What is a Debtor in Possession (DIP)?

A debtor in possession (DIP) is a person or corporation that has filed for Chapter 11 bankruptcy protection, but still holds property to which creditors have a legal claim under a lien or other security interest. A DIP may continue to do business using those assets, but is required to seek court approval for any actions that fall outside of the scope of regular business activities. The DIP must also keep precise financial records, insure any property, and file appropriate tax returns.

Rights as a Debtor in Possession (DIP)

The key advantage to DIP status is, of course, to be able to continue running a business, albeit with the power and obligation to do so in the best interest of any creditors. After filing for Chapter 11 bankruptcy, the debtor must close the bank accounts they used prior to the filing and open new ones that name the DIP and their status on the account.

A company's actions as a DIP are closely regulated by the courts, but the status may allow it to salvage some assets.

From that point on, a number of decisions the debtor might previously have made alone must now be approved by a court. Provided they obtain that permission, however, a DIP may be able to secure debtor-in-possession financing (DIP financing) that can help to keep the business solvent until it can be sold.

A debtor in possession can sometimes even retain property by paying the creditor fair market value for it, again if the court approves the sale. For example, a debtor may seek to buy back their personal car (a depreciated asset) so they can use it to work or find work to pay off the creditor.

Obligations as a Debtor in Possession (DIP)

A debtor in possession must not only act in the best interests of creditors, but also of employees of the business. Wages must be paid and withholdings made, with the withheld funds used to deposit taxes and pay both the employee and employer share of FICA.

Other spending is closely regulated. For example, the debtor cannot pay off any debts that arose prior to filing for bankruptcy unless those are permissible under the Bankruptcy Code or have been approved by the court. Nor can the DIP put up company assets as collateral or employ and pay professionals without the same permission.

Similarly, unless the court rules otherwise, federal, state, and local tax returns must continue to be filed when due, or with extensions sought by the DIP as needed. The DIP also needs to maintain adequate insurance on estate assets—and to be able to document that coverage—and must provide periodic reporting on the financial health of the business.

Should the debtor not meet these obligations, or fail to follow court orders, the DIP designation can be terminated, after which the court will appoint a trustee to manage the business. That step can make it more difficult for the debtor to salvage its enterprise and deal with its debts.