DEFINITION of 'Bankruptcy Financing'

Bankruptcy financing is another term for debtor-in-possession financing, or the money a lender provides to a company going through a chapter 11 bankruptcy reorganization. This money is used by a company to fund its operations while it goes through the bankruptcy process. 

BREAKING DOWN 'Bankruptcy Financing'

It may seem odd that a company going through bankruptcy would be able to access bankruptcy financing. After all, the company has filed for bankruptcy because it is unable to pay back its debts. But bankruptcy financing, or debtor-in-possession financing, is a common activity for many financial institutions to engage in, and it's an essential part of the corporate bankruptcy process. 

Chapter 11 bankruptcy is so named because the rules for this process are enumerated in chapter 11 of the United States Bankruptcy Code. A firm files for Chapter 11 bankruptcy when it cannot pay its debts back in full, and wants a federal judge to oversee the reorganization of their debts. Because Congress understood that lenders may be reluctant to lend to a business that just filed for bankruptcy, it has allowed judges to declare that the lender of bankruptcy financing will be repaid before many other creditors, like previous lenders, employees, or suppliers. Typically, debtor-in-possession financiers will require a first-lien on a company’s receivables, or the money it is owed by its customers, and a second-lien on real property like plants and equipment. 

For large bankruptcy cases, a company will typically arrange bankruptcy financing prior to filing for bankruptcy and making those plans public. Bankruptcy financing of this type tends to be much larger in size than the expected needs of the company, to account for any unforeseen circumstances that may arise during the bankruptcy process. 

Example of Bankruptcy Financing

Let’s say that the Tallahassee Widget Company has issued $1 million in bonds at 6% interest, unsecured against any capital, and has taken out a $2 million bank loan at 4%, secured against its Tallahassee factory. The company’s sales plummeted after its rival, the Albuquerque Widget Company debuted a new widget that is half the price and twice as effective. The decline in sales has made it impossible for the Tallahassee Widget Company to service its bond and loan payments, and the company has decided to file for Chapter 11 bankruptcy. 

The company believes it can make a comeback if able to refurbish its factory so that it can make a similar product to its Albuquerque rival, and has convinced a lender to promise it bankruptcy funding so that it can make those improvements. The bank lends it bankruptcy financing at 10% interest, which it will begin repaying in three years. During the course of the bankruptcy process, the judge forces bond holders and the original lending bank to accept a delay in payments so that the Tallahassee Widget Company can reorganize and fight its way back to profitability.

RELATED TERMS
  1. IRS Publication 908

    IRS Publication 908 explains the basic federal income tax aspects ...
  2. Technical Bankruptcy

    Technical bankruptcy refers to a state of either unprotected ...
  3. Bankruptcy

    Bankruptcy is the legal proceeding involving a person or business ...
  4. Bankruptcy Trustee

    Bankruptcy trustee is a person appointed by the United States ...
  5. Debt Loading

    Debt loading occurs when one spends case reserves, maxes out ...
  6. Chapter 10

    Chapter 10 was a type of corporate bankruptcy filing that was ...
Related Articles
  1. Taxes

    How To Survive A Bankruptcy Filing

    Learn how to make filing for bankruptcy less painful so you can successfully rebuild your financial life.
  2. Taxes

    Changing The Face Of Bankruptcy

    A 2005 law attempts to unmask fraudulent debtors and still save those who are struggling. Will it affect you?
  3. Personal Finance

    What You Need To Know About Bankruptcy

    Don't choose this last-resort option until you learn how it will affect your future.
  4. Investing

    5 Energy Companies Crushed by Low Oil in 2016

    Oil companies globally are at risk of slipping into bankruptcy, and many of these businesses could disappear, leaving the sector worse off than in 2008.
  5. Small Business

    The 5 Biggest Oil Bankruptcies of All Time (CVX, OGXP3.SA)

    Learn about the five largest bankruptcies in the oil industry. With oil prices in a slump and a global oversupply of oil, more bankruptcies loom on the horizon.
  6. Retirement

    Boomer Bankruptcy Strains Retirement

    Having to file for bankruptcy adds risk and steals the luster from your golden years.
  7. Personal Finance

    Prevent Bankruptcy With These Tips

    Filing for bankruptcy is often viewed as an easy out of debt. This financial decision should only be used as a last resort. Find out how to avoid it.
  8. Investing

    Buying a House After Bankruptcy? It Is Possible!

    Buying a house after bankruptcy is not impossible. It just takes time to repair your credit score and demonstrate you're a good risk for a mortgage.
  9. Small Business

    Not Too Big To Fail: Corporate Financial Struggles

    Even the biggest corporations are not immune to financial failure. Here are five the biggest corporate bankruptcies of the decade.
  10. Investing

    Halcon Resources Exits Bankruptcy Restructure (HK)

    Halcon Resources exits quickly from prepackaged Chapter 11 bankruptcy agreement.
RELATED FAQS
  1. Can personal loans be included in bankruptcy?

    Read about debts that are dischargeable when filing for bankruptcy. Learn about how personal loans are treated when filing ... Read Answer >>
  2. Do shareholders lose all their equity once Chapter 11 bankruptcy is filed?

    Learn what happens to an investor's equity when a company files for Chapter 11 bankruptcy. Find out what happens if a company ... Read Answer >>
Trading Center