Bankruptcy Financing in 2025: Costs, Benefits, and How It Works

Julia Kagan is a financial and consumer journalist with extensive experience in personal finance editorial work at Investopedia.

Understanding Bankruptcy Financing in 2024

Bankruptcy financing, also known as debtor-in-possession (DIP) financing, is a specialized loan or credit line extended to companies undergoing Chapter 11 bankruptcy reorganization. This financial support enables companies to continue their daily operations and avoid shutdown while they restructure their debts.

Key Insights

• Bankruptcy financing provides crucial funding for businesses navigating Chapter 11 bankruptcy.
• It allows companies to maintain operations instead of ceasing them entirely.
• Lenders offering bankruptcy financing receive priority repayment over other creditors, reducing their lending risk.
• The financing amount is typically larger than anticipated needs to cover unforeseen expenses during bankruptcy.

How Does Bankruptcy Financing Operate?

It may seem counterintuitive that a company in bankruptcy can secure new loans, given its existing debt challenges. However, bankruptcy financing is a common and essential element of the Chapter 11 process. Chapter 11 bankruptcy focuses on reorganizing debts rather than liquidating assets, allowing the company to retain ownership and continue operations under court supervision.

To facilitate this, companies can borrow additional funds through bankruptcy financing. Courts often prioritize repayment to these lenders by granting them senior claims, such as first liens on accounts receivable and second liens on real estate or machinery, ensuring their loans are repaid before other creditors.

Typically, companies arrange for bankruptcy financing before publicly filing for Chapter 11, securing a loan or credit line that exceeds expected needs to handle any unexpected developments. Existing lenders may participate in this financing to support the company’s turnaround and protect their investments, although they can also object if they hold secured interests that might be impacted.

Illustrative Example of Bankruptcy Financing

Consider the Tallahassee Widget Company, which issued $1 million in unsecured bonds at 6% interest and a $2 million secured bank loan at 4%. After a competitor introduced a superior, cheaper product, Tallahassee’s sales dropped sharply, forcing it to file for Chapter 11 bankruptcy.

The company secured bankruptcy financing at 10% interest to refurbish its factory and compete effectively. The bankruptcy court delayed payments to existing creditors, allowing Tallahassee to reorganize and strive toward profitability.

Chapter 11 Bankruptcy Explained

Chapter 11 bankruptcy involves reorganizing a debtor’s assets and liabilities, primarily used by businesses. It allows companies to maintain control and avoid asset liquidation while restructuring their debts under court oversight.

Who Is the Debtor in Possession?

The debtor in possession is the entity filing for Chapter 11, retaining control of its assets during the bankruptcy process instead of turning them over to a trustee.

Debt Repayment Priorities in Bankruptcy

During bankruptcy, debts are repaid based on a hierarchy: preferred creditors first, followed by secured creditors, and finally unsecured creditors.

Why Do Banks Provide Bankruptcy Financing?

Lenders provide bankruptcy financing because it offers them priority repayment and a chance to recover their investments if the company successfully reorganizes or is sold post-bankruptcy.

Conclusion

Bankruptcy financing is a vital financial tool in 2024, allowing companies in Chapter 11 bankruptcy to fund operations and restructure effectively. By offering priority repayment, lenders mitigate risks and support businesses aiming for a successful turnaround or sale.

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