CAN DEBTOR-IN-POSSESSION (DIP) FINANCING WORK IN INDIA?
KIRAN KUMAR K V
The proposed bill on bankruptcy and insolvency, awaiting parliamentary nod anytime soon, is aimed to achieve few objectives – Creditor Protection, Economic Growth, Corporate Bond & Credit Market Development and Stakeholder Protection. There is a pressing need for the same to be implemented at the earliest. Fuelling this are the cases of corporate borrowers like Kingfisher Airlines and such others totaling to a shocking INR 300000 crores sitting in the form of NPAs of Indian banking sector.
The objective of this article to discuss the mechanism of DIP financing currently being practiced in US in the cases of corporate borrowers applied for insolvency under Chapter 11 of Bankruptcy Code.
What is DIP financing?
A corporate debtor opting for a Chapter 11 process initiation will go through a set of procedures. After his voluntary filing, the debtor’s management is instructed to maintain control over the assets. All the pre-petition creditors are put on automatic hold with regards to any transaction with the debtor.
The next step is to create a restructuring plan and identifying the amount of fresh funding required for executing such a plan and the stringent layout how the new funding is going to be deployed. It must be noted that the debtor is still in possession of assets of the firm and day-to-day operations are on even during this period, except that any major financial outlay decision needs court permission during such period.
It is at this stage the debtor finds a lender who is presumably convinced to lend the former’s financial restructuring plan, and the debtor files petition for availing DIP financing. The court, in turn, recognizes the financing need into two parts – temporary and permanent. Court also initiates a motion to authorize such credit, while allowing a fifteen day window period for the creditors to respond. Irrespective of the creditors’ responses, court may decide to approve borrowing of temporary part of financing need, to avoid any “immediate and irreparable harm”. The permanent financing is approved (or rejected) after giving due considerations to existing creditors’ concerns.
As per US Bankruptcy Code, there are four types of DIP financing approvals possible: (1) Borrowing without court approval, but ceiled to the extent of day-to-day administrative expenses funding; (2) Unsecured borrowing after approval from court for purposes other than day-to-day requirements; (3) Secured loans with mortgage on non-hypothecated assets with a higher priority; and (4) Highly secured loans with lien on already hypothecated assets, and this acting as a super-lien and superseding any existing mortgage.
Challenges of Adaptation in India
In theory DIP financing seems to be a workable model in India as well. But, there are few possible thwarts that need attention, as discussed hereunder:
1. Dilution of Control: Existing creditors’ control over the business may be diluted, as DIP lenders command a super-priority over existing ones, this may create an imbalance in the business model. This is also aggravating as the DIP lenders are generally high-risk takers and they may expect a high return on their investment and in pursuit of the same, pressure on the management to take swift actions on risky projects may mount up.
2. Burden of Proof: It may be difficult for both the debtors and the court to prove the need for a DIP financing being the only option for reviving the business. There exists a fair amount of subjectivity involved in both proving and getting convinced by both the parties.
3. Takeover Strategy: DIP financing can be a powerful tool in the hands of possible acquirers, who might have failed earlier. How to ensure the debtor firms are safeguarded against the possible exploitation of DIP lender to favor a possible absorption of the firm, especially, at an unfavorable terms.
4. Roll–up Strategy: Roll-up strategy refers to the practice of DIP financing to repay the pre-petition obligations owed to the same DIP lender. This arrangement can make the DIP lender unduly benefit at the cost of other creditors.
5. Cross-Collaterisation Strategy: Using this strategy, a DIP lender can convert his pre-petition unsecured (non-asset-backed) lending also into a secured (asset-backed) lending, again at the cost of other existing creditors.
6. Cash Settlements: Another challenge of DIP financing in settling every creditor in cash. It was practiced in US that it need not be a full cash settlement, as the objective is to maximize the overall estate value.
7. Protection of Junior Creditors: At the time of deploying DIP financing to settle existing creditor’s dues, it’s possible that senior creditors and large creditors may be given a higher priority and thus, making the junior and small creditors a miss.
8. Inter-Creditor Agreements: Pros and cons of inter-creditor agreements between the creditors of the DIP will have to be analysed before such financing is approved. But, gaining knowledge of the same is the challenge.
The Bankruptcy Law Reforms Committee (BLRC) opines that DIP financing, as a rescue financing option can very well be workable in India, provided the rules are made clear as to the above challenges discussed, in addition to the other challenges of Bankruptcy Law Reforms. The biggest challenge in India would be convincing the existing creditors to give a superseding priority to DIP lenders. It is for this reason, a legal provisioning is needed that lays down duties for creditors in the case of financially distressed debtor opting for DIP financing. Also, the stricter control over takeover tactics is needed to safeguard vulnerable companies being targeted through DIP financing.
(February 2015). Interim Report of The Bankruptcy Law Reform Committee.