Definition of debtor in possession (DIP)

What is a Debtor in Possession (DIP)?

A Debtor in Possession (DIP) is a person or company that has filed for Chapter 11 bankruptcy protection, but still holds property over which creditors have a legal claim under a lien or of another surety. A DIP can continue to do business using these assets. However, it is necessary to seek court approval for any action outside the scope of regular business activities. The DIP must also maintain accurate financial records, insure all property, and file the appropriate tax returns.

Key points to remember

  • A Debtor in Possession (DIP) is a person or company that has filed for Chapter 11 bankruptcy protection, but still holds property over which creditors have a legal claim under a lien or of another surety.
  • Debtor in Possession (DIP) is usually a transitional stage where the debtor attempts to recover the value of assets after bankruptcy.
  • Although DIPs often wield substantial influence over assets in their possession, creditors can ultimately use the courts to force the sale of DIP assets.
  • The main benefit of DIP status is being able to continue to run a business, but with the power and obligation to do so in the best interests of all creditors.

Understanding Debtor in Possession (DIP)

Debtor in Possession (DIP) is usually a transitional stage where the debtor attempts to recover the value of assets after bankruptcy. The most obvious reason for obtaining DIP status is if the assets are used in the course of a going concern with a higher resale value than the assets themselves. DIP status allows bankrupt businesses and individuals to avoid liquidation at rock bottom prices, which helps both those who are bankrupt and their creditors.

Consider a family restaurant that was forced out of business during a recession. The restaurant may still have talented staff, a good reputation and loyal customers. These could all be more valuable to the right buyer than the restaurant building and equipment. However, it can take months or even years to find that buyer. A debtor in possession might be able to continue operating until they find the right buyer.

Alternatively, debtor-in-possession status can be used to reorganize a business. Going back to the example of the bankrupt restaurant, they might eventually find a local investor willing to buy their building and rent it to them. The funds from the sale could be used to pay off all their creditors and get out of bankruptcy. The restaurant would then resume its activities on another basis.

Although DIPs often wield substantial influence over the assets they own, it is essential to realize that they no longer own those assets. Creditors can ultimately use the courts to force the sale of the DIP’s assets.

Benefits of a debtor in possession (DIP)

The main benefit of DIP status is, of course, being able to continue to run a business, but with the power and obligation to do so in the best interests of all creditors. A DIP may also be able to obtain debtor in possession financing (DIP financing) which can help maintain the solvency of the business until it can be sold.

A debtor in possession can sometimes even keep the property by paying the creditor fair market value if the court approves the sale. For example, a debtor may be looking to buy back his personal car (a depreciated asset), so he can use it to work or find work to repay the creditor.

The ability to continue to do business as a debtor in possession is naturally limited by creditors. Creditors will eventually demand payment and force the sale of the assets in the debtor’s possession.

Disadvantages of a debtor in possession (DIP)

After filing for Chapter 11 bankruptcy, the debtor must close the bank accounts they were using before the filing and open new ones that name the DIP and their status on the account. From this point on, many decisions that the debtor could previously make alone must now be approved by a court.

A debtor in possession must act in the best interests of creditors and its employees. The DIP must pay salaries and make the appropriate deductions. The business must use the withheld funds to file taxes and pay both the employee and employer portion of the FCIA. Other expenses are carefully regulated. For example, the debtor generally cannot repay debts incurred before the bankruptcy filing. Debt payments that are authorized under the Bankruptcy Code or approved by the court are the exceptions. The DIP also cannot pledge company assets or employ and remunerate professionals without court permission.

Likewise, unless the court orders otherwise, federal, state, and local tax returns must continue to be filed when due, or with extensions requested by the DIP if necessary. The DIP must also maintain adequate insurance on the assets of the estate – and be able to document this coverage – and must provide periodic reports on the financial health of the business.

If the debtor fails to comply with these obligations or fails to comply with court orders, the DIP designation may be terminated, after which the court will appoint a trustee to manage the business. This step can make it more difficult for the debtor to rescue their business and settle their debts.