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DIP financing can be used to keep a business running until it can be sold as a current business[4], if it should provide creditors with a higher return than closing the business and liquidating assets. It can also give a new start to a company in difficulty, but under strict conditions. In this case, “debtors in possession” refer to debts incurred during bankruptcy and “exit-financing” is a debt that occurs after the termination of the reorganization under bankruptcy law. [5] If the bankruptcy court accepts a DIP loan and finds that it was granted in good faith, the loan will not be subject to compensatory measures. This is different from the same loan that was granted outside of bankruptcy and could have been subject to compensatory measures. Many lenders see debtor financing as a mandatory credit option, as insolvency loans are particularly taken into account by U.S. bankruptcy legislation. By law, DIP creditors must receive payment before other creditors. Many lenders will commit to a Chapter 11 DIP loan, whereas in the absence of an insolvency application, they would not make a credit commitment for the same company. The macro-economic effects of coronavirus (COVID-19) on almost all sectors of the industry are forcing companies directly and indirectly affected by the global pandemic to consider restructuring alternatives. Given that potential businesses wishing to restructure or liquidate as part of the Chapter 11 process are likely to require immediate money to operate, these businesses will often turn to existing or third-party lenders (and, in some cases, stalking horse suppliers or client groups) to provide debt financing (DIP). As a result, lenders facing troubled borrowers could try to protect their existing credit positions and collateral by providing DIP financing, while new lenders may find that the returns and protection granted to DIP lenders offer an attractive opportunity to extend the credit. Given a wave of bankruptcies expected in the wake of the current crisis, affected businesses and lenders could benefit from a brief overview of DIP financing.

Companies can also use factoring as a financial instrument for funding the DIP. Factoring is a possibility that many small entrepreneurs do not recognize. Debt financing can be one of the most flexible ways to obtain financing and recapitalization during chapter 11 bankruptcy proceedings. Factoring can be a win-win situation for both the loan and factoring business. The borrower receives the necessary financing, which is not based on its credit status, and the factoring company obtains priority status under the Bankruptcy Act. A debtor, who needs the financing of Chapter 11, whether it is a new loan, the use of “cash guarantees” (which require a firm agreement from the creditor and/or authorization from the bankruptcy court) [2] or a combination of the two must provide an existing secured creditor with “appropriate protection” to protect those creditors from the erosion of the value of its security resulting from a basic credit or the use of the cash guarantee by a debtor. Although the Bankruptcy Act does not define adequate protection, Section 361 (e) of the Bankruptcy Act provides for three non-exclusive means of providing adequate protection: (i) cash payment or periodic cash payments to the extent that the value of guarantees is reduced; (ii) additional or replacement sponsorship to the extent that the value of the security is reduced; or (iii) any other discharge that leads the secured creditor to receive the “unreducable equivalent” of its shares in the guarantees.