DIP Financing for Bankrupt Retailers

In order for a retailer to complete a successful restructuring through the bankruptcy process, it must have sufficient liquidity.  In many cases, a retailer’s ability to borrow is still limited by high leverage.  Many retailers borrowed heavily during the credit boom that preceded the recession.  As a result, many retailers today have few unencumbered assets left to attract new money financing from a lender other than the prepetition lender.

Two methods are generally used to fund bankruptcy proceedings:  (a) obtain Debtor-In-Possession (or DIP) financing or (b) use cash collateral (essentially the Debtor’s cash on hand).

Use of Cash Collateral: The Bankruptcy Code requires the bankrupt retailer to receive the consent of the secured lender or authorization from the Court to use cash collateral.  The Court generally only allows the use of cash collateral for a limited duration of time and if additional time is needed, the retailer must seek Court approval.  It is not unusual for the use of cash collateral to be restricted to the payment of rent, payroll and limited purchases of inventory.  As a result, retailers typically use cash collateral only to fund a quick sale or liquidation of the business.

DIP Financing: Obtaining adequate DIP financing is one of most important and difficult obstacles facing bankrupt retailers.  DIP financing can provide funds to pay rent and payroll while, at the same time, maintaining vendor confidence in order to ensure an adequate inflow of new merchandise.

DIP Financing has been more restrictive recently due to a combination of the accelerated 210-day timetableto reject store leases and the collapse of the credit markets in late 2008.  Lenders now have a lower appetite for risk, which has caused DIP financing to become harder to obtain particularly for small and medium sized retailers.  There has also been a drop in the number of active DIP lenders.  As a result, costs to obtain DIP financing, where available, have skyrocketed.

Recently, most DIP financings came primarily from prepetition lenders rolling up their existing secured debt into a DIP facility.  Consequently, this has provided minimal additional liquidity for these bankrupt retailers.  In addition, DIP lenders provided shorter terms on the DIP financings.  As a result, DIP financing for retail debtors became little more than the funding needed to complete a going-out-of-business sale or a sale of the Company rather than the means to fund a reorganization of the business.

However, towards the end of 2010, it appears that the credit markets might be improving.  Experts have suggested that commercial banks are increasing their lending to small and medium-sized retailers.  For example, last month the bankrupt supermarket chain A&P obtained an $800 million DIP facility from new lenders, not the pre-petition lenders.

As such, it appears that the ability of retailers to obtain DIP Financing may improve in 2011.

Do you foresee an improving market for DIP financings in 2011?