What is a Priming Loan?
A priming loan is a form of debtor-in-possession (DIP) financing that allows a company that is in Chapter 11 bankruptcy proceedings to obtain credit to assist in specific areas of its business operations and reorganization. Funds from a priming loan can usually be used only to maintain the core business, such as repairs, supply chain management, and payroll. A priming loan may also be called a DIP loan.
How a Priming Loan Works
Priming loans are usually negotiated in the weeks leading up the beginning of Chapter 11 proceedings.
Companies that enter into a Chapter 11 reorganization are almost always run by the same management as before their bankruptcy filing. The company that has filed for bankruptcy is known as a debtor in possession or DIP. The bankruptcy filing gives the DIP protection from the claims of creditors, but also makes it likely that the company will need immediate financing to cover payroll and other pressing costs. The company's vendors may provide some financing for inventory, but they are more likely to require cash on delivery or cash before delivery.
Since it is, in effect, a loan to a bankrupt company, lenders willing to make a priming loan take on some added risk. A priming loan must also satisfy requirements for the the borrower's existing creditors, and language in the loan contract may call for money to be automatically set aside by the debtor company to pay interest and outstanding debt to those existing creditors.
Incumbent creditors—those secured lenders who lent money to the company before it filed for bankruptcy protection—will have a say in whether or not the company can get a priming loan. This is because repayment of a priming loan will take priority over any pre-existing debts the company has. A priming loan is valid only until a company emerges from bankruptcy.
Pros and Cons of a Priming Loan
From the borrower's point of view, a priming loan (or DIP loan) can provide the cash that a company needs to get through a Chapter 11 reorganization healthy enough to make a fresh start. It may also be the only viable option the company has.
But providers of debtor-in-possession financing, such as priming loans, are taking a significant risk in lending to companies that are wending their way through the bankruptcy and reorganization process. As such, the courts extend to DIP lenders a number of significant protections.
If a debtor company can prove that it could not obtain financing by any other means, the bankruptcy court may authorize the company to grant the DIP lender a lien that has priority not only over pre-bankruptcy secured lenders but also over administrative expenses, including vendor and employee claims. With such a lien, known as a priming lien, the DIP lender can typically insist on first priority to the debtor's inventory, receivables and any cash. The loan agreement may also give the DIP lender a second lien on encumbered property and first priority on the debtor's unencumbered property.
[Important: A priming loan can help a company emerge from bankruptcy and make a fresh start.]