Debtor-in-possession financing (“DIP financing”), which is new short-term financing obtained by an insolvent company after the commencement of an insolvency proceeding, is a recurring theme for two primary reasons. First, insolvent companies are generally desperate for an immediate infusion of cash to sustain operations. Second, creditors will usually provide such financing only on a super-priority basis, jumping ahead of existing secured creditors of the insolvent company. The court is then called upon to perform a cost/benefit analysis to determine whether DIP financing should be approved.
Adding a wrinkle to the standard DIP financing scenario, suppose that Company A and Company B are insolvent affiliates. Suppose also that a DIP lender is only willing to provide financing to Company A if Company B provides a super-priority secured guarantee. In this case, it would appear that the secured creditors of Company B would be asked to bear the cost of the desperation of Company A to obtain DIP financing.
Indalex Limited presented an Ontario court this spring with a proposition similar to the one described above. In that case, a Canadian debtor and a US debtor were both to receive benefits under a DIP credit agreement. The DIP financer proposed that the Canadian debtor would provide a super-priority secured guarantee for the obligations of the US debtor under the DIP credit agreement.
The Indalex Limited matter provides a neat list of the following criteria that a court will evaluate, which are unique to the guaranteed DIP financing context:
- The need for additional financing by the guarantor to support a going-concern restructuring;
- The benefit of the breathing space afforded to the guarantor by protection under the Companies’ Creditors Arrangement Act (CCAA);
- The availability of any financing alternatives (or lack thereof);
- The practicality of establishing a stand-alone solution for the guarantor;
- The contingent nature of the liability of the proposed guarantee and the likelihood that it will be called on;
- Any potential prejudice to the creditors of the entity if the request is approved, including whether unsecured creditors are put in any worse position by the provision of a cross-guarantee of a foreign affiliate than existed prior to the filing, apart from the impact of the super-priority status of the new advances to the debtor under the DIP financing;
- The benefit that may accrue to the stakeholders if the request is approved and the prejudice to those stakeholders if the request is denied; and
- A balancing of the benefits accruing to stakeholders generally against any potential prejudice to creditors.
In addition, Ontario courts have, on several occasions, highlighted the importance of actively involving all creditors in the consideration of such DIP financing guarantees. If such creditors cannot be involved, the Monitor should be engaged in an expedited fashion to provide the court with some analysis of the above factors.
The facts of the Indalex Limited matter were very favourable to the DIP financer’s proposal. The viability of the Canadian affiliate was in jeopardy without the receipt of a portion of the DIP financing and the likelihood that the guarantee would be called was minimal. Ultimately, the extension of DIP financing along with the connected guarantees and super-priority security were found to be justified in the circumstances.
The Indalex matter and other recent decisions highlight the importance of strategically choosing the optimal DIP guarantor to propose to a court based upon some of the following criteria:
- the guarantor should be able to show that it needs, for its own purposes, at least a small portion of the DIP financing (in some cases even less than 10% of the overall DIP financing has been sufficient);
- the guarantor should be able to show that it intends to take steps toward a restructuring that has a reasonable chance of success (retention of jobs has proven to be a very persuasive factor); and
- if the guarantor cannot make use of any of the proposed DIP financing itself, one should seek to show that the guarantor’s operations are nevertheless dependent upon the ongoing operations of affiliates for which the financing is provided.
There are many variations on the Indalex scenario that may be of considerable interest to prospective DIP lenders. For example, suppose that a guarantor is not receiving any desperately needed funding from a particular DIP loan, but is being asked to provide a super-priority secured guarantee of an affiliate’s DIP loan nonetheless. Alternatively, suppose that there is a high likelihood of the guarantee being called. Either of these adjustments may have a substantial impact on the viability of a DIP financing proposal.