DIP FINANCING STRATEGIES FOR DISTRESSED COMPANIES
Carole Hunter, Jonathan Levin and Edmond F.B. Lamek
When companies face troubled times financially, they inevitably find themselves
in a situation where their existing lenders and other creditors are looking for a material recovery
on their claims as soon as possible, and yet the company itself is in need of additional
borrowings in order to implement a strategy to maximize returns to existing creditors. These
incongruous realities make the negotiation of financing during a restructuring a delicate, and
often times hotly contested debate among stakeholders who may have differing agendas, or
differing views of the ultimate viability of the company’s business. Below, we look principally
at a number of business dynamics of “debtor in possession” financing in a formal courtsupervised restructuring environment, as well as some of the exit financing strategies that have
been employed by companies coming out of formal restructuring proceedings in Canada.
I.
DEBTOR-IN-POSSESSION FINANCING
When a corporation is faced with the prospect of commencing restructuring
proceedings under the Companies’ Creditors Arrangement Act1 (the “CCAA”), one of the issues
that will invariably arise is the manner in which the company’s ongoing operations will be
funded during the restructuring period. Over the past several years, many debtors have utilized
what is known as “debtor-in-possession” (“DIP”) financing, a concept (and phraseology) adapted
from financing which is legislated in Chapter 11 of the United States Bankruptcy Code2. DIP
financing refers to financing provided to an insolvent debtor while it attempts to reorganize in
accordance with applicable insolvency legislation, which, in the majority of cases in Canada, is
the CCAA. This type of financing will ordinarily be sought at the time of the debtor’s initial
application for protection from its creditors under the CCAA. The DIP financing will be
authorized and secured by a court order made in the CCAA proceedings, which will also grant a
charge on the property and assets of the debtor in favour of the DIP lender (hereinafter “DIP
Charge”).
In Canada, the development of DIP financing in the context of restructuring
proceedings has been the product of much negotiation and ingenuity among the financial
stakeholders in the major Canadian restructurings, and a certain degree of judicial interpretation
and arm-twisting. In most cases, the provision and structure of the DIP financing is
unchallenged by the time it is brought before the court for approval, since the DIP financing is
generally the subject of intense negotiations between the principal stakeholders of the debtor
company prior to the commencement of proceedings under the CCAA. Because the Courts do
not tend to take an interventionist role in DIP financing issues unless a dispute arises, the debtor
1
2
R.S.C. 1985, c. C-36, as amended.
Bankruptcy Code, 11 U.S.C.
and the DIP lender are afforded considerable latitude in negotiating the terms and structure of the
financing. Canadian courts will generally only become involved in issues relating to DIP
financing where the terms of the financing are controversial (e.g. most commonly, where the DIP
lender is given a super-priority security position over the objections of existing creditors with
security over the debtor’s assets being charged).
(a)
Choosing the DIP Lender
When faced with a cash-flow crisis and an inevitable insolvency filing, a debtor
company can, at least in theory, look to two principal sources of DIP financing: its existing
senior lender or lenders, or external lenders with no current stake in the company’s business. As
discussed later in this chapter, the financing can, however, be provided by the debtor’s other
existing stakeholders.3 On the surface, an existing lender with a financial stake in the outcome of
the company’s restructuring would appear to be the most convenient source of DIP financing,
since the debtor has an ongoing relationship with the existing lender and because the existing
lender should have an understanding of the company’s business prospects, asset values and cash
flow requirements. While the specialized third party DIP lenders have garnered a reputation for
moving quickly in arranging loans, their inability to conduct extensive due diligence can often
lead to a lower level of funds being available to the company, and materially higher fees being
charged.
There are a variety of factors that will affect a debtor’s choice of (and ability to
choose) the party that will become the DIP lender. The company’s existing relationship with its
senior lender will invariably dictate the role that lender will take in the restructuring proceedings,
be it DIP lender or not. Since most financial institutions (or syndicates of them) do not, on a
regular basis, make DIP loans, or advance credit in situations where a borrower is already in
default, existing lenders will have to be satisfied that there is a substantial business case for them
to advance additional credit by way of DIP loan. The lender will first look at its existing
collateral coverage and compare the likely outcome in a liquidation scenario (i.e. an immediate
orderly shut down as opposed to a restructuring). If the lender’s position is clearly in a shortfall
position in a liquidation scenario, then the lender will next have to consider whether or not it
would be “throwing good money after bad” by advancing additional funds to the company. This
is the time when the lender must take a long hard look at the ways in which the company got
itself into this position, and whether those factors can be remedied by restructuring in a timely
and cost effective manner, and by the existing company management team. Conversely, if the
existing lender finds itself in a comfortable over-secured position, its decision to advance DIP
financing is made easier, since any degradation of collateral as a result of an unsuccessful
attempt at a restructuring will not economically impact the lender’s existing position.
3
A discussion of the financing that can be provided by other stakeholders is set out in further detail in the section
on “Financing from Key Suppliers and Customers”. Depending on the circumstances and the financial or other
interests of the parties, the DIP financing could also be provided by other creditors of the debtor.
2
An existing lender will be motivated to provide the DIP financing principally to
maintain the maximum level of control over its security position and the direction of the
restructuring process, and avoid being “primed”4 by a third party lender. Because an existing
lender is able to exercise a significant degree of control over the conduct of the company’s
refinancing through the imposition of conditions, covenants and court orders which require
consultation with the DIP lender on various matters in the restructuring, the existing lender will
likely be more comfortable about providing the financing. The existing lender may also be
concerned that a third party lender will have a different perspective on the restructuring of the
debtor that may not result in the existing lenders’ position being maximized or protected
throughout the restructuring process. From the debtor’s perspective, the existing lender as the
DIP lender has its advantages, particularly where the parties have a good working relationship,
and the causes of the company’s financial difficulties are identifiable and solvable. The existing
lender knows and understands the debtor’s business and may be able to offer valuable insights
into the restructuring, and will have the incentive to do so, given its larger stake in the outcome.
The existing lender may also be less aggressive in establishing the fee structure for the DIP
financing. However, equally commonplace are situations in which the existing lender has lost
confidence in the debtor’s business model, long term viability, or management, with the result
that regardless of the financial position of the lender’s existing position, the existing lender will
propose onerous terms of the financing which result in the lender retaining almost complete
control of the restructuring process. This is unlikely to be conducive to a restructuring and may
greatly increase the likelihood that the restructuring is a failure. In these cases, the debtor will
invariably be better off locating a new source of financing, even over the objections of the
existing lender.
A third party DIP lender also has its advantages and disadvantages. Obviously,
DIP lenders are motivated to provide DIP financing because of the significant monetary returns
that are available by way of distressed debt level interest rates and a myriad of fees, and the very
limited financial risk that is associated with court ordered priming security. A new lender has
the principal advantage to the company of being solely profit-based, and having no preconceived
notions or biases in respect of the direction of the restructuring of the debtor’s business, and may
therefore provide the debtor with significantly more flexibility in the restructuring as long as the
DIP lender achieves its expected profit levels in the anticipated time horizon.
(b)
Issues Affecting the Structure of the DIP Financing
There are many issues that affect the structure of the DIP financing. The amount
and timing of availability of the DIP financing to the debtor is generally the most important issue
to deal with by the Courts in approving a DIP borrowing at the outset of a CCAA proceeding. At
this time, very few creditors will have received notice of the commencement of the CCAA
4
“Priming” is a term used to describe the subordination of the existing lender’s security position to a superpriority security charge established in favour of the third party DIP lender.
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proceedings or been afforded the opportunity to review and respond to any application materials
they may have received. It is as a result of the desire to balance a debtor’s need to obtain critical
financing with the need to protect the rights of other creditors, that the court will generally prefer
to limit the initial borrowing under the DIP facility during the first 30 days of the CCAA
proceedings5. In order to ensure that the debtor has sufficient funding during this period, care
must be taken to ensure that the cashflow projections accurately reflect the debtor’s needs as well
as any unforeseen difficulties which may arise.
The existence of other secured debt and the nature and value of the debtor’s
security will also affect the terms and conditions of the DIP financing. In cases where there are
unencumbered assets or assets exceeding the value of the secured debt, the terms on which the
DIP financing is provided may be less restrictive and the fees associated with the financing may
also be less. If, however, there are assets of diminishing or uncertain value, the debtor may find
that the terms of the DIP financing are more cumbersome and the interest rates and fees imposed
by the DIP lender are akin to rates charged on high risk loans. The nature and value of the assets
will also affect the security position which the DIP lender will require in order to provide the
financing.6
The court orders that approve the provision of DIP financing and establish the
DIP Charge generally provide that the DIP Charge does not need to be registered in accordance
with provincial personal property security legislation (“PPSA”) in order for it to be effective
against other creditors or a trustee in bankruptcy. The DIP lender may, however, decide to
register a financing statement to protect its security position in any event. The decision to
complete a PPSA registration will depend on, among other things, whether the DIP lender is an
existing lender, whether the DIP lender is likely provide the exit financing, and the jurisdiction
where the proceedings have been commenced. The jurisdiction and registration issue is of
biggest concern in the Province of Quebec, where there is some uncertainty as to whether an
unregistered court ordered DIP Charge can effectively grant the DIP lender a security interest in
the debtor’s collateral, despite the Court order.
The DIP lender will always require provisions in the DIP term sheet that provide
them with information about the ongoing operations and financial position of the debtor. This
information allows the DIP lender to assess the progress of the debtor towards a restructuring
and the continued viability of the lender’s exit strategy. For this reason, the DIP lender requires
real time information about any changes in the management of the debtor, the sale of assets or
the closure of any operations, and will often request that the initial CCAA order specify that the
DIP lender be consulted (or in cases of an existing lender acting as DIP lender, grant its prior
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6
See for example, Re Ivaco Inc. (September 16, 2003), Farley J. (Ontario S.C.J.) and Royal Oak Mines Inc., Re
(1999), 6 C.B.R. (4th) 314, 1999 Carswell Ont 625 (Ont. Gen. Div. [Commercial List]).
A discussion of the financing that can be provided by other stakeholders is set out in further detail in the section
on “Negotiating the Security Position of the DIP Charge”.
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approval) before any such actions are taken by the debtor. The DIP lender may also place
restrictions on such things as inter-company transactions and payments to the directors and
officers of the debtor to ensure that the security position of the DIP lender is not unnecessarily
eroded, and to ensure that the financing is not used in a manner that is not beneficial to the
restructuring.
(c)
Negotiating the Security Position of the DIP Charge
The initial order that is obtained by the debtor in respect of its restructuring under
the CCAA will establish a number of charges against the debtor’s property, assets and
undertaking, including an administrative charge, a directors’ and officers’ charge and a DIP
Charge. The security position of the DIP lender is often the subject of intense negotiation and
debate, particularly where the DIP lender is a third party lender and wants as high a ranking of a
“super-priority” charge over the debtor’s assets as it can possibly get. It is rare that the DIP
lender’s security will rank in absolute first priority over a debtor’s assets. Generally, the
“administrative charge” which secures the unpaid balance of any fees and expenses (and other
liabilities should there be any) of the monitor and any professionals retained by the debtor, will
be the highest ranking court ordered charge established in an initial CCAA Order. The most
common “battle” generally arises in respect of the relative ranking of the DIP Charge and the
charge that is generally established to protect the directors and officers of the debtor from
incurring any additional liability in their furtherance of the CCAA restructuring (the “D&O
Charge”). Even the most well-meaning of directors will want to maximize the protection that
can be achieved under a D&O Charge as they head into a CCAA restructuring. As such, there
will be great pressure to have the D&O charge: (a) rank ahead of the DIP Charge; (b) encompass
in its terms as expansive a time period (i.e. pre-filing as well as post filing) and as broad a scope
as possible; (c) maximize its dollar amount; and (d) make it available to the directors without
regard to existing policies of directors’ and officers’ insurance. The points of contention
between a DIP lender and a company’s directors are obvious. Not uncommonly in recent CCAA
filings, the DIP charge is split – either by subject matter (i.e. post filing liabilities) or by quantum
– such that a portion of the D&O Charge would rank in priority to the DIP Charge, and the
balance would rank in a subordinate position, but still be ahead of existing secured creditors.
The priority of the DIP charge is not the only matter that has been the subject of
significant negotiation and debate in recent CCAA restructurings. Another issue for DIP lenders
and other secured creditors of the debtor is the desire for cross-collateralization of the DIP loan
in circumstances where the filing is being made by a group of related entities, each of which has
a different financial circumstance. The creditors of a particularly healthy and (relatively) assetrich entity may complain that their company’s assets should not be used as collateral for a DIP
loan to the corporate group as a whole, since that will unfairly degrade their positions as
creditors to the benefit of creditors of other affiliated entities.
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Existing DIP lenders may in some circumstances use a DIP loan and/or a DIP
Charge to improve their existing security position, either by making it a condition of the DIP
loan that the DIP Charge also secure the creditor’s existing position, or that the debtor continue
to pay down the creditor’s existing facility by way of DIP loan advances during the course of the
restructuring. These conditions allow a lender to improve its position by: (i) gaining courtordered security over any assets of the debtor company which it did not previously have security
over; (ii) negating any problems (such as flawed PPSA registrations or flawed security
documentation) with existing security by means of the DIP Charge; or (iii) paying down the
existing (problematic) position with a well secured DIP loan (which also has the benefit of
keeping the existing loan as a performing loan on the books of the lender). In the CCAA
proceeding in Air Canada, the DIP term sheet required that the DIP Charge ordered by the court
secured not only the financing to be provided by the DIP lender, but also the obligations owing
to an affiliate of the DIP lender in respect of various aircraft leases.7 What is more interesting is
that while Air Canada negotiated such significant DIP financing and supported the
collateralization of the affiliated aircraft lease position as a necessary condition of the financing
being imposed by the DIP lender, Air Canada barely drew upon its DIP facility during the course
of its restructuring.
(d)
Using DIP Financing as Marketing Tool during the Restructuring
In the time period preceding a filing under the CCAA, the debtor’s cashflow is
often restricted by the availability formulas under its existing credit facilities. At the same time,
suppliers begin to impose cash-on-delivery or cash-in-advance terms, or worse, require pay
downs of existing debt levels before any further goods will be supplied. At the commencement
of CCAA proceedings, to the extent that they have not already done so, suppliers will often seek
to impose cash-on-delivery terms upon the debtor which will have the effect of causing an
immediate drain on the company’s already strained cash position. The provision of DIP
financing not only provides the debtor with cash availability critical for its operations during the
restructuring period, it also has the ancillary benefit of bolstering customer and supplier
confidence about the likelihood that they will get paid should they advance credit to the debtor
company for goods and services delivered during the restructuring. This comfort may allow the
debtor the latitude to negotiate with customers of suppliers to ease off on the restrictive payment
policies instituted prior to the CCAA filing, and provide the debtor with greater cash flow to
fund its ongoing operations. The customers will also have more confidence in the debtor’s
ability to remain in business, at least in the short term, and continue to purchase products and
services in the hopes of the debtor surviving and remaining a customer (and source of future
profits) of the supplier after a successful restructuring.
7
See the April 1, 2003 commitment letter from General Electric Canada Inc. in Air Canada, Re (2003), 2003
Carswell Ont 1220 (Ont. S.C.J. [Commercial List]).
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II.
FINANCING FROM OTHER STAKEHOLDERS
As an alternative to, or a condition of, a lender providing DIP financing, a debtor
may also obtain certain credit facilities and other financial accommodations from its key
suppliers and/or its key customers which will improve the debtor’s cash flow position during its
restructuring. Financing received from suppliers and customers is generally not in the form of a
line of credit or other formal credit arrangement, but results instead from a change in the manner
in which the parties conduct business with one another.
The debtor will often seek longer payment terms from suppliers during a
restructuring. The increased time in which the debtor has to make payments for goods and
services required for its operations allows the debtor to have more cash flow available with
which to fund other aspects of its business and restructuring. This may also have the effect of
decreasing the debtor’s reliance on other, more expensive forms of financing. Where a debtor has
multiple sources of supply of a particular input, and has the financial support of a DIP loan, the
debtor can often use the offer of increased levels of future business as an incentive to its
suppliers to provide credit terms during a restructuring.
The debtor can also attempt to improve its cash flow by obtaining financing from
its customers, which is often accomplished by the debtor and the customer entering into an
accommodation agreement, which has become the norm in the automotive industry. This type of
agreement obligates the debtor to continue to produce the customers’ products (and, if so funded
by the customer, to build additional inventory banks for the customer in case the restructuring is
not successful), and also obligates the customers to accelerate the payment of their pre-filing
accounts receivable without set-off, and to continue to purchase products from the debtor on a
cash-on-delivery or cash-in-advance basis for a fixed period of time. An accommodation
agreement can also provide that the customer will purchase the raw materials required by the
debtor to produce the customers’ products. This has the benefit of allowing the debtor to avoid
funding the up-front costs of production while still obtaining payment for the finished product
(less the cost of the raw materials) in a timely manner.
Given the need for continued and continuous just-in-time delivery in the
automotive sector, lenders to automotive manufacturers are keenly aware of the leverage that
they hold over the customers of a debtor company by the threat of a shut down of manufacturing
activities. This can provide the debtor with a considerable boost to its cash flow during a
restructuring. In many cases, if the lender is sufficiently secured, and the component
manufactured by the debtor company is essential enough, the lender can transfer much of the risk
associated with the debtor’s restructuring over to the customer by merely threatening to liquidate
the debtor.
Recently, in the case of Greening Donald Co. Lid., the principal financial
investors sought to petition the debtor company into bankruptcy, recognizing that its single
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largest customer (representing over 90% of Greening’s business), purchased an essential
component of air bags used in the vast majority of automobiles manufactured in North America.
Ultimately, the customer had to take the novel step of applying to the Court for an order pushing
Greening into CCAA proceedings and approving a DIP loan from the customer on a DIP Charge
priority basis.8 It is noteworthy that the customer was not a creditor of Greening but in fact owed
Greening approximately $2 million for goods supplied – sufficient monies to fund Greening
through the initial stages of its CCAA proceedings. Had the customer simply accelerated
payment of its receivable, the customer would have lost any leverage or control it had as DIP
lender, and would also have lost its set-off rights in respect of the amounts owing to Greening.
Ultimately, the other creditors of Greening negotiated for an accelerated payment schedule for
the customer’s receivables in order to reduce the amounts required by Greening under the DIP
loan.
DIP loans can also be advanced by prospective purchasers of the business under
CCAA protection. For example, in the CCAA proceedings of Hemosol Corp and Hemosol LP,
the company’s existing lenders advanced a DIP loan during the marketing process for the
Hemosol business. However, when the successful bidder began to encounter delays in
negotiating a number of ancillary arrangements which were conditions of its offer, the principal
lender refused to advance any additional amounts to fund the monthly cash burn of the business
(and the professionals) while the bidder continued with negotiations, and also refused to be
primed by any additional DIP financing. As such, rather than lose the bid and see the Hemosol
assets go into liquidation, the bidder agreed to advance a second DIP loan, subordinate to both
the existing DIP Loan and the principal lender’s existing position.
One of the most creative non-traditional DIP lending strategies employed in
recent years involved the acquisition of the Hamilton Specialty Bar (“HSB”) division of Slater
Steel Inc. (“Slater”) in 2004. During the course of the Slater CCAA proceedings, Slater had
unsuccessfully attempted to find a going-concern buyer for the HSB division. In part because of
certain issues relating to the HSB collective agreement, not the least of which was the significant
shortfall in the hourly workers’ pension plan, no parties were interested in buying HSB as a
going concern. However, a party did come forward with an offer for the assets which provided
that, following the acquisition of the assets by the purchaser, Slater would continue to operate the
HSB business and employ the hourly employees for a period of time while the purchaser
negotiated a revised collective agreement, with the HSB union and also a resolution of the
pension issues with the union and the Financial Services Commission of Ontario (“FSCO”).
During this negotiation period, the purchaser did two unique things: it completely funded the
costs to Slater of operating the HSB business (including significant protections for employeerelated director liabilities for Slater directors), and second, the purchaser (a single purpose entity)
itself went into CCAA protection immediately upon acquiring the assets from Slater, and itself
8
See the November 17, 2006 commitment letter from Autoliv Asp, Inc. in Greening Donald Co. Ltd. et al.
(November 17, 2006), 06-CL-6738 Lederman J. (Ont. S.C.J.).
8
obtained a DIP loan from a company related to it (the “New DIP Lender”). By putting such a
structure in place, the purchaser was able to avoid becoming a successor employer by keeping
the business operating under the Slater legal entity with the purchaser’s assets on loan, and
because the purchaser itself was insolvent from the outset, the threat of an asset liquidation by
the New DIP Lender remained throughout the purchaser’s negotiations with the Union and
FSCO, if satisfactory arrangements could not be reached. Once acceptable pension and
collective agreement amendments were agreed upon, the New DIP Lender effected what
amounted to a judicial foreclosure of the HSB assets, and ultimately became the new HSB
operating entity.
As can be seen from the foregoing anecdotal examples, the uses, sources and
strategies of DIP loans in CCAA restructurings can be as limitless as the imaginations of the
insolvency professionals and financial stakeholders who structure them. By keeping this kind of
flexibility in mind, a restructuring professional can achieve much more than simply “keeping the
body alive” while the restructuring takes place around it. By managing, and in some cases
completely skewing the business dynamics in a restructuring through an appropriate DIP loan
structure, the chances of a successful outcome for all stakeholders can be greatly increased.
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