Quick Answer
Debtor-in-possession (DIP) financing is post-petition credit extended to a Chapter 11 debtor under court approval. The Bankruptcy Code provides four authorization tiers, ranging from ordinary-course unsecured credit (no court approval) up to priming-lien financing senior to existing secured creditors (notice, hearing, inability to obtain credit otherwise, and adequate protection for the primed lender). Most DIP facilities are negotiated with the consent of the pre-petition senior secured lender, who often becomes the DIP lender to protect its position.
DIP financing is the bridge that lets a debtor keep operating during a Chapter 11 case. The exam tests the four authorization tiers, what "adequate protection" means for a primed lender, and the loan features that distinguish DIP credit from ordinary commercial lending.
The Four Post-Petition Credit Tiers
| Tier | Type | Authorization Required |
|---|---|---|
| Tier 1 | Unsecured credit, ordinary course | No court approval required |
| Tier 2 | Unsecured credit, outside ordinary course | Notice and hearing |
| Tier 3 | Credit with administrative-expense super-priority, junior liens, or liens on unencumbered assets | Notice and hearing; must show inability to obtain credit under Tiers 1 or 2 |
| Tier 4 | Credit with a priming lien senior to existing secured creditors | Notice and hearing; must show (i) inability to obtain credit otherwise AND (ii) adequate protection for the primed lender |
Most real-world DIP facilities involve Tier 3 or Tier 4. The court order approving the DIP describes the priority structure and any liens the DIP lender will receive.
Exam Tip: Gotchas
- Tier 4 priming-lien financing CAN BE senior to pre-petition secured lenders, but only if the court finds adequate protection for the primed lender AND the debtor could not obtain credit on less burdensome terms.
- Most DIP facilities are consensual. The pre-petition secured lender usually agrees (or actually IS the DIP lender) to protect its existing position; contested priming is the exception.
Common DIP Loan Features
DIP loans typically include several features that distinguish them from ordinary commercial credit:
- Super-priority administrative claim: paid before all other administrative claims (professional fees, ordinary post-petition trade)
- Liens on unencumbered assets and/or junior liens on encumbered assets: maximize collateral coverage for the new money
- Priming liens (with consent of the pre-petition secured lender in most cases, or by court order over objection in contested cases)
- Tight financial covenants and budget compliance requirements: the DIP budget controls cash use week by week
- Roll-up of the pre-petition revolver into the DIP facility: the pre-petition lender's existing exposure gets re-papered as DIP debt and obtains super-priority status
- Milestones: sale-process deadlines, plan-confirmation deadlines, or other gates the debtor must hit on a defined timeline
The combination of super-priority status, broad collateral, tight covenants, and milestones gives the DIP lender enormous control over the case.
Exam Tip: Gotchas
- A "roll-up" converts pre-petition debt into DIP debt. The pre-petition senior secured lender's existing exposure gets relabeled and gains super-priority status. Roll-ups are heavily contested by unsecured creditors because they reduce the pool of recoveries.
- The DIP budget controls cash use. A debtor that drifts from the approved DIP budget can lose access to further DIP draws and may face acceleration; the DIP budget is a hard operational constraint, not a soft forecast.
Adequate Protection
When a pre-petition secured creditor's collateral is used, sold, or primed, the Bankruptcy Code requires the debtor to provide adequate protection to compensate for any diminution in value:
- The concept protects existing secured creditors when their collateral position is impaired by the case
- Forms of adequate protection: periodic cash payments, replacement liens on other property, or an "indubitable equivalent" of the secured interest
- Failure to provide adequate protection is grounds for relief from the automatic stay
Adequate protection is the doctrine that lets a Chapter 11 case proceed without immediately wiping out pre-petition secured creditors. It is also the negotiating space where most DIP financing deals get done.
Exam Tip: Gotchas
- Adequate protection compensates for DIMINUTION in value, not for the secured creditor's full claim. If the collateral is not depreciating, no adequate protection payment may be required at all.
- Failure of adequate protection is grounds for stay relief. The pre-petition secured lender can move to lift the stay and foreclose if adequate protection fails; this is the leverage that disciplines debtors and DIP lenders.
How a DIP Order Typically Gets Approved
The standard DIP-financing approval sequence:
- Day-one motions: at filing, the debtor moves for interim DIP approval and authority to use cash collateral
- Interim order: court typically approves an interim DIP order at a first-day hearing, providing some draws and basic protections
- Final hearing: scheduled 21-30 days after filing for the final DIP order, with notice to creditors and the UCC
- Final DIP order: court enters a comprehensive final order setting priority, liens, milestones, and remedies
The interim order keeps the company funded while the UCC and other creditors review the terms; the final order locks in the structure for the rest of the case.
Exam Tip: Gotchas
- The interim DIP order is signed within the first 24-48 hours of the case. Operating businesses cannot wait three weeks for a final order before funding payroll; the Bankruptcy Code permits emergency interim relief.
- The UCC negotiates against the final DIP order. The interim order locks in some basics, but the final order is where the UCC pushes back on roll-ups, milestones, and lender protections.