a priming loan is a loan that allows a company in Chapter 11 bankruptcy to get credit and assistance for certain business operations and reorganization.
Priming Loan Details
Priming loans are also known as debtor-in-possession (DIP) loans. Usually, a business can only use money from a priming loan for core business functions, such as repairs, supply chain management, and payroll. These loans are most often negotiated between the bankrupt company and creditors in the weeks leading up to Chapter 11 proceedings. Companies that declare Chapter 11 reorganization are usually managed by the same people before filing bankruptcy—meaning that management is the same throughout the bankruptcy process. Because of this, the company is known as a DIP.
The filing helps protect the company from the creditors they had before filing bankruptcy. However, it also means that the company will need help with basic business operations and pressing costs like payroll and such. Sometimes vendors may give financing for inventory, but they will more likely demand cash on delivery or cash before delivery.
A priming loan needs to provide enough money for basic operations and make existing creditors happy. Language in the loan's requirements will also state that the company must set aside money to pay interest and outstanding debts to the existing creditors. A priming loan takes precedence over any debts the company has—the company will have to pay off the priming loan first. The loan is only valid until the company comes out of bankruptcy. This means that anyone who lent the company money before filing for bankruptcy will have a say in whether or not the bankrupt company can get a priming loan since, basically, they will be waiting even longer for the company to repay them.
Example of Priming Loan
ABC, Inc. is going to file for Chapter 11 bankruptcy. Currently, they owe $1 million to incumbent creditors and need $5 million to keep basic operations up while reorganizing. After successfully filing for bankruptcy, they now could possibly qualify for a priming loan. The company applies for the loan, and the incumbent creditors give the go-ahead. ABC, Inc. must only use the money to keep the company going. They must also pay off the $5 million first before they start to pay back the $1 million they owe to the incumbent creditors.
Significance of Priming Loan
Priming loans are only meant to keep a company going while they reorganize. The loan also helps the company come out of Chapter 11 in a somewhat healthy condition. Sometimes a priming loan is the only option the company has if it wants to keeps its doors opens. But this type of loan by no means takes care of the financial problems that the company was having during operation.
The biggest problem with a priming loan is the risk presented to the lenders. The lenders are taking a significant risk giving money to a company that had to file bankruptcy. Due to the loan's risk, courts give priming loan lenders a significant amount of protection.