Chapter 2: Trends in DIP Financing in the Aftermath of the Credit Crisis of 2008–2009

by Abhilash M. Raval, Tyson Lomazow, Samuel A. Khalil & Brian Kinney

Milbank, Tweed, Hadley & McCloy LLP, New York

Chapter 2 examines the effects of the turmoil in the credit and stock markets from 2008-2009 upon debtor in possession financing ("DIP Financing"). Prior to this period, companies entering chapter 11 enjoyed virtually unfettered access to additional liquidity from lenders willing to extend postpetition credit to debtors to facilitate their reorganization efforts. As a growing number of corporate failures and mortgage and credit defaults began wreaking havoc on the global economy, however, credit markets rapidly contracted. By the time the economic downturn reached its nadir in late 2008, credit markets were essentially frozen. As a result, traditional sources of third-party DIP Financing were unwilling-and, in many instances unable-to extend new credit. Distressed companies during this "credit crisis" were compelled to invoke innovative strategies to secure sufficient financing to salvage their businesses and preserve any chance of a successful reorganization. This chapter examines the evolution of DIP Financing during an economic pandemic of historic proportion that witnessed the failure of industry giants such as Lehman Brothers and precipitated the chapter 11 filings of General Motors and Chrysler. Finally, this chapter identifies developing trends in DIP Financing structures and explores their practical implications as credit markets thaw and distressed companies enjoy renewed access to capital.

This chapter begins with a brief discussion of the statutory predicates for a debtor's ability to obtain postpetition financing (¶ 2.02). The following section explores the macro-trends in the DIP Financing market during the 2008-2009 credit crisis, and examines the impetus for the marked shift in the balance of power among chapter 11 debtors and postpetition lenders (¶ 2.03). This section examines the terms and conditions that were necessary to induce lenders to extend postpetition credit-and protect such investment-under these circumstances.

Section four of the chapter (¶ 2.04) identifies changes in the sources of DIP Financing during the credit crisis and examines corresponding changes in the structure of DIP facilities. As traditional sources of third-party DIP Financing were unwilling to extend credit during this period, distressed companies turned to their prepetition secured lenders as primary sources of emergency capital. In order to induce prepetition secured lenders to extend further credit, several chapter 11 debtors offered to "roll-up" prepetition indebtedness and provide additional benefits to lenders willing to "backstop" their funding requirements.

Section five of the chapter (¶ 2.05) examines DIP lenders' expanding roles in recent chapter 11 cases. As an incentive for lenders to extend credit during the credit crisis, many debtors agreed to provisions in DIP credit agreements enabling DIP lenders to exert increased control over debtors' affairs while in chapter 11. These types of provisions were attractive to prepetition lenders willing to invest new money and convert existing debt claims into a controlling stake in the reorganized debtor.

Finally, section six (¶ 2.06) explores significant changes to customary terms and conditions of DIP credit agreements during the credit crisis. The replacement of mezzanine financing with second lien indebtedness, the return of leveraged buy-out ("LBO") transactions, and the prominent use of "covenant-lite" financings earlier in the decade left many distressed companies with few options when the credit markets froze in late 2008. As a result, bankruptcy courts were presented with DIP Financing proposals reflecting lenders' significant bargaining power over cash-starved debtors with no other alternative to liquidation. This section examines the terms and conditions necessary to induce lenders to extend postpetition credit-and protect their investment-under these circumstances. This section also focuses on unique challenges that confronted DIP lenders during this period, innovative solutions crafted in response thereto, and the implications for DIP lenders in future chapter 11 cases.

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Collier Guide to Chapter 11 authors will be participating in a free CLE accredited webinar on Oct. 19, beginning at 2 pm ET. During the webinar, you will hear highlights from the new publication that will cover topics including issues affecting reorganizations for the retail industry, treatment of hospitals and health care businesses in Chapter 11 and Debtor-in-Possession (DIP) financing in the aftermath of the credit crisis.

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