Debtor in Possession
“Debtor in possession” is a term in U.S. bankruptcy law that refers to an individual or entity that has filed Chapter 11 bankruptcy, but remains in possession and control of property against which a creditor has a lien. In the case of a business, this gives the business owner the power to continue operating the business until the details of the bankruptcy have been settled.
The debtor in possession (“DIP”) may undertake any ordinary course of business, but must obtain the permission of the bankruptcy court before taking any action that falls outside the normal course of business activities. In addition, the DIP is required to keep meticulous financial records and file all appropriate tax documents, as these are likely to be scrutinized by the bankruptcy court. To explore this concept, consider the following debtor in possession definition.
Definition of Debtor in Possession
- A debtor who has filed for business reorganization or refinancing under Chapter 11 bankruptcy, and who is allowed to maintain possession of the business throughout the proceedings.
About Chapter 11 Bankruptcy
Chapter 11 bankruptcy is a form of bankruptcy in which an individual, corporation, or partnership reorganizes or restructures its debts. The business owner/debtor maintains possession and limited control over the business and assets, operating under close supervision of the bankruptcy court throughout the process. A committee of the business’s largest unsecured creditors is appointed by the Bankruptcy Trustee to provide oversight to the plan of reorganization. Such a plan can only be accepted by a vote of acceptance by the committee.
Restructuring of Debt
Chapter 11 bankruptcy involves companies facing financial distress reducing and renegotiating its delinquent debts, as such restructuring often helps restore financial solvency. Restructuring of debt outside of the bankruptcy setting involves working with creditors, bankers, vendors, and tax authorities to negotiate a lower debt and/or interest rate, and extension of payment terms. Many of these creditors feel that such out-of-court restructuring of debt is less expensive than allowing the debtor to go into bankruptcy.
Debtor in Possession Financing
In certain cases, a debtor in possession may obtain financing after filing Chapter 11 bankruptcy, for the purpose of keeping the business afloat until it can be sold as a going concern. Debtor in possession financing side steps the absolute priority rule in that it moves to the front of the line where debts in bankruptcy are concerned. Debtor in possession financing, also referred to as a “debtor in possession loan,” may be incurred only with the consent of the committee, and is used if it will provide a more beneficial end for the creditors than would the closure of the business.
Debtor in Possession Bank Accounts
When Chapter 11 bankruptcy is filed, all of the debtor’s existing bank accounts must be closed. This is because, during the reorganization under Chapter 11, the court and United States Trustee have the right to access information regarding the debtor’s bank accounts. As such, the debtor must open new bank accounts with a financial institution approved by the Office of the United States Trustee, clearly stating that each account is a debtor in possession bank account.
Depending on the type of business, the debtor may be required to open as many as three separate debtor in possession bank accounts with the approved bank. The first account type to be opened by all Chapter 11 businesses is a simple operating account into which monies received are deposited, and from which bills are paid. Other types of account that may be necessary include a payroll account, and an account for sales and use taxes, 401K pension monies, and other funds. In each case, the Trustee will specify what accounts need to be opened, and how they are to be used. By breaking down the company’s finances in this comprehensive manner, it is easier for the court, the Trustee, and the debtor to have a clear look into where the company stands throughout the recovery period.
Writing Checks on a DIP Account
Bankruptcy law requires that the fact that the check is being written by a debtor in possession be printed on every check from DIP accounts. This makes writing checks on a DIP account uncomfortable for some people, as they worry others may refuse to accept a check from someone who is in bankruptcy. While it is certainly possible to have the phrase pre-printed on the checks above or below the name line, it isn’t required. Many debtors writing checks on a DIP account simply hand write “DIP,” either in upper or lower case letters, after the name. This has satisfied the U.S. Trustee’s office in the past, but debtors should check with their Trustee before ordering or issuing checks.
Related Legal Terms and Issues
- Debtor – A person or entity that is in debt, or under a financial obligation to another.
- Creditor – A person or entity to whom money is owed by another person or entity.
- Unsecured Creditor – A creditor who extended credit to a debtor without obtaining assets as collateral.
- Going Concern – A company that has sufficient resources to continue operating for the foreseeable future.
- Absolute Priority Rule – A bankruptcy rule which asserts that creditors’ claims have absolute priority over shareholders’ claims. This rule requires payment be made in full to priority creditors before any other claims be considered.