Financing Failure: Bankruptcy Lending, Credit Market Conditions, and the Financial Crisis

Abstract

When contemplating Chapter 11, firms often need to seek financing for their continuing operations in bankruptcy. Because such financing would otherwise be hard to find, the Bankruptcy Code authorizes debtors to offer sweeteners to debtor-in-possession (DIP) lenders. These inducements can be effective in attracting financing, but because they are thought to come at the expense of other stakeholders, the Code permits these inducements only if no less generous a package would have been sufficient to obtain the loan. Anecdotal evidence suggests that the use of certain controversial inducements—I focus on roll-ups and milestones—has skyrocketed in recent years, leading critics to question whether DIP lenders were abusing their power. Lenders, however, respond that DIP loan terms simply reflect economic conditions: when credit is tight, as it was in recent years because of the Financial Crisis, more sweeteners are needed to induce lending.