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Is it Safe to Sell to a DIP Customer With Approved Financing?
by Wanda Borges, Borges & Associates
If one is to be a total skeptic, then the answer is that it is never safe to sell to a DIP customer except on a "cash in advance" or "cash on delivery" basis. However, there are often many reasons why selling to a debtor-in-possession makes sense. The real question to be addressed, therefore, is "What are the risks of selling to a DIP customer, and does approved financing minimize those risks?
Immediately upon the filing of a chapter 11 petition, the debtor will file many "First Day Motions". These motions include applications to retain counsel and accountants, applications to continue the use of existing bank accounts, and most importantly, applications to use cash collateral or to obtain DIP financing. There is a difference between a debtor who gets permission of the court to use cash collateral and a debtor who obtains DIP financing. Sometimes the debtor using cash collateral is actually in the better financial position.
Use of cash collateral means that the debtor has sufficient equity built into its inventory or accounts' receivable that it does not need to borrow any fresh cash but can use what it has in its own business to continue to run its business at least in the short term. On the flip side however, it can mean that the debtor has a totally uncooperative financer and the only way the debtor can operate is by using its own assets turned into cash.
DIP financing means that the debtor has a bank or other source of financing who is willing to lend the debtor the funds necessary to operate its business. The keys to understanding whether or not the DIP financing provides a safe haven for creditors include: 1) how much money does the debtor have to pay in order to obtain the DIP financing and what continuing fees are locked in place?; 2) what is the Budget which is presented to the court when the debtor seeks approval of the DIP financing, does this Budget provide enough money for the debtor to buy the products and/or services which it requires?; 3) is the debtor going to use any of the DIP financing to pay pre-petition "essential" vendors to the detriment of the post-petition vendors, or is the debtor going to buy its goods only from its "essential" vendors and ignore other vendors?; is there going to be a "carve out" specifically for post-petition trade creditors so that those creditors know there is money there to pay them?
In inverse order, if there is a "post-petition trade-creditor carve-out", then it is still incumbent on the creditor selling to the debtor-in-possession to be sure there is enough money to pay for that creditors goods. If the debtor intends to pay its "essential vendors" from the DIP financing, the creditor needs to find out how much money there is left for post-petition creditors. Is the Budget clear enough to make the trade creditors understand what the DIP financing is being used for or should a trade creditor object to the Budget when it is originally filed in court. Understand that the DIP lender will insist that the debtor adhere to the Budget so there is little flexibility in spending.
Finally, a creditor must watch the DIP financing to see if the debtor is being so choked with ongoing fees that it won't ultimately survive even with DIP financing.
Certainly, it is safer to sell to a debtor-in-possession which obtains DIP financing than to a debtor who has no financing, but as stated above, there are several pitfalls of which to be aware. The best rule of thumb is for a creditor to determine what amount it is willing to gamble and then to monitor the debtor very carefully not just in its initial phases of its chapter 11 but throughout the continuing relationship.
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