What is debtor-in-possession (DIP) financing?

Debtor-in-possession (DIP) financing is funding offered by banks to distressed firms in a Chapter 11 style-reorganization in order to finance the operations during the restructuring process, generally being arranged only under order of the bankruptcy court.  DIP financing differs from other financing methods in that it usually has priority over existing unsecured debt, equity and other claims during the course of the insolvency proceedings.

DIP financing is considered senior to all other debt, equity and any other financing by the firm.  It gives a super-priority security ranking in relation to the debtor’s unencumbered assets, ahead of the claims of existing creditors and in contraviction of any absolute priority rule.  The absolute priority rule, which is invoked during the liquidation of assets of a business entity, especially when an entity files a bankruptcy petition in a bankruptcy court, arises when a court confirms a plan of reorganization over the objections of a class creditor that the plan is not fair and equitable.

The availability of DIP financing depends on the perceived viability of the bankrupt company during the proceeding and its ability to successfully complete a plan of reorganization.  It is used to keep a business operating until the distressed firm can be restructured as a going concern.