Priming DIP Financing Remains Rare Despite Threats in Bankruptcy Negotiations

In most chapter 11 bankruptcies, existing lenders provide post-petition debtor-in-possession financing to allow the company enough liquidity to continue operations while it restructures (rather than be forced into liquidation). For the lender, this can help preserve collateral value and maximize recovery on the outstanding amount it’s owed.

Sometimes, however, a borrower will threaten to ditch the existing lender to pursue a hostile filing and secure a priming debtor-in-possession loan from another party. This essentially hands an ultimatum to its current lender: cooperate with our restructuring proposal or we’ll file without you and find a new lender willing to jump ahead of you in the capital structure.

But how often does this actually happen?

Proskauer’s latest restructuring client update says that, despite how often the maneuver is discussed, the reality is that non-consensual priming DIPs remain extraordinarily rare. While such financing is permitted in a bankruptcy process, the practical hurdles make successful execution unlikely in most scenarios.

Under Section 364(d)(1) of the Bankruptcy Code, a debtor seeking a priming DIP must prove it meets two criteria: first, that it cannot obtain financing without the priming lien, and second, that existing lienholders’ interests will be “adequately protected.”

This second requirement is typically the biggest obstacle.

The concept of adequate protection isn’t just a bankruptcy term, but rather is based on the constitutional protection of property interests granted by the Fifth Amendment and specifically extended to lenders in a rule that ensures secured creditors are not “deprived of the benefit of their bargain.”

In other words, adequate protection is meant to protect a secured lender’s right to collateral as it existed on the date of the bankruptcy filing.

It’s a high bar to meet, and courts require concrete evidence.

In practice, debtors typically attempt to demonstrate adequate protection through an equity cushion—the amount by which collateral value exceeds the secured claim to be primed. Courts have generally held that a cushion of around 20 percent is sufficient.

The rule is straightforward, but it can be hard to make the math pencil out: if a lender has liens on substantially all assets and the company is distressed enough to be considering bankruptcy, a 20 percent equity cushion is not likely to actually exist.

If they can’t make it work with the equity cushion argument, debtors occasionally test an alternative adequate protection theory: that existing lenders are adequately protected when a priming DIP is the only path to preserve going concern value. This argument suggests that without new financing, liquidation would destroy value, making the priming DIP beneficial even to the primed lenders.

If you think that sounds like a stretch, the courts would tend to agree with you—the going concern argument rarely works.

Beyond the legal hurdles, incumbent lenders already understand the business and its collateral, which accelerates timelines, and they have every incentive to provide DIP financing (the aforementioned collateral preservation and recovery maximization), which often means more competitive pricing than a new lender without such motivation.

With these hurdles, the challenge of successfully executing a priming DIP means threats are often more about negotiation leverage versus a serious attempt at the strategy. For borrowers and advisors, it’s a tool to bring existing lenders to the table.