The Impact of the Credit Crisis on DIP Financing

Corporate and consumer spending have continued to decline since the second half of 2008. As a result, many highly leveraged companies have continued to face severe liquidity constraints as cash flow continues to decline, and borrowing bases for asset-based facilities decrease. Prior to the global credit pandemic, a company in default or that faced a near-term covenant breach could either obtain relief through waivers and amendments, or refinancings. As the availability of credit shrank, the latter choice was no longer a viable solution. Moreover, a byproduct of the frozen credit markets was the unexpected contraction of available debtor-in-possession financing (DIP financing). Historically, DIP financings have had the lowest default rates among commercial loans, and until the recent market disruption, only two significant DIP loans had defaulted, and only one of those resulting in a sub-par recovery. As a practical matter, access to DIP financing usually is the pivotal aspect of a company's ability to restructure in Chapter 11. Without access to capital, companies with performance issues that might otherwise have filed for Chapter 11 protection (or at least should have) could not, while companies with imminent maturity defaults or severe liquidity crises filed for Chapter 11 protection with limited liquidity, resulting in quick sales or liquidations. In the United States, the most notable liquidation victims were some of the country's largest retailers, including Circuit City and Linens 'n Things.