Debtor-In-Possession (DIP) Financing Rules

DIP Financing is the lifeline that allows a bankrupt company to keep operating while restructuring - fresh money injected during insolvency with super-priority.

US calls it DIP under Section 364 Bankruptcy Code, India calls it Interim Finance under Sec 5(15), 20, 28 IBC - same economics, different priority rules.

1. US - Section 364 - Tiered Approach

Statute: 11 U.S.C. § 364 provides bankruptcy courts with power to authorize post-petition financing for Chapter 11 debtor-in-possession.

Tiered structure - debtor must try lower tier before higher:

Tier 1 - § 364(a) - Ordinary Course Unsecured:
If in ordinary course of business, debtor can obtain unsecured credit as administrative expense under §503(b)(1) without court approval.

Tier 2 - § 364(b) - Outside Ordinary Course Unsecured:
Outside ordinary course, after notice and hearing, court may authorize unsecured credit as administrative expense.

Tier 3 - § 364(c) - Super-Priority / Secured - When Unsecured Not Available:
If debtor is unable to obtain unsecured credit allowable as administrative expense, then court after notice and hearing may authorize:

• (c)(1) - Superpriority administrative expense - priority over any and all administrative expenses of kind specified in §503(b)
• (c)(2) - Lien on unencumbered property - secured by property not otherwise subject to lien
• (c)(3) - Junior lien on encumbered property - junior to existing lien

Tier 4 - § 364(d) - Priming Lien - Most Controversial - Senior or Equal Lien on Encumbered Property:
If unable to obtain credit under (c), court may authorize debt secured by senior or equal lien on property already subject to lien - called priming. Requires:

1. Debtor unable to obtain credit otherwise
2. Adequate protection to existing lienholder whose lien is primed

Three-Part Test Courts Apply - In re Pro Set, Defender Drug Stores, Vineyard Bay:

Courts articulate three-part test to determine whether debtor may obtain §364(c) financing:

1. Unavailability: Debtor attempted but unable to obtain unsecured credit as administrative expense - need evidence two national banks refused to grant unsecured
2. Business Judgment: Financing is necessary to preserve estate, in best interest of estate, and terms are fair, reasonable, adequate
3. Good Faith: Negotiated at arms-length, no insider advantage, no cross-collateralization of pre-petition debt unless justified

Case law: In Matter of Vineyard Bay Develop. Co., 132 F.3d 269, 272 (5th Cir. 1998), In re Pro Set, Inc., 193 B.R. 812 (Bankr. N.D. Tex. 1996), In re Defender Drug Stores, 126 B.R. 76 (Bankr. D. Ariz. 1991) - court’s prior order authorized debtor to incur post-petition indebtedness under section 364.

Protections for Lender:

• Superpriority claim under 364(c)(1) having priority in right of payment over any and all other obligations, subject to Carve-Out for professional fees
• First position security interests, liens and security interests in essentially all assets including but not limited to all assets of debtor
• Automatic stay does not apply to enforcement of DIP liens post-default with court permission
• Roll-up Prohibition: Courts generally disallow roll-up where pre-petition debt is rolled into post-petition DIP to gain priority - must be justified

Case Law:

a) In re Fairpoint Communications - DIP Approval Standards
Court filed DIP Credit Agreement evidencing DIP Facility on petition date. Held Section 364 provides tiered approach first allowing unsecured credit to be incurred in ordinary course as administrative expense under subsection (b). If debtor cannot obtain, then superpriority. Debtor must satisfy burden of showing unavailability of alternative unsecured financing.

b) In re RTC - Banco Panamericano - Jones Day Lesson in DIP Due Diligence
After conversion to Chapter 11, court authorized RTC to obtain DIP financing from Banco Panamericano. Order provided claims would have superpriority administrative expense priority under 364(c)(1) and secured by liens in essentially all RTC assets. Loan agreement defined collateral to include all assets of debtor. Case shows broad collateral package typical.

c) In re Sun Federal Credit Union Case - Clear Coast Capital LLC - Case 15-12420-KG Doc 13
Motion requesting final order authorizing debtor to enter into post-petition financing arrangement with first position security interests pursuant to §364(c)(2). Debtor has no viable alternative to proposed DIP facility due to immediate need for funds. Obtaining financing as unsecured debt is not viable option. Court approved because unavailability proven.

d) Cross-Collateralization Disallowed - In re Texlon Corp
Court disallowed clause where lender cross-collateralizes pre-petition unsecured debt with post-petition DIP lien - gives pre-petition lender unfair advantage over other creditors.

2. India - Interim Finance - IBC

Definition Sec 5(15): Interim finance means any financial debt raised by IRP/RP during insolvency resolution process.

Powers:

Sec 20(2)(c) & (e): IRP/RP shall manage operations as going concern, may raise interim finance subject to approval of CoC under Sec 28. No security interest can be created over encumbered property without prior consent of secured creditors.

Sec 28(1)(a): Raising interim finance requires 66% CoC approval. There is no legal basis to direct contribution absent such approval - Axis Bank Ltd vs Morarjee Textiles Ltd - NCLT Mumbai Bench 5 Nov 2025

Priority - Sec 53(1)(a) & Sec 20: Interim finance enjoys super-priority status - ranks ahead of most other claims. Included in Insolvency Resolution Process Costs (IRPC) under Sec 5(13)(c) and Reg 31 IBBI CIRP Regulations - paid first in resolution and in liquidation waterfall.

Under Sec 53(1)(a), IRPC including interim finance paid in priority over secured creditors, workmen dues. This mirrors §364(c)(1) superpriority.

Distinctive Features vs US:

1. No Priming Lien: India prohibits creation of security interest over encumbered property without consent of secured creditor - Sec 20(2)(c). So cannot prime without consent, unlike US §364(d) where court can prime with adequate protection.
2. Financial Debt: Interim finance constitutes financial debt - can vote? No, but counts as financial creditor for priority.
3. No Automatic Superpriority Over Secured Without Consent: Need CoC + secured creditor consent for lien on encumbered asset.
4. Regulation 31: IRP costs include interim finance, wages of employees who actually worked when corporate debtor was going concern - Rajendra Prasad Bansal judgment - wages of employees who worked during CIRP included in CIRP costs

Indian Case Laws:

a) Axis Bank vs Morarjee Textiles - NCLT Mumbai 2025
Held interim finance constitutes financial debt and can only be raised with 66% CoC approval as per Sec 28, no legal basis to direct contribution absent approval. Tribunal cannot force lenders to contribute to interim finance.

b) Impex Metal & Ferro Alloys Ltd - NCLAT New Delhi - Sec 20 Going Concern
NCLAT held perusal of Sec 20 makes clear IRP/RP required to manage corporate debtor as going concern. Sec 20(2)(e) gives power to take all actions necessary to keep as going concern. In such process, if advance payments for supply of goods received, cannot be considered misuse - part of going concern. Allows RP to use customer advances as interim finance like source.

c) Bhatt & Joshi Associates Analysis - Interim Finance in CIRP
Legislative design incorporates super-priority - ranks ahead of most other claims in distribution waterfall during liquidation. But unlike US, minimal recovery for creditors if interim finance too large - risk of abuse. Courts cautious.

d) Sidco Leathers & Section 529A Analogy - Supreme Court
SC held Sec 529A Companies Act does not abrogate inter-se priority amongst secured creditors. Same applied to Sec 53(1)(b) IBC. Even in Sec 53, inter-se priority preserved - interim finance cannot disturb inter-se among secured creditors without consent.

3. Comparative - Rules Summary

4. Practical Issues - DIP Lender Protection

• Adequate Protection: In US, if priming, existing secured creditor must get adequate protection - replacement lien, cash payments, equity cushion. In India, no priming, so adequate protection is consent.
• Carve-Out: US DIP orders always have carve-out for US Trustee fees and professional fees of debtor and committee - even superpriority DIP subordinate to carve-out.
• Milestones & Covenants: DIP agreements include milestones - filing of plan within 60 days, sale process, budget covenants. Breach = event of default.

Lesson from Cases: Courts permit debtors in possession to exercise basic business judgment if financing necessary to preserve estate and negotiated at arms-length. Debtor must satisfy burden of showing unavailability of alternative unsecured financing.