Seven weeks after Lyondell Chemical filed for Chapter 11 in early January, the judge in the case approved an $8 billion “debtor-in-possession,” or DIP, loan to the Houston-based company, one of the largest bankruptcy loans in U.S. history. Such loans are “the fuel that keeps companies going through bankruptcy, allowing them to continue paying their suppliers and their employees as they try to become profitable again,” according to Thompson Financial News. Exit financing, another class of bankruptcy loans, is needed at the end of the process when the company is ready to emerge from Chapter 11.
But despite the record-setting size of Lyondell’s loan, most companies are struggling to find bankruptcy financing, and the consequence is, essentially, death. “Without bankruptcy financing, you can neither keep the company alive long enough to fix it or to sell it,” says Jeffrey Wurst, a bankruptcy lawyer in Uniondale, N.Y. Experts estimate that as recently as a year and a half ago as many as 30 companies were vying to provide bankruptcy financing, and today there are fewer than five.
Historically, financial institutions have been eager to provide the cash necessary for firms to survive the bankruptcy process because these loans are the first to be paid back, command high interest rates and fees and rarely default. “I get e-mails every day from lenders saying they are looking to make DIP loans,” says Wurst. But they can no longer find borrowers that look like a good risk, he says.
Companies entering bankruptcy these days already have pledged so many of their assets as collateral for earlier loans that there’s nothing left to pledge to a new lender. Not only have companies put up their inventories, accounts receivable, equipment and plants as collateral, oftentimes they have put up intangibles like intellectual property as well, long before bankruptcy was even contemplated.
Even when unencumbered assets can be found that could be pledged for a DIP loan, their value keeps dropping and is difficult to determine in this economic climate. “It’s comparatively easy to value an asset if the business is going to be running a year from now, but it’s hard to know that will be the case now,” says David Skeel, a professor of corporate law at the University of Pennsylvania Law School. “And it’s comparatively easy to value an asset if you know there is an active market for the assets of companies,” he adds, “but there aren’t liquid markets for much of anything right now.”
With traditional providers of bankruptcy financing stepping back, companies in Chapter 11 have had to turn to their existing lenders. And the interest rates, fees and conditions those lenders are imposing are often onerous. “The interest rates for DIP financing are astronomical now,” says William Lenhart, national director of business restructuring services for BDO Consulting. “In addition, the post-petition financing may only be for 60, 90 or 120 days,” he adds, which often leaves no time to reorganize and forces the debtor into a sale or liquidation.
Many times the DIP loan doesn’t actually include much fresh money. Lenders roll their pre-bankruptcy loans into the DIP financing, garnering higher interest rates and fees in the process. In addition, as the value of a debtor’s assets continues to decline, lenders will often restrict the amount it can borrow even further. After Circuit City’s bankruptcy filing last November, it arranged DIP financing with a face value of $1.1 billion from its existing bank group. But Circuit City’s lawyers told the bankruptcy judge that when all was said and done, there would only be $50 million of fresh money available to the retailer, at a cost of $30 million in fees and expenses. A little more than three months after filing, Circuit City shut down, selling its assets and letting its 34,000 employees go.
Some bankruptcy experts argue the credit markets are simply broken and that the federal government may need to step in. “My bottom line is that I would much rather have the government provide DIP financing in a bankruptcy than bail out an industry,” says Skeel. Providing DIP financing would be cheaper, he says, because “all a bankrupt company needs is enough cash to fund its operations; it doesn’t have to pay its general creditors.”
Choosing which industries to help would be tricky. “The government would have to prioritize industries,” says Skeel, “based on which would have the most devastating consequences if companies filed for bankruptcy and could not find financing.” Altman of New York University says that if General Motors ends up in Chapter 11, the federal government should step in and provide the necessary DIP financing, which he estimates could amount to as much as $50 billion.
But Altman is not prescribing the same medicine for other companies. “There are not too many companies like GM,” he says. Rather than provide bankruptcy financing directly to other companies in Chapter 11, he recommends government arm-twisting of traditional lenders of DIP and exit loans — many of whom received bailout money themselves — to get back in the game.
Or the government, he says, could set up a DIP fund and arm-twist the country’s largest banks and corporations, like General Electric, which have financial subsidiaries, to contribute a total of $40-$50 billion.
On second thought, he says, the government could be a contributor as well. “Why not,” he asks, “if that would get it going, since DIP financing is usually a pretty good investment?”
But other bankruptcy experts say this multibillion-dollar corner of the credit markets is not broken and needs no government intervention. “Bankruptcy financing is a way in which the market imposes discipline on businesses,” says Williams of the American Bankruptcy Institute. “If the market itself will not provide financing because it’s not confident that the business will generate enough revenue to cover the cost and return on that investment, then if the government provides that financing instead, it’s doing so for reasons that have nothing to do with economic reality.”
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