Bankruptcy Financing: How DIP Loans Work Under Section 364

When a company files for Chapter 11, it almost always needs new cash on day one to keep paying employees, suppliers, rent, and utilities. Debtor-in-possession financing, usually called DIP financing, is how a Chapter 11 debtor gets that cash: it’s borrowing authorized by Section 364 of the Bankruptcy Code, approved by the bankruptcy court, and backed by lender protections that ordinary commercial loans don’t carry.¹ Without it, many filers would have no realistic choice but to convert the case to a Chapter 7 liquidation.

DIP loans work because the Bankruptcy Code lets the court hand the new lender a package of priorities and liens strong enough to make lending into an obviously distressed business worth doing. Understanding how DIP financing works in Chapter 11 means understanding that package: what the lender gets, what it costs the estate, how the court approves it, and how it eventually gets paid off.

Why a Chapter 11 Debtor Needs New Money

The moment a Chapter 11 petition is filed, trade creditors go on alert, suppliers often demand cash in advance, and existing credit lines usually freeze. Operating revenue by itself is rarely enough to bridge the gap. A DIP facility solves two problems at once: it funds immediate operating needs, and it signals to vendors, customers, and employees that the business has liquidity to keep running while it restructures.

Some smaller cases don’t need a new loan at all and instead rely on cash collateral, which is covered further down. But most Chapter 11s of any size involve at least some DIP borrowing, and the terms of that borrowing often shape the direction of the entire case.

The Section 364 Priority Ladder

Section 364 sets up a tiered system. Each rung offers the lender more protection than the last, and the debtor can only climb to the next rung by proving it couldn’t attract financing on less aggressive terms.

Unsecured Credit as an Administrative Expense

At the bottom, a debtor authorized to keep operating can borrow unsecured in the ordinary course of business without any special court order. That debt is automatically treated as an administrative expense of the estate.¹ Administrative expenses sit near the top of the overall priority hierarchy, behind only domestic-support obligations, which almost never apply in a corporate case.² That means these loans must be paid in full before any general unsecured creditor sees a dollar. For routine trade credit, that priority is often enough.

Superpriority and Secured Positions

When administrative-expense status isn’t enough, the court can authorize more. Section 364(c) allows three enhancements, used alone or stacked:¹

Superpriority status, which puts the DIP lender’s claim ahead of every other administrative expense, including the debtor’s own professional fees.
A lien on property that isn’t already pledged to anyone else.
A junior lien on property that is already pledged, sitting behind the existing lien holder.

The debtor has to show it tried and failed to borrow on ordinary administrative-expense terms before the court will approve any of this. That showing is real. Lenders frequently negotiate for all three protections at once, building a position with belt and suspenders.

Priming Liens

The most aggressive option is a priming lien, which leapfrogs the DIP lender over existing secured creditors. If a bank held a first-priority mortgage on the debtor’s factory before the filing, a priming lien puts the DIP lender ahead of that bank in line for the factory’s value.¹

Two requirements apply. The debtor must prove it cannot obtain financing on any less invasive terms, and the existing secured creditor whose lien is being primed must receive adequate protection: the court has to be satisfied that creditor’s collateral position won’t deteriorate. The debtor carries the burden of proof.

Section 361 lists three forms adequate protection can take:³ periodic cash payments equal to any decline in collateral value, replacement liens on other property, or any other relief that gives the creditor the “indubitable equivalent” of its original interest. Priming fights are among the most contentious moments in a Chapter 11 case, and existing lenders sometimes offer to provide the DIP loan themselves rather than risk being primed by a third party.

Cash Collateral as an Alternative

Not every debtor needs to borrow new money. Many businesses generate cash from ongoing operations, and if a pre-bankruptcy lender has a security interest in that cash, receivables, or deposit accounts, the Bankruptcy Code calls it cash collateral. The debtor cannot spend cash collateral without either the secured creditor’s consent or a court order, and any court authorization requires adequate protection for the creditor’s interest.⁴

Many cases involve both a cash collateral order and a DIP loan. The cash collateral order lets the debtor keep spending its own operating revenue, and the DIP loan provides a cushion for expenses that revenue won’t cover. Smaller cases sometimes run entirely on cash collateral with no new borrowing at all.

Getting the Loan Approved

DIP financing cannot proceed without a court order. The debtor files a motion requesting approval, usually among the very first filings on the day the case begins. Federal Rule of Bankruptcy Procedure 4001(c) requires the motion to attach the credit agreement and to include a concise summary of every material term: interest rates, borrowing limits, liens, defaults, and any controversial features.⁵

Interim Order, Then Final Order

Because the debtor often needs cash immediately, approval splits into two stages. An interim hearing in the first few days authorizes limited borrowing so the debtor can meet payroll and pay critical vendors. Rule 4001 prohibits the final hearing from starting any earlier than 14 days after the motion is served, giving creditors and the unsecured creditors’ committee time to review the deal and object.⁵

The final hearing is where the real scrutiny happens. Objections typically target the interest rate, fee structure, scope of liens, whether the debtor genuinely shopped the financing, and whether any provisions lock in a particular outcome for the lender. The court decides whether the financing serves the best interest of the estate and whether the terms are fair given the debtor’s limited alternatives.

Provisions Rule 4001 Makes You Flag

Rule 4001(c) lists specific provisions that must be individually highlighted in the motion if they appear in the credit agreement: grants of priority or liens under Section 364, attempts to validate a pre-bankruptcy claim, waivers of the automatic stay, deadlines for filing a plan, releases or waivers of estate claims, and indemnification of any party.⁵ The flagging requirement exists because these provisions can quietly reshape the entire case if they’re buried in a long credit agreement.

What’s Inside a DIP Credit Agreement

DIP loan documents impose controls far more restrictive than a typical commercial loan. The lender is extending credit into a bankruptcy and needs ongoing assurance that the money is being used as agreed.

Budget Covenants

Every DIP agreement requires the debtor to operate within a detailed cash flow budget, usually broken down week by week. If actual spending exceeds the budget by more than a specified threshold, commonly around 10% for total disbursements in a period, the lender can declare a default. Some agreements set tighter limits on individual line items. Day-to-day friction between the debtor and lender tends to live here.

Restructuring Milestones

Lenders also impose deadlines tied to the Chapter 11 calendar. Typical milestones include dates for filing a reorganization plan, obtaining court approval of a disclosure statement, and completing a plan vote. Missing a milestone usually triggers a default, which gives the lender significant leverage over the pace and direction of the case.

Events of Default

Default triggers go well beyond missed payments. Common triggers include the appointment of a Chapter 11 trustee, conversion of the case to Chapter 7, dismissal of the case, or breach of the budget or milestone covenants. When a default happens, the lender can stop advancing new funds, accelerate the balance, and seek relief from the automatic stay to exercise its lien rights.

The Professional Fee Carve-Out

One provision protects the bankruptcy process itself. A carve-out reserves a pool of money from the DIP lender’s collateral to pay the debtor’s lawyers and financial advisors even if the lender isn’t fully repaid. Without one, no professional would work the case, because the lender’s superpriority claim would consume everything. Many courts insist on a reasonable carve-out as a condition of approving the financing.

What DIP Loans Cost

DIP loans are expensive. The debtor is in bankruptcy, its leverage is minimal, and lenders price the risk accordingly. Interest rates commonly run SOFR plus 5% to 12%, depending on the size and risk profile of the borrower, with smaller or riskier deals pushing higher. Some facilities charge interest on a payment-in-kind basis, meaning it accrues and is added to the loan balance rather than paid currently in cash.

On top of interest, DIP agreements usually layer on fees. Commitment fees compensate the lender for reserving capital, typically 1% to 3% of the facility. Exit fees, paid when the loan is repaid or the debtor leaves bankruptcy, commonly run 1% to 5% of the commitment but can reach 10%. Backstop fees reward lenders who guarantee the financing will be available, and structuring premiums compensate lead arrangers. The all-in effective cost can be meaningfully higher than the stated rate suggests.

All of these costs are administrative expenses of the estate and get paid before almost all pre-bankruptcy claims. Every dollar paid in DIP fees is a dollar unavailable for distribution to unsecured creditors, which is why creditor committees look at the terms closely.

Roll-Ups and Cross-Collateralization

A roll-up lets the DIP lender convert some or all of its pre-bankruptcy debt into post-petition debt, transforming an old loan that would be paid at whatever rate the plan provides into a new administrative expense that must be paid in full. If a bank was owed $50 million before the filing and provides a $20 million DIP loan with a $50 million roll-up, the bank’s entire $70 million position becomes a post-petition obligation with administrative-expense priority.

Courts generally permit roll-ups when the DIP facility also provides genuinely new credit, meaning the total lending commitment exceeds the pre-bankruptcy exposure. The theory is that the new money benefits the estate enough to justify the priority upgrade on the old debt. Unsecured creditors frequently object anyway, arguing a roll-up simply jumps the queue.

Cross-collateralization is a related and more disputed concept, where pre-bankruptcy debt gets secured by post-petition assets it wasn’t originally entitled to. It has no explicit statutory authorization, and courts split on whether it can be approved at all. Some have allowed it under the equitable powers of Section 105; others have held it violates the Bankruptcy Code’s priority scheme.

How the Loan Gets Repaid

DIP financing is designed to be temporary. It is repaid when the Chapter 11 case concludes, through one of a few paths.

Sale of the Business Under Section 363

Many Chapter 11 cases end not with a reorganization plan but with a sale of most or all of the debtor’s assets. Section 363 authorizes these sales, and the DIP lender’s superpriority claim and liens typically mean it is paid from the proceeds before anyone else. A secured DIP lender also has the right to credit bid, using the debt it is owed as currency at the auction instead of writing a check. A lender owed $30 million can bid $30 million. Courts can restrict credit bidding for cause, but doing so is rare and usually requires evidence of bad faith or genuine disputes about the validity of the lender’s liens.⁴

Repayment Through the Plan

If the debtor successfully reorganizes, the confirmed plan specifies how the DIP loan is treated. The most straightforward approach is a roll-off, repaying the loan in full in cash on the plan’s effective date. Alternatively, the DIP loan converts into exit financing, a longer-term loan secured by the assets of the reorganized company. Exit facilities typically carry lower interest rates and fewer restrictive covenants than the DIP loan they replace, reflecting the reduced risk of lending to a company that has shed its legacy debt.

Conversion to Chapter 7

If the debtor can’t reorganize and no buyer appears, the case typically converts to Chapter 7 liquidation. The DIP lender keeps its priority and lien rights and is paid from whatever the liquidation trustee recovers before lower-priority creditors. Section 364(e) adds another layer: if the DIP financing order is later reversed on appeal, the debt and liens already granted remain valid as long as the lender extended credit in good faith.¹ That appellate shield is a powerful reassurance for lenders worried about contested situations.

Smaller Cases Under Subchapter V

Subchapter V offers a streamlined Chapter 11 for smaller businesses. To qualify, the debtor’s total noncontingent, liquidated debts, excluding debts owed to insiders and affiliates, must fall below a statutory cap. As of mid-2024 the cap was $3,024,725, and the figure adjusts periodically for inflation.⁶

The DIP financing mechanics are identical because Section 364 applies the same way, but the practical picture differs. Subchapter V cases move faster, there is no official creditors’ committee by default, and the financing amounts are smaller. One wrinkle: because eligibility is based on total debt, a company considering pre-filing bridge financing has to be careful that the new borrowing doesn’t push it over the cap and disqualify it from Subchapter V. Some businesses use preferred equity instead of debt specifically to preserve eligibility. DIP lenders in these cases tend to be existing lenders rather than specialized distressed-debt funds, but the same core trade-off applies: enhanced priority and lien protection in exchange for putting new money into a business that is already in trouble.

1
Office of the Law Revision Counsel. 11 U.S. Code 364 – Obtaining Credit
2
Office of the Law Revision Counsel. 11 USC 507 – Priorities
3
Office of the Law Revision Counsel. 11 USC 361 – Adequate Protection
4
Office of the Law Revision Counsel. 11 U.S. Code 363 – Use, Sale, or Lease of Property
5
Legal Information Institute. Federal Rules of Bankruptcy Procedure – Rule 4001
6
U.S. Department of Justice. Subchapter V