Debtor In Possession Vocabulary Phrase Relevant To Bankrupt Debtors    by Ben Pate

in Finance / Bankruptcy    (submitted 2011-02-14)

Debtor in possession (DIP) is a highly specific legal concept used frequently by insolvency lawyers and insolvency practitioners. It refers to a natural person or corporation that has formally declared them self a bankrupt (that is, filed a bankruptcy petition) but remains in possession of assets upon which a creditor has some form of security interest (such as, for example a lien). In practice, the term is most often used in connection with a corporation rather than a natural person.

A company that continues to run its affairs under Chapter 11 is a DIP. In this situation, the company submits a plan for reorganization with factoring receivables. It is permitted to manage in this way without oversight by a bankruptcy trustee Its reorganization plan usually includes proposed refinancings.

An entity that files a bankruptcy petition is, effectively, seeking protection by the court (that is, by the legal system) from creditors. The rights enjoyed by a DIP granted bankruptcy protection, as well as the rights of creditors dealing with a DIP, can vary between jurisdictions. Parties are commonly referred to specialist legal counsel in these circumstances.

In certain circumstances, a DIP may not only continue to manage and operate assets under claim by creditors, they may even purchase them from those creditors at market value. Courts are particularly likely to approve such purchases if the DIP can substantiate the assets are necessary for the ongoing viability of the business and hence vital for the eventual repayment to creditors.

Modern bankruptcy law exists to protect debtors from attack by creditors. It has its roots when commercial dealings in Florence during the 1400s and 1500s. In those days, bankrupt debtors had few rights. Disgruntled creditors regularly petitioned the courts to take seize all possessions of a bankrupt and have that individual thrown in jail with no opportunity to recover from the straitened circumstances.

Over the centuries, society has progressively adopted a more enlightened attitude toward bankruptcy situations. It came to view bankruptcy as an inevitable fall-out of modern business activity. Commercial risk makes some bankruptcies inevitable, often more because of situational circumstances rather than personal weaknesses.

Legal systems in most western countries these days recognize that risk taking is an inherent part of business. Things do sometimes go wrong. Bankruptcy law acknowledges that reality. It has evolved a framework that protects creditors and also allows debtors to claim a right to recover from adverse circumstances if they can establish that the recovery effort will be of benefit to creditors.

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One small example of this principle in action is debtor in possession financings. These funding arrangements are provided to entities that have declared themselves bankrupt with accounts receivable factoring. When concluded in this context, financings are assigned special status under law. For example, any security offered in a DIP financing has senior ranking in a default scenario; it even stands ahead of equity.