In a recent article in the Emory Bankruptcy Developments Journal, Professor Kenneth Ayotte and Alex Zhicheng Huang, a Robbins J.S.D. Fellow, analyze how “debtor-in-possession” (DIP) loans, which are intended to help a company finance its bankruptcy case, are effectively reorganization plans in disguise. Often, the DIP lenders becomes the creditors that win what they describe as the “golden ticket”: the ability to control the bankruptcy case and decide on the payoffs to creditors in the reorganization plan. But while this process can preserve the company, it works against the respect for priorities, a main goal of the bankruptcy system.
Using the 2020 J.C. Penney bankruptcy as a case study, they estimate that a standardized, unbundled DIP loan would have required an interest rate of at least 545% to give the majority group the same payoff — far higher than any judge would be likely to approve. These sub rosa processes must be made more transparent to protect priorities, they argue.
“If lenders want approval of a first-priority loan with a 545% interest rate, they should be forced to present this transparently to a court, Ayotte and Huang write. “We think judges would be much more likely to push back against extreme terms like these when the true cost is brought to light.”