14. What is the authority of the debtor in possession?
Post-Petition Financing – The DIP may establish unsecured credit (incur debts) in the ordinary course of business following the filing of bankruptcy. This practice creates new obligations for the bankruptcy estate that are often superior or have priority over payment of the existing debts. This is known as “administrative expense priority”. These debts must be actual, necessary costs and expenses of preserving the estate. This ability is limited by the rule that an equity owner in the business cannot retain any value in a Chapter 11 bankruptcy until all other creditors are paid. The court may, however, grant an exception when a current shareholder extends new credit to the bankruptcy estate. While authority to secure post-petition financing is extremely important in reorganizing the bankruptcy estate, it can have a detrimental impact on existing shareholders who lose priority in favor of the post-petition creditors. If the DIP is unable to obtain credit, even with the promise of administrative expense priority, the court may, after notice and hearing, order:
⁃ Super-priority Administrative Expense – This provides the creditor with priority over any or all administrative expenses of the kind.
⁃ Lien on Unencumbered Property of the Estate – This provides the creditor with a lien on property of the estate that is not otherwise subject to a lien.
⁃ Junior Lien on Encumbered Property of the Estate – This provides the creditor with a junior lien on property of the estate that is subject to a lien.
The court may only authorize a junior lien on encumbered property if the DIP is unable to otherwise obtain such credit and there is adequate protection of the senior lien holder.
⁃ Discussion: Why do you think the bankruptcy law allows a DIP to seek post-petition financing? Is it fair that post-petition debt receives administrative expense priority? Why or why not? Are the measures that a court may take to allow the DIP to obtain new financing fair to existing debtors? Why or why not?
⁃ Practice Question: ABC Corp files for Chapter 11 Bankruptcy. The DIP continues business operations. She realizes that the business will require new capital. What are her options for obtaining post-petition financing and the benefits she can offer to creditors? If she is unable to obtain financing by this method, what methods may a court employ to provide financing for the business?