Debtor-in-possession (DIP) financing is court-approved funding that a business raises after filing for Chapter 11 bankruptcy in the United States to pay for ongoing operations like payroll, inventory, and restructuring costs. Governed by Section 364 of the U.S. Bankruptcy Code, these loans attract lenders to an insolvent business by granting special repayment priority, including superpriority administrative status or senior liens that sit ahead of pre-bankruptcy creditors. To access the money, the borrower must pass a two-step bankruptcy court review made up of an emergency interim hearing and a final hearing after creditors have a chance to object.
Imagine a regional restaurant chain files for Chapter 11 on a Tuesday with $2 million in the bank and $4 million in biweekly payroll due on Friday. Even though the money sits in the company’s own checking accounts, existing lenders usually hold a security interest over that cash, blocking management from spending it freely. Without an immediate injection of approved post-petition credit, the chain would shut its doors before it ever got the chance to negotiate a debt restructuring plan.
Why does a debtor in possession need new loans?
When a company files for Chapter 11 under the U.S. Bankruptcy Code, existing management usually stays in charge of daily business operations as a “debtor in possession” under 11 U.S.C. § 1107(a) rather than handing control over to a court-appointed trustee, according to the Administrative Office of the U.S. Courts (2024). Only when a party proves cause, such as fraud, dishonesty, or gross mismanagement, does a judge replace leadership with a Chapter 11 trustee, though small business cases under Subchapter V always include a standing trustee to monitor the case (Administrative Office of the U.S. Courts, 2024).
Running the business during reorganization requires immediate cash, yet a debtor cannot simply spend the money already sitting in its bank accounts. Under 11 U.S.C. § 363, cash and accounts receivable pledged to existing lenders count as “cash collateral,” meaning the company cannot touch a dollar of it to pay employees or suppliers without the existing lender’s consent or a court order, according to U.S. Bankruptcy Court procedures (2023).
Operating inside Chapter 11 also brings mandatory court costs on top of normal business bills. Under 28 U.S.C. § 1930(a), filing a Chapter 11 petition requires a $1,167 case filing fee and a $571 miscellaneous administrative fee, and the debtor in possession must pay quarterly U.S. Trustee fees ranging from $325 to $30,000 depending on total quarterly disbursements (Administrative Office of the U.S. Courts, 2024). As a real-world example of how corporate groups fund operations during restructuring, restaurant franchisor affiliates FAT Brands Royalty I, LLC, FAT Brands Fazoli’s Native I, LLC, and FAT Brands GFG Royalty I, LLC entered into a formal Debtor-in-Possession Credit Agreement on March 25, 2026, while operating under Chapter 11 (U.S. Securities and Exchange Commission, 2026).
How does Chapter 11 debtor-in-possession financing priority work?
Because few lenders want to hand money to a bankrupt borrower on normal terms, 11 U.S.C. § 364 creates four escalating tiers of repayment priority to entice credit into the bankruptcy estate (Cornell Law School Legal Information Institute, 2020). A bankruptcy judge will only approve a higher tier if you prove the business cannot secure financing at a lower one.
- Unsecured ordinary-course credit under Section 364(a): If the debtor is authorized to operate its business, it can incur routine unsecured trade credit (such as standard 30-day supplier invoices) without a special court hearing, and those bills automatically count as administrative expenses (Cornell Law School LII, 2020).
- Unsecured credit outside the ordinary course under Section 364(b): For larger unsecured borrowing, the court can authorize the debt after notice and a hearing as a standard administrative expense under 11 U.S.C. § 503(b)(1) (Cornell Law School LII, 2020).
- Superpriority and junior liens under Section 364(c): If the company cannot get unsecured credit as a regular administrative expense, the court can grant the lender one or more of three protections: “superpriority” over any or all other administrative expenses under Sections 503(b) and 507(b), a first lien on unencumbered estate property, or a junior lien on property that already has a lien (Cornell Law School LII, 2020).
- Priming liens under Section 364(d): As a last resort, the court can authorize a senior or equal “priming” lien on collateral that is already pledged to an existing pre-bankruptcy lender. To win a priming lien, the debtor bears the burden of proving both that it could not obtain credit any other way and that the existing lienholder receives “adequate protection” against any loss in the value of its collateral (Cornell Law School LII, 2020).
To see how the priority math works in plain numbers, suppose a manufacturing company enters Chapter 11 with a factory valued at $50 million that already secures a $40 million pre-petition bank loan, plus $20 million in unpaid pre-petition supplier invoices. The company needs $10 million in new DIP financing to finish open customer orders. If the judge approves a Section 364(c) junior lien on the factory, the pre-petition bank keeps first claim on the first $40 million of factory value, the DIP lender claims the remaining $10 million of collateral value (plus superpriority over administrative cash flow), and the $20 million in pre-petition unsecured supplier claims wait at the back of the line. If the judge instead grants a Section 364(d) priming lien, the new $10 million DIP loan jumps to the very front of the collateral line, meaning if the factory later sells for $45 million, the DIP lender collects its full $10 million first, leaving $35 million for the pre-petition bank unless adequate protection made up the $5 million shortfall.
How do bankruptcy courts approve a DIP loan?
Motions to obtain DIP credit follow Federal Rule of Bankruptcy Procedure 4001(c) and move through court in two distinct stages: an emergency interim hearing and a final hearing, according to 364 Capital (2025). Debtors typically file their DIP financing motion on day one of the bankruptcy case alongside a detailed 13-week cash-flow budget showing every dollar coming in and going out (364 Capital, 2025).
At the first-day hearing, the bankruptcy judge does not approve the entire loan package at once. Instead, the court enters an interim order allowing the company to draw only the exact amount of cash required to avoid immediate and irreparable harm to the business (such as covering the next payroll and keeping the lights on) until a final hearing can take place (364 Capital, 2025).
Between the interim and final hearings, the U.S. Trustee appoints an official committee of unsecured creditors under 11 U.S.C. § 1102 to represent the interests of the largest unsecured claimants (Administrative Office of the U.S. Courts, 2024). That committee and other creditors review the loan documents, negotiate changes to interest rates or lender controls, and file objections before the judge enters a final order unlocking the rest of the facility (364 Capital, 2025).
What do roll-ups, milestones, and carve-outs mean in a DIP contract?
Pre-bankruptcy secured lenders provide most DIP loans because funding the case allows them to protect their existing collateral and shape the timetable of the restructuring, according to Boston University School of Law scholarship (2020). In exchange for putting up fresh cash, DIP lenders negotiate three contractual provisions that control how the case runs:
- Roll-ups: A pre-petition secured lender uses proceeds from the new DIP loan to pay off its own pre-bankruptcy loan, converting older pre-petition debt into post-petition DIP debt with superpriority status (Boston University School of Law, 2020). Take a lender owed $20 million before bankruptcy that agrees to lend $10 million in new DIP cash with a two-for-one roll-up: the total DIP facility becomes $30 million, moving all $20 million of the old loan into the highest repayment tier.
- Case milestones: Even though 11 U.S.C. § 1121(b) gives a debtor in possession a 120-day exclusive period to file a reorganization plan, DIP loan contracts routinely impose much tighter deadlines (Administrative Office of the U.S. Courts, 2024; Boston University School of Law, 2020). These milestones require the debtor to file a plan or complete a Section 363 asset sale by exact dates or face an event of default (364 Capital, 2025).
- Carve-outs: Because a DIP lender’s superpriority lien can cover every asset the company owns, the court order sets aside a specific dollar buffer called a carve-out. This carve-out guarantees that court-approved restructuring lawyers, financial advisors, and mandatory U.S. Trustee quarterly fees get paid even if the company defaults on the DIP loan (364 Capital, 2025).
What do people get wrong about DIP financing and international rules?
One widespread misconception is that any business in Chapter 11 can automatically force a priming lien onto its existing secured lenders. Under 11 U.S.C. § 364(d), non-consensual priming is an exception: if the debtor cannot prove that existing lienholders are protected by periodic cash payments, replacement liens, or an equity cushion under 11 U.S.C. § 361, the judge will deny the priming request (Administrative Office of the U.S. Courts, 2024; Cornell Law School LII, 2020).
Creditors also frequently assume that challenging a DIP order on appeal can strip a lender of its priority lien months later. Under 11 U.S.C. § 364(e), as long as the DIP lender extended credit in good faith, a reversal or modification on appeal does not invalidate the debt or any priority or lien granted under Section 364 unless the objector obtained a formal stay of the financing order pending appeal (Cornell Law School LII, 2020; Boston University School of Law, 2020).
When the case reaches its finish line, DIP lenders do not take a percentage haircut like pre-bankruptcy unsecured creditors often do. Under 11 U.S.C. § 1129(a)(9)(A), a Chapter 11 plan of reorganization cannot be confirmed unless administrative expense claims, including the DIP loan, are paid in full in cash on the effective date of the plan, unless the lender explicitly agrees to convert the balance into exit debt or equity (Boston University School of Law, 2020; 364 Capital, 2025).
These rules apply specifically to federal bankruptcy courts in the United States under Title 11 of the U.S. Code, and even within the U.S., individual districts like the Southern District of Texas enforce their own local guidelines on emergency DIP motions and budget reporting (U.S. Bankruptcy Court for the Southern District of Texas, 2023). Unlike sovereign bankruptcy restructurings, where no single international bankruptcy code or court can grant priming liens, corporate insolvency in other countries follows national statutes such as Canada’s Companies’ Creditors Arrangement Act or the United Kingdom’s Administration regime, which set their own rules on whether management stays in place and how interim funding ranks. Because bankruptcy priority rules carry strict statutory deadlines and affect creditor recoveries, businesses and creditors facing a Chapter 11 filing should consult a licensed bankruptcy attorney or restructuring advisor regarding their specific case.
Frequently asked questions
What happens if a company defaults on its DIP loan during bankruptcy?
If a debtor breaches its 13-week budget limits or misses a required case milestone, the DIP lender can file a notice of default and ask the court for an expedited hearing to cut off further loan draws or lift the automatic stay to seize collateral, which often forces an immediate asset sale or liquidation (U.S. Bankruptcy Court for the Southern District of Texas, 2023; 364 Capital, 2025).
Can third-party lenders compete with existing banks to offer a DIP loan?
Yes, specialty distressed-debt funds and third-party commercial lenders can pitch competing DIP packages if they offer lower interest rates or fewer restrictive milestones, though pre-petition lenders retain a strong advantage because they rarely consent to having their existing liens primed by an outsider (Boston University School of Law, 2020; 364 Capital, 2025).
How does a company pay off its DIP financing when exiting Chapter 11?
Unless the DIP lender agrees to roll its claim into long-term debt or equity in the reorganized company, the debtor pays off the loan in full in cash using proceeds from a court-approved asset sale or a new “exit financing” loan package arranged for the day the company emerges from bankruptcy (Boston University School of Law, 2020; 364 Capital, 2025).