What is Bankruptcy Financing?

Bankruptcy financing refers to special financing from a lender to a company that is in the process of reorganization under Chapter 11 of the US Bankruptcy code. The lender gives out the money to a firm to help it fund its business operations as it goes through the bankruptcy process and seeks to confirm a plan of debt reorganization. 

Bankruptcy financing is a form of preferred debt that is given repayment priority over other debts. Bankruptcy financing is also commonly referred to as debtor-in-possession financing.

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Bankruptcy Financing Example

Lets assume that the XYZ Company dealing with widget has issue bonds worth $1 million at an interest of 6%, which is unsecured against any given capital. The bank has also secured a bank loan worth $2 million at an interest of 4%. Company XYZ later falls out as a result of its competitor Company ABC, creating a widget that is more effective and sells at half the price. Due to this, there has been a decline in sales, which has made it difficult for Company XYZ to service its loan payment as well as bond. As a result, the Company resolves to file for Chapter 11 bankruptcy. The company has faith that it will be able to revive and restore its manufacturing factory and make the same product and come back in the market again. So, the company goes ahead to convince the lender to extend bankruptcy funding to enable work on those improvements. Finally, the lender who, in this case, is a bank agrees to lend the company bankruptcy financing at a 10% interest rate. The bank also gives the company a grace period of 3 years. As the company works through the process of bankruptcy, the judge puts the initial lending bank as well as the bondholders on notice regarding payments. He or she lets them know that there will be a delay in payments to enable Company XYZ to reorganize and work towards stabilizing itself in terms of profits. Generally, where large bankruptcy is involved, a company usually arranges bankruptcy financing ahead of the bankruptcy filing, where it also makes its plan public. Note that this kind of bankruptcy financing happens to be larger and may surpass the needs of the company's needs. The reason is to enable the company to cater to any unforeseen situations that are likely to come up while the company is the process of reorganizing itself.

Related Topics

• Bankruptcy Law (Intro)
• What is Bankruptcy?
• Insolvency - Definition
• What are the types of business bankruptcy?
• Chapter 9 Bankruptcy 
• Chapter 12 Bankruptcy
• Chapter 15 Bankruptcy 
• Who are the participants in the bankruptcy process?
• Key concepts behind the bankruptcy process?
• Absolute Priority Rule
• Pari Passu
• What rules govern the bankruptcy process?
• Bankruptcy Abuse Prevention and Consumer Protection Act
• American Bankruptcy Institute Definition
• What the authority of the bankruptcy court?
• What is the authority of the trustee (debtor in possession) in bankruptcy?
• Debtor in Possession
• What assets of the debtor are included in the bankruptcy estate?
• Bulk Sales Law
• What is the automatic stay in bankruptcy?
• What is a claim by creditors of the bankruptcy estate?
• What is voluntary and involuntary bankruptcy?
• What is the Chapter 7 bankruptcy process?
• What is the Chapter 11 bankruptcy process?
• How to File Bankruptcy for a Business
• Accept or reject contracts?
• Avoiding powers?
• Stay of Proceeding?
• Use of Business Assets?
• Post-Petition Financing?
• Bankruptcy Financing - Definition
• What is the appointment of a Trustee or Examiner in business bankruptcies?
• What is a Plan of Reorganization?
• Reorganization - Definition
• Subordinated Debt
• Preferred Debt
• What is Cramdown of a reorganization plan? 
• To what extent does the bankruptcy process relieve a debtor's debts?