DIP financing in chapter 11: risks and strategies for Swedish lenders
Recent Chapter 11 filings by Swedish companies in the US have raised important considerations for Swedish creditors and legal practitioners. In a previous piece, we discussed why creditors may find themselves compelled to comply with Chapter 11 restructurings—even if US court rulings are not recognised in Sweden—due to the need to maintain access to USD clearing. Below, we examine additional key aspects identified by Swedish transactional finance and restructuring specialists.
When a Swedish debtor enters Chapter 11 in the US, Swedish lenders with security interests in the debtor’s assets or involvement in USD financing are likely to face unexpected challenges. These challenges are particularly pronounced when the original financing arrangements are governed by Swedish law.
One notable feature of Chapter 11 is Debtor-in-Possession (DIP) financing, which provides funding for the debtor to continue operations during the restructuring process. However, for Swedish lenders, DIP financing introduces significant risks. US bankruptcy laws may allow DIP lenders to take precedence over existing secured creditors, fundamentally altering the priority of claims. Below, we analyse these risks and explore strategies Swedish lenders can employ to safeguard their interests. This analysis is from a Swedish legal perspective, and creditors are encouraged to seek advice from both US and Swedish counsel for specific cases.
DIP Financing and Priming Liens Explained
What is DIP Financing?
DIP financing is funding provided to a debtor after entering Chapter 11. It enables the debtor to maintain operations and restructure effectively, helping preserve the value of the estate and maximise recoveries for all stakeholders.
Priming Liens and Their Impact
Under Section 364(d) of the US Bankruptcy Code, DIP lenders can receive priming liens, security interests that take precedence over existing liens. This means that even lenders with previously first-priority security interests may be subordinated, significantly impacting the value and enforceability of their collateral.
Requirements for Granting Priming Liens
Priming liens are not granted lightly. For a court to approve a priming lien, the debtor must meet the following key requirements:
- Adequate Protection
The debtor must demonstrate that existing secured creditors are adequately protected to ensure they are not unfairly disadvantaged. Adequate protection can include:
- Replacement Liens: New liens on alternative assets to offset the diminished value of the original collateral.
- Periodic Cash Payments: Payments to mitigate the risk of collateral erosion.
- Other Protections: Priority rights to future income or profits.
Adequate protection often becomes the most contentious issue, as creditors may argue that proposed measures do not sufficiently mitigate their risks.
- Necessity of Financing
The debtor must prove that DIP financing is essential for its continued operations and the preservation of the estate’s value. Without it, the debtor risks collapse, reducing recoveries for all creditors.
- Inability to Obtain Alternative Financing
The debtor must show that alternative financing—without the need for a priming lien—is unavailable. This typically involves documenting attempts to secure less intrusive funding and providing explanations from potential lenders.
- Court Approval
The court must ultimately approve the DIP financing package, including any priming liens, after hearing objections from existing creditors, particularly on the adequacy of protection measures.
Challenges for Swedish Lenders
Cross-Border Recognition Issues
Swedish law does not recognise the concept of a priming lien, and US bankruptcy orders are not automatically enforceable in Sweden. However, commercial realities—such as maintaining access to USD clearing—may compel Swedish lenders to comply with US rulings, even when these contain unfavourable terms.
Collateral Erosion Risks
Priming liens can significantly undermine the value of a lender’s collateral. Even if replacement liens or cash payments are offered, they may not fully compensate for the loss of first-priority status.
Conflicts with Swedish Law
Swedish insolvency principles emphasise creditor hierarchy and predictability. The super priority afforded to DIP financing under US law can create conflicts with these principles, particularly if Swedish security is affected.
The Role of Intercreditor Agreements
Swedish-Law Agreements
Intercreditor agreements governed by Swedish law often do not address DIP financing or priming liens, creating ambiguity during a Chapter 11 process.
US-Law Components in Agreements
Intercreditor agreements with US-law provisions are more likely to include terms related to DIP financing. These provisions may require lenders to accept priming liens or cooperate in the restructuring, reducing negotiation leverage.
Strategies for Swedish Lenders
Active Engagement in DIP Negotiations
Swedish lenders should actively participate in negotiations related to DIP financing, focusing on securing:
- Specific Replacement Collateral: High-value, accessible assets.
- Priority Cash Flows: Rights to certain income streams to offset losses.
- Oversight Roles: Participation in the management or monitoring of DIP fund usage.
Revisiting and Updating Agreements
Lenders should revise intercreditor agreements to include provisions addressing:
- Conditions for priming liens.
- Adequate protection terms.
- Dispute resolution mechanisms for cross-border insolvencies.
Proactively including such provisions may help lenders navigate future Chapter 11 cases more effectively.
Alternative Approaches – Offensive and Defensive DIP Financing
In the context of Chapter 11, Swedish lenders might consider participating as DIP lenders themselves with a view to gain greater control over the restructuring process and collateral priorities. On this note there are two distinct approaches to DIP financing: offensive and defensive, each with unique implications and strategies.
Offensive DIP Financing
Offensive DIP financing refers to funding provided by a new lender aiming to secure strategic control over the debtor’s restructuring or assets. This approach is typically used by opportunistic lenders or investors seeking to influence the direction of the restructuring process or acquire valuable assets at a later stage.
- Key Characteristics of Offensive DIP Financing:
- Often includes aggressive terms, such as “roll-ups,” where pre-petition debt is converted into super-priority post-petition DIP debt.
- May prime existing secured creditors, substantially altering the capital structure.
- Enables the DIP lender to exert significant control over the debtor’s financial and operational decisions.
While this strategy can yield high rewards for the DIP lender, it poses a significant threat to existing creditors, including Swedish lenders, as it can dilute or entirely subordinate their claims.
Defensive DIP Financing
Defensive DIP financing, by contrast, is used by existing creditors or lenders to protect their pre-existing claims and maintain influence over the restructuring. This strategy is often employed as a reaction to the risk of being primed by an external DIP lender.
- Key Characteristics of Defensive DIP Financing:
- Allows the existing creditor to safeguard its pre-petition position and maintain a voice in the restructuring process.
- Typically involves less aggressive terms compared to offensive DIP financing.
- Enables the lender to monitor and influence the use of DIP funds to ensure the protection of their collateral.
For Swedish lenders, defensive DIP financing can serve as a practical tool to preserve their interests, particularly when collateral or claims are at risk due to aggressive moves by third-party DIP lenders.
Practical Implications for Swedish Lenders
When confronted with DIP financing proposals, Swedish lenders should assess whether a defensive DIP financing strategy is feasible and beneficial. Participating as a DIP lender could:
- Protect the priority and enforceability of existing claims.
- Provide greater control over the debtor’s restructuring process.
- Minimise the risks associated with aggressive priming by an offensive DIP lender.
On the other hand, offensive DIP financing is less likely to be a strategy pursued by traditional Swedish lenders but could be relevant for opportunistic investors in Swedish-related assets subject to Chapter 11.
Practical Implications: Commercial Realities and USD Clearing
Access to USD clearing is often critical for international banking operations. Swedish lenders may find that rejecting DIP financing terms or priming liens jeopardizes this access, creating a strong commercial incentive to align with US bankruptcy outcomes.
Conclusion
DIP financing, particularly the use of priming liens, poses significant risks for Swedish lenders involved in Chapter 11 cases. By understanding the legal framework, engaging in DIP negotiations, and updating contractual terms, lenders can better protect their interests. Balancing domestic legal principles with the realities of USD clearing dependencies will be crucial for navigating these complex scenarios. Swedish lenders should also consider the provision of defensive DIP financing in order to protect their interests.
Disclaimer
The above analysis is provided for informational purposes only and is not intended as legal advice. The matters discussed herein involve complex cross-border legal considerations, and the specific circumstances of each case may vary significantly. Creditors are strongly encouraged to seek advice from competent Swedish and US legal counsel to address their unique situations and ensure compliance with applicable laws.
