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DIP LOANS: A NEW POCKETBOOK FOR DISTRESSED MUNICIPALITIES?
By: Manny Grillo
In most large bankruptcy reorganizations, the entity filing for protection (known in bankruptcy lingo as the debtor in
possession or “DIP”) requires new funding to finance the costs of the Chapter 11 case. Known as “DIP Loans,” this type of
financing is almost always secured by senior liens on the debtor’s assets. Special opportunity investment funds dominate the
landscape and provide much of the capital for these loans. In recent weeks, municipalities, such as Scranton, Pennsylvania,
facing significant short-term liquidity crises, have started to reach out to hedge funds as possible lending sources. This
raises the question as to whether municipalities will seek DIP Loans in Chapter 9 municipal bankruptcy cases, and, if so, on
what basis?
While not all of the provisions of the Bankruptcy Code apply in Chapter 9 cases, Section 901 of the Bankruptcy Code, makes
Sections 364(c) and (d) of the Bankruptcy Code applicable to Chapter 9 municipality bankruptcy cases. Under these
provisions, a debtor may borrow money on a senior secured (and even a priming) basis. Therefore, a court could grant an
order authorizing a municipal debtor to borrow money and grant senior security interests in its assets.
Municipalities typically borrow funds on a variety of bases and Scranton recently issued a tax anticipation note (TAN), a
practice it has used in the past, to cover payroll as part of its recovery plan. Unlike an “all assets” superpriority lien that is
common with DIP Loans in Chapter 11 reorganization proceedings, it remains to be seen what will happen if Scranton’s
economic recovery plan and the anticipated tax revenue to support the TANs falls short of expectations. Will Scranton or
another municipality look to the investment funds experienced in the distressed lending arena to provide DIP Loan financing?
Can the investment funds get comfortable with any pledge of collateral for the DIP Loan that a municipality may make?
As part of these transactions, DIP Lenders typically ask for a variety of other protections such as budgets and performance
covenants based upon these budgets. While courts can order debtors to comply with such provisions in most Chapter 11
cases in which DIP Loans are authorized, potential DIP Lenders in Chapter 9 cases should realize that the court’s power
over a municipal debtor may be limited. Under Section 904, absent the municipal debtor’s consent, the court may not
“interfere” with any of the “property or revenues of the debtor” or its “use or enjoyment of any income producing property.”
While a debtor might consent to the terms of the DIP Loan when made, will the municipality consent to the type of actions
lenders are normally permitted to take upon default? When underwriting a DIP Loan, DIP lenders carefully scrutinize their
ability to exercise remedies against their collateral. Will a bankruptcy court allow a DIP Lender to do that in a municipal
case? We may find out sooner rather than later.
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