Debtor in Possession (“DIP”) financing is essentially new bridge financing that is provided to a corporation as it undergoes insolvency proceedings. The term exists because the corporation maintains possession of its assets during this process as opposed to having a bankruptcy trustee take possession. The concept derived from the United States of America where DIP financing is expressly provided for under c.11 of the Bankruptcy Code and allows a bankrupt corporation to incur new debt for the purposes of carrying on business operations.

In Canada, there is no statutory basis for DIP financing under the Companies’ Creditors Arrangement Act and only recently the Bankruptcy and Insolvency Act was amended to provide for “interim financing” for the purpose of wage earner protection.

Notwithstanding this, the Courts in Canada have, by virtue of their “inherent jurisdiction,” granted DIP financing, and super-priority to DIP lenders for their security, even where doing so may impede on the rights of prior secured creditors. The courts have found that, notwithstanding the absence of legislative authority, the granting of DIP financing furthers the objectives of the legislation in that it provides a means for corporations to remain solvent while balancing the rights of corporations’ creditors. In a sense, it can also be said that the debtor in possession has the same role as the courts in that the corporation is attempting to reorganize for the benefit of all creditors, as would a receiver.

Miller Thomson Analysis

In the recent case of Simpson’s Island Salmon Ltd (Re) (2006), the courts allowed a DIP facility to be entered into. It was, however, limited to what was necessary to meet the corporation’s operating needs until its harvest of salmon. The Court held that there was cogent evidence that the benefit outweighs the potential prejudice to secured creditors; that the financing ought to be restricted to what is reasonably necessary to meet the debtor’s urgent needs while a plan of arrangement or compromise is being developed; and there was a reasonable prospect that the debtor would be able to make an arrangement with its creditors and rehabilitate itself.

In addition to granting DIP finance to companies undergoing a reorganization, courts have gone further and have allowed those DIP finance facilities to be secured over assets of the corporation, and in many instances postponing the rights of prior secured parties. In M.N.R. v Temple City Housing Inc. (2008), the debtor had debts in excess of $5 million. The Canada Revenue Agency (CRA) was owed a significant amount of money in source deductions, which it claimed were a property interest that cannot be subordinated. It was held that source deductions are a “security interest” and can be subordinated in favour of a DIP lender in the same way as any other security. The court granted an order for a super-priority charge in favour of the DIP financier ranking ahead of the CRA.

What the case law suggests is that secured creditors should be aware that, notwithstanding their existing priority ranking, their security interests may be subordinated to a DIP financier in the event that the debtor files an application for reorganization under the CCAA or BIA.

Debtors on the other hand need to be aware that in some cases a DIP finance facility may not be the answer to their cash flow issues or provide the funds needed for their reorganization. Given the increase over the past 12 months in companies filing for bankruptcy protection and reorganizations, the cost of DIP financing has become exorbitant, particularly in the United States of America. Reportedly, Circuit City recently paid a standby fee of $30 million to secure its DIP loan and its been suggested that Nortel Networks Corporation rejected a DIP loan with a standby fee of $20 million. In the case of Circuit City, its existing lenders had decreased their existing facility and repackaged their loans as a DIP finance facility, except with the costly stand-by fee. In effect, what it meant was that 95 per cent of the DIP finance facility was to be used to repay the existing debt owing to the same syndicate of existing lenders.