Bankruptcy Financing: How DIP Loans Work Under Section 364

When a company files Chapter 11, it usually needs cash on day one to keep the lights on, and the Bankruptcy Code lets it borrow that cash through what is called debtor-in-possession, or DIP, financing. This is how DIP loans work in Chapter 11: Section 364 of the Bankruptcy Code lets the debtor take on new credit while the case is pending, and it lets the court give the new lender priority, liens, or both, sweetening the deal enough that a lender is willing to fund a business that has just filed for bankruptcy.¹ Without that mechanism, most debtors would run out of operating cash within weeks and convert to a Chapter 7 liquidation.

The Section 364 Priority Ladder

Section 364 gives the court a series of escalating tools. Each rung offers the lender more protection than the last, and the debtor can only climb higher by showing it couldn’t attract financing on the terms below.

Ordinary-Course Borrowing and Administrative Expense Status

The lowest rung: an operating debtor can borrow unsecured in the ordinary course of business without a special court order, and 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, a category that almost never applies to a corporate debtor.² For routine trade credit and small operating advances, that priority alone is often enough.

Superpriority and Liens

When administrative-expense treatment doesn’t attract a lender, Section 364(c) lets the court authorize three enhancements, individually or stacked together:¹

Superpriority status, which puts the lender’s claim ahead of every other administrative expense, including the debtor’s own professionals.
A lien on unencumbered property, meaning assets not already pledged to someone else.
A junior lien on already-encumbered property, sitting behind the existing lien holder.

The debtor must show it tried and failed to obtain financing on ordinary administrative-expense terms before the court will grant any of these. That showing is real, not a formality. Aggressive lenders sometimes negotiate for all three protections at once to build a belt-and-suspenders position.

Priming Liens

The most aggressive tool is a priming lien: a security interest that jumps ahead of a pre-bankruptcy secured creditor. If a bank held a first-priority mortgage on the debtor’s factory before filing, a priming lien puts the DIP lender ahead of that bank in line for the factory’s value.¹

Two requirements have to be met. First, the debtor must demonstrate that no less invasive financing is available. Second, the creditor being primed has to receive adequate protection, meaning the court must be satisfied that the creditor’s collateral position won’t deteriorate as a result. The debtor carries the burden of proof.¹

Section 361 identifies three forms adequate protection can take: periodic cash payments equal to the decline in collateral value, a replacement lien on other property, or any other relief that gives the creditor the indubitable equivalent of its original interest.³ Priming fights are among the most contentious moments in a Chapter 11 case, and existing lenders often choose to provide the DIP loan themselves rather than let a third party jump ahead of their collateral.

Cash Collateral: A Parallel Source of Liquidity

Not every Chapter 11 debtor needs to borrow new money. Many businesses generate cash from receivables, rents, or deposit accounts, and when a pre-bankruptcy lender has a security interest in that cash, the 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.⁴

Many cases run on both: a cash collateral order to keep operating revenue flowing, plus a DIP loan for expenses the existing cash flow won’t cover. Smaller cases sometimes run entirely on cash collateral with no DIP borrowing at all. The adequate-protection analysis is essentially the same either way.

How the Court Approves the Loan

A DIP loan requires a court order. The debtor files a motion, usually on day one of the case, and Federal Rule of Bankruptcy Procedure 4001(c) requires that motion to attach the credit agreement and include a concise statement of every material term: interest rates, borrowing limits, liens, defaults, and any controversial features.⁵

Because the debtor typically needs cash immediately, approval happens in two stages. An interim hearing within the first few days authorizes limited borrowing to meet payroll and pay critical vendors. Rule 4001 then prohibits the final hearing from starting earlier than 14 days after the motion is served, giving creditors and the unsecured creditors’ committee time to review the deal and file objections.⁵

The final hearing is where real scrutiny happens. Objections tend to focus on the rate, the fees, the scope of the liens, whether the debtor genuinely shopped the financing, and whether particular provisions lock in outcomes for the lender. Rule 4001(c) also requires the motion to individually flag a specific list of provisions if they appear in the credit agreement, including grants of priority or liens under Section 364, validation of pre-bankruptcy claims, stay waivers, plan deadlines, releases of estate claims, and indemnification of any party.⁵ The flagging requirement exists because these provisions can quietly reshape a case if they’re buried inside a 200-page credit agreement.

What Goes Into a DIP Agreement

DIP loan documents impose controls far tighter than a normal commercial loan. The lender is putting money into a bankruptcy and wants ongoing assurance about how it’s spent.

Budget Covenants

Every DIP agreement requires the debtor to operate within a detailed cash flow budget, usually on a weekly cadence. If actual spending exceeds the budget by more than a specified threshold — a common figure is roughly 10% on total disbursements — the lender can declare a default. This is where most day-to-day tension between the debtor and lender plays out.

Milestones

Lenders impose restructuring milestones tied to the Chapter 11 calendar: deadlines for filing a plan, obtaining approval of a disclosure statement, and completing a vote. Missing a milestone typically triggers a default, which gives the lender significant leverage over the pace and direction of the case.

Events of Default

Default triggers reach well beyond missed payments. Common events include appointment of a Chapter 11 trustee, conversion of the case to Chapter 7, dismissal of the case, or any breach of the budget or milestone covenants. On default, the lender can stop advancing new funds, accelerate the outstanding balance, and seek relief from the automatic stay to enforce its liens.

Professional Fee Carve-Outs

The carve-out protects the bankruptcy process itself. It reserves a pool of money from the lender’s collateral to pay the debtor’s lawyers and financial advisors even if the case falls apart and the lender isn’t fully repaid. Without a carve-out, professionals wouldn’t take the case, because the DIP lender’s superpriority claim would consume everything. Many courts insist on a reasonable carve-out as a condition of approval.

What DIP Financing Costs

DIP loans are expensive. The debtor is in bankruptcy, its leverage is minimal, and lenders price the risk accordingly. Interest rates on DIP facilities in 2026 commonly run SOFR plus 5% to 12%, with higher-risk or smaller deals pushing above that range. Some facilities charge interest on a payment-in-kind basis, letting it accrue and add to the loan balance rather than being paid currently in cash.

Fees layer on top. Commitment fees for reserving capital typically run 1% to 3% of the total facility. Exit fees, paid when the loan is repaid or the debtor emerges, 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 effective cost of a DIP loan is often materially higher than the stated rate suggests, and because every dollar of that cost is an administrative expense of the estate, creditor committees scrutinize 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 a plan provides into a new administrative expense that must be paid in full. If a bank was owed $50 million pre-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, on the theory that the new money benefits the estate enough to justify the priority upgrade on the old debt. Unsecured creditors often object anyway, arguing that a roll-up jumps the queue and shrinks what’s left for them.

Cross-collateralization, a related concept where pre-bankruptcy debt gets secured by post-petition assets it wasn’t originally entitled to, faces heavier resistance. It has no explicit statutory authorization, and a meaningful circuit split exists on whether courts can approve it at all.

How the Loan Gets Repaid

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

Sale Under Section 363

Many Chapter 11 cases end not in a plan but in a sale of most or all of the debtor’s assets under Section 363. The DIP lender’s superpriority claim and liens usually mean it gets paid from the proceeds first. A secured DIP lender also has the right to credit bid, using the debt it’s owed as currency at the auction instead of paying cash. A lender owed $30 million can bid $30 million without writing a check. Courts can restrict credit bidding for cause, but that’s rare and typically requires evidence of bad faith or genuine disputes about lien validity.⁴

Repayment Under a Plan

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

If the Case Fails

If the debtor cannot reorganize or attract a buyer, the case typically converts to Chapter 7 liquidation. The DIP lender keeps its priority and lien rights in that scenario and gets paid from whatever the liquidation trustee recovers, ahead of lower-priority creditors. Section 364(e) adds another layer: if the DIP financing order is later reversed on appeal, the debt and the liens already granted remain valid so long as the lender extended credit in good faith.¹ That appellate shield is a large part of what makes lenders willing to fund contested cases.

Small Business Cases Under Subchapter V

Subchapter V of the Bankruptcy Code offers a streamlined Chapter 11 for smaller businesses. To qualify, the debtor’s total noncontingent, liquidated debts (excluding debts to insiders and affiliates) must fall below a statutory cap that adjusts periodically for inflation; as of mid-2024, that cap was $3,024,725.⁶

The DIP mechanics are the same, because Section 364 applies equally, but the practical dynamics differ. Subchapter V cases move faster, there is no official creditors’ committee by default, and financing amounts are smaller. One wrinkle: because eligibility is based on total debt, a company considering pre-filing bridge financing needs to make sure the new borrowing doesn’t push it over the cap and disqualify it. Some businesses have used equity instruments like preferred shares 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 core trade-off is unchanged: the lender gets enhanced priority and lien protection in exchange for putting fresh 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