Debtor-in-Possession Financing: Looking Beyond the Debtor

Abstract

A concern often raised in relation to the U.S. bankruptcy regime is the high level of control over proceedings enjoyed by secured lenders. In particular, through the use of the arsenal of provisions in debtor-in-possession (DIP) financing, secured lenders can quickly effectuate asset sales. While this strategy minimizes the time taken to realize cash recoveries for the secured lenders, it may not maximize the value of the estate for all creditors. To understand how this set of strategies is playing out in the housing market during the current economic recession, we undertake an in-depth study of three recent bankruptcy cases of residential developers: Shores of Panama, Inc., Suncrest LLC and LandSource Communities Development LLC. Our analysis shows that DIP financing often comes at a cost which other stakeholders might consider to be extraordinary. Looking beyond the debtor’s situation to the banks involved, we found that the banks which succeeded in repossessing uncompleted property had trouble either maintaining the development in the aftermath or selling the property after purchasing it through a credit bid – further evidence that a mix of secured lender control and preference for quick asset sales might not produce optimal results even for lenders themselves. We also illustrate the case where a bank which succeeded in repossessing the property was seized by regulators 2 months later for being insufficiently capitalized, indicating why banks, in this crisis, might push for a quick liquidation at the cost of an economically optimal outcome in specific cases. Through an analysis of the financial condition and capital adequacy of the banks involved, we also explore in greater detail the motivations and constraints of the secured lenders themselves, which contemporary bankruptcy literature often fails to do.

Keywords: bankruptcy, corporate reorganization, Chapter 11, debtor-in-possession financing, creditor control, bank regulation, capital adequacy

JEL Classification: G21, G33, G34, G38, K29, L51, O16