a lot of tag and whiffle ball growing up.)

Avoidance Actions Carve-Outs. If you are a lawyer representing a DIP lender, you probably need to manage your client’s expectations here.

Usually, U.S. Trustees and unsecured creditors’ committees will strenuously object to the DIP lender getting liens on, or super-priority administrative status in connection with, chapter 5 avoidance actions. And they will win. Why? Don’t ask me. It’s tradition. Usually, the best you can hope for is maintaining basic administrative claim status in connection with chapter 5 action recoveries (which you get under Section 364(a) automatically anyway).

The carve-out of avoidance actions applies a fortiori (again with the Latin) to adequate protection packages in protective DIP loans to the extent that the packages would otherwise grant potential replacement liens on the actions to secure prepetition claims. And if the secured creditor wants all the other benefits of its adequate protection package, it usually will have to disclaim at the outset any potential 507(b) priority the extent that priority would apply to chapter 5 actions and their proceeds.

Section 549 Carve-Out to the Carve-Out. There’s one exception to

the chapter 5 carve-out from the DIP lender’s liens that I believe

the DIP lender should strive to keep as part of the deal:

Section 549 actions — at least to the extent that they concern

the recovery of what was, before the avoided transfer, the DIP

lender’s collateral.

Fee Carve-Outs. Lawyers and other professionals don’t like to work for free. Virtually every DIP loan will subordinate its liens and other forms of senior interests in certain funds so that these funds will first be available to pay case professionals (along with the clerk of court and U.S. Trustee) whose charges, by themselves, are entitled only to garden variety 503(b) status. It’s a simple and reasonable cost of doing business for the DIP lender. In a typical chapter 11 case, professionals are paid (irretrievably) with DIP loan and collateral proceeds as their fees are budgeted and

allowed by the court unless and until the DIP lender sends a post-default

“trigger” notice. The DIP lender’s lien and interest subordination with

regard to professional fees for work performed after a trigger notice is sent

is subject to a hard amount cap.

Adequate Protection Provisions in Protective Facilities.

Transformation of Prepetition Status. The most aggressive DIP

packages do more than provide generous adequate protection. They

transform prepetition claims secured by prepetition estate property into

claims with DIP loan status (or near DIP loan status).

Cross-Collateralization. A “cross-collateralized” DIP loan is one

in which the DIP lender’s prepetition loan via the DIP loan

approval order becomes secured by the estate’s postpetition assets

and previously unencumbered prepetition property right behind the

DIP loan. Because this sort of claim bootstrapping does violence

to the Bankruptcy Code’s priority scheme (to say nothing of

Section 552(a)), it is generally disfavored. In fact, the Eleventh

Circuit has prohibited it altogether. 9 Other jurisdictions may

grudgingly allow cross-collateralization after a full and final

hearing, provided that the debtor can establish that (1) absent

the proposed financing, the enterprise will not survive, (2) no

viable free-standing DIP lender financing is available,

9 See In re Saybrook Mfg. Co., Inc., 963 F. 2d 1490 (11th Cir. 1992).

(3) the prepetition lender really, really means it when it says it will

not provide postpetition financing on less favorable terms and

(4) the proposed financing package is, on balance, better for

the general unsecured creditors than a liquidation.10

Rollups. A rollup occurs when a new DIP financing facility

completely takes out the prepetition facility. If the new DIP

facility is provided by the prepetition lender, a rollup is like a

cross-collateralized DIP loan, except even more egregiously lender

favorable. The old loan now has the DIP loan’s full collateral

package and its super-priority administrative status, which means

it has to be paid in full at exit. It can’t be crammed down or

crammed up. To me, full rollups make sense only when

the prepetition secured loan is so small and so clearly over-secured

that it’s not worth the hassle of dealing with the administrative

entanglements the loan would otherwise have with the DIP loan.11

Rollovers. “Rollover” is a confusing term, because it refers to two

different situations, one controversial and the other far less so:

10 In re Vanguard Diversified, Inc., 31 B.R. 364 (Bankr. E.D.N.Y. 1983). 11 Tellingly, S.D.N.Y. Bankr. L.R. 4001-2(k)(3) requires the following “regurgitation” provision to be included in any proposed order approving a cross-collateralized DIP loan or rollup facility:

A proposed order approving cross-collateralization or a rollup shall include language that reserves the right of the Court to unwind, after notice and hearing, the post-petition protection provided to the pre-petition lender or the pay down of the pre-petition debt, whichever is applicable, in the event that there is a timely and successful challenge to the validity, enforceability, extent, perfection, or priority of the pre-petition lender's claims or liens, or a determination that the pre-petition debt was undersecured as of the petition date, and the cross-collateralization or rollup unduly advantaged the lender.

Slow Motion Rollups. The first type of rollover is a rollup that happens over time, rather than all at once. The rollover usually occurs through principal reduction payments made with DIP loan or postpetition property proceeds. This type of rollover is a little less aggressive than the one-time rollup because it can be terminated before completed if the

DIP lender elects (or is compelled) to stop lending after an event of default.

True Rollovers. The second type of rollover does not involve the direct use of DIP loan or postpetition property proceeds to pay prepetition debt. Instead, the DIP loan is used to keep the enterprise alive while the collected proceeds of prepetition collateral (and only prepetition collateral) are used to pay prepetition secured claims. Of course, this works well only in those situations where prepetition and postpetition collateral are and can remain separately identifiable, as with real property, accounts receivable and (in some cases) inventory. When the collateral for the prepetition loan is a general intangible, such as enterprise value, true rollovers usually aren’t workable.

Budgets. DIP lenders often will insist that the debtor adhere to an agreed upon series of expenditure budgets during the pendency of the bankruptcy case. Expenditure budgets are particularly common in protective DIP facilities, where they represent part of the adequate protection package offered in exchange for the use of the lender’s cash collateral for its prepetition claim. DIP financing orders typically require the debtor to regularly submit proposed budgets for approval by the lender (with service to certain other parties, such as the unsecured creditors’ committee), with the bankruptcy court standing available to resolve any inability of the parties to agree on the proposed expenditures. DIP loan budgets typically allow for line item and total period percentage variances, as well as some ability to carry unspent budgeted expenditures forward.

Claim Allowance, Lien Avoidance and Release Provisions. Protective

DIP lenders want to make certain as soon as possible that they have a prepetition secured claim to protect. For this reason, they almost always will request that the debtor immediately agree (1) not to object to the DIP lender’s prepetition claim, (2) not to challenge its prepetition liens and

(3) release it from any liability for prepetition conduct. More significantly, the DIP lender will insist that the time allowed for other interested parties to advance the claims and challenges abandoned by the debtor be severely truncated. In a typical protective DIP loan approval order, the time for any interested party to commence a challenge of

the DIP lender’s prepetition claims, liens and conduct is limited to 45 –

120 days (those aren’t the outside limits on either side by the way; they’re just typical in my humbly correct opinion) after entry of the final DIP loan approval order or the appointment of the unsecured creditors’ committee.

The order usually will include a provision allowing for an extension of the challenge period by an agreement of the parties. The DIP lender may also seek to limit the amount of DIP loan proceeds or carve-out funds that may be used to investigate its prepetition claims, liens and conduct. When it comes to actually suing the DIP lender, the lender often will insist that such funds be limited to $0. Finally, the DIP lender frequently will ask that the order relieve it of the hassle of filing a timely proof of its prepetition claim.

Cash payments. As part of an adequate protection package, a DIP lender may insist that, as a prepetition lender, it receive periodic cash payments measured by, and applied to, postpetition accrued interest as a means of preserving its secured status as of the petition date. Of course, this may work fine if the prepetition lender is over-secured on the petition date. But what if later the court determines that the prepetition loan was undersecured or, gulp, not secured at all? Because of this possibility, DIP loan approval/adequate protection orders usually will hold that any adequate protection payment of interest made in respect of a prepetition claim be subject to re-characterization as a payment of principal or to refund to the estate altogether.

Replacement Liens. Obviously, every prepetition secured lender should

insist on replacement liens on as much estate property as may be available

(other than the sacred chapter 5 actions, of course) to the extent of any

diminution of its secured status during the pendency of the case. So of

course you will insist on them if you are providing the DIP credit facility.

Section 506(c) Waivers. A requirement that the debtor relinquish

the right to surcharge collateral both for the DIP loan and the prepetition

claim for preservation or disposal expenses is common to most DIP loan

packages. One frequently offered justification is that the professional fee

carve-out discussed above provides a sort of “I gave at the office” excuse

for not having to worry about Section 506(c).

Impact of Prepetition Intercreditor and Subordination Agreements.

Section 510(a) states that “a subordination agreement is enforceable in a case under this title to the same extent that such agreement is enforceable under applicable non-bankruptcy law.” Seems clear enough, right? Ah, but lenders’ lawyers are creative, and they will cram a lot of interesting stuff in a document called an “Intercreditor and

Lien Subordination Agreement”. They will then show up in bankruptcy court, point to

Section 510(a) and argue that every sentence in the agreement is fully enforceable.

This can have ramifications at virtually every juncture of the case, including at the

DIP loan approval stage. For example, a typical intercreditor agreement may call for the junior creditor to agree to not (1) object to the terms and conditions of any DIP credit facility that is offered or consented to by the senior creditor, (2) offer a DIP credit facility

itself without the senior creditor’s permission or (3) seek to impede the senior creditors efforts to exercise remedies after a postpetition default.

Are these and similar chapter 11 specific provisions in intercreditor agreements fully enforceable? Most of them probably are, but right now it’s difficult to say for sure.

There are only a handful of reported cases that address these issues.

New World Pasta. One such case is In re New World Pasta Acquisition Corp.,

Case No. 04-02817, 2004 Bankr. LEXIS 2639 (Bankr. M.D. Pa. July 9, 2004). In

New World Pasta, junior lenders objected to the motion requesting approval of

senior lenders’ DIP financing, in part because the proposed orders contained

“offending” language that “potentially deprives the pre-petition junior lenders of

fundamental bankruptcy rights and protections that cannot be traded away in pre-

petition agreements to the extent that [such agreements] purport to do so.” (In

this case, the intercreditor agreement contained a waiver of the junior lender’s

rights to adequate protection and to vote on a plan). The junior lenders filed

the objection “out of an abundance of caution to ensure that future

disputes…regarding the enforceability of certain provisions…are not adjudicated

summarily by the inclusion of certain language in a Final DIP Order.” It is

important to note that the junior lenders acknowledged that subordination

agreements are enforceable under Section 510(a) insofar as they provide for debt

subordination, turnover of funds received by junior lenders and similar provisions

relating to the priority of liens.

The court approved the DIP loan facility — and approved the subordination of

payment of the junior lenders — but the approval order did not include

the “offending” language, replacing it with a reservation of rights.

Conclusion.

What is this, a sermon? A state of the union address? Where does it say that I have to have some pithy conclusion about DIP lending? Anyway, I got nuthin’. If you’ve read this far, though, I’m impressed. And you have my heartfelt thanks.