Despite the credit crunch, 2009 was a record-setting year for debtor-in-possession financing by almost any measure. Debtors in 2009 raised 356 DIPs totaling $59.67 billion through Nov. 15, compared with 300 DIPs totaling $17.36 billion over the same period a year earlier, according to The Deal Pipeline.

Obviously, the numbers are skewed by the mamoth DIPs lent by the U.S. Treasury Department and Export Development Canada in the megabankruptcies of General Motors Corp. (which received $33.3 billion in DIP financing) and Chrysler LLC ($4.96 billion). But even without those cases, debtors had secured $21.41 billion in DIP financing through Nov. 15, still more than 2008's total and way ahead of the pace through the same period in 2006 and 2007.

But the numbers are only part of the story. More important are the heavily layered capital structures with which debtors entered Chapter 11 and how those complicated structures defined the real power brokers in each case.

Deeply levered debtors also usually have little or no unencumbered assets to offer traditional DIP lenders as collateral. Absent a priming battle in bankruptcy court -- a rare, but lengthy and expensive, occurrence -- a DIP lender cannot move in and prime an existing lender's security interests. Add to that a decline in valuations, and you are left with a very slim equity cushion (if any at all) that DIP lenders can look to as security.

The result is a shift to an era of postpetition finance dominated by existing lenders -- mostly traditional banks with no real appetite for bankruptcy lending. This shift is taking place despite the existence of third parties with the funds and desire to enter the lucrative DIP market.

Not including Treasury and EDC, Citigroup Inc. was the biggest DIP lender in 2009 through Nov. 15, providing $2.4 billion through seven loans. Bank of America Corp. was next with 29 DIPs totaling $2.33 billion, followed by General Electric Co. ($1.12 billion, 22 DIPs), UBS ($953.17 million, seven DIPs) and Goldman Sachs Group Inc. ($911.99 million, two DIPs).

"We still haven't seen a really true, new DIP lender, one that's looking for an opportunity to lend strictly for a return on their capital," says Brett Barragate, co-head of Jones Day's financial institutions litigation and regulation practice in New York.

Barragate notes that in the rare case when a debtor could raise a third-party DIP in 2009, it usually came from an investor looking to acquire its assets out of bankruptcy and using the loan as a bridge to a Section 363 sale. Sun Capital Partners Inc. used this strategy to purchase Catterton Partners portfolio company Lang Holdings Inc.

Lang entered Chapter 11 on July 16 with a $16 million DIP from Sun Capital affiliate Sun Lang Finance LLC. The Boca Raton, Fla., firm teamed with Catterton to form LHI Enterprises Inc. to buy Lang. Sun Capital credit-bid roughly $15 million outstanding on its DIP, while Catterton credit-bid a portion of debt it acquired from prepetition lender Bank of America.

"The concept of hiring an investment banker to get the right terms for DIP financing and get [lenders] to compete against each other" no longer exists, says Cathy Hershcopf, a partner in Cooley Godward Kronish LLP's bankruptcy and restructuring group.

The dominance of traditional banks in DIP lending has changed how DIPs are structured. Refinancing through rolling up outstanding debt into a DIP loan is by no means a new phenomenon. But in 2009, existing lenders were as creative as ever in rolling up their debt, giving them priority above almost all other creditors in repayment. The result has been less bang for the debtor's buck.

The 356 DIPs raised by debtors through Nov. 15 include $50.37 billion, or 84.4%, of "new money." Take GM and Chrysler out of the equation, and the remaining DIPs include $12.11 billion, or just 56.5%, in new money. In other words, DIP lenders, excluding Treasury and EDC, used almost half of their total DIP commitments to roll up their existing debt. And that often serves only as a means for existing lenders to keep the lights on long enough to liquidate their collateral.

Circuit City Stores Inc. is a case in point. The electronics retailer entered bankruptcy in late 2008 with a $1.1 billion DIP from existing lenders led by BofA, GE Capital Markets Inc. and Wells Fargo Retail Finance LLC. The DIP rolled up some $898 million outstanding on Circuit City's $1.3 billion prepetition line of credit and required Circuit City to raise $75 million in junior financing.

When the chain could not do that -- and missed revenue projections to boot -- its DIP lenders pulled the plug and forced it into liquidation.

In early 2009, two bankruptcies introduced a creative way to give lenders an incentive to fund large DIP loans with new capital. Lyondell Chemical Co.'s $8.5 billion DIP (the second-largest commitment in 2009, behind GM's) and Aleris International Inc.'s $1.62 billion DIP both feature a dollar-for-dollar rollup of prepetition debt.

Lyondell's DIP includes a $6.5 billion term loan, half of which is new funding, while the remainder rolls up prepetition debt. (The DIP also includes a $1.52 billion revolver, expandable to $2 billion, to replace existing working capital facilities.) In addition to a $575 million revolver, Aleris' DIP rolls up as much as $540 million in term debt and contains roughly $500 million in new money.

Such a structure gives lenders incentive to lend new money to a bankrupt company and provides debtors with enough capital -- and time -- to successfully reorganize. "What we saw [in 2009] in the way of these imaginative devices is a testament to how we started the year without [financing] and clawed our way through it with incentive-driven DIPs," Baena says.

Following Lyondell and Aleris, it seemed that virtually every bankruptcy loan with a substantial new-money commitment would include a dollar-for-dollar rollup. But rather than become the new norm, DIPs with this structure may reflect only the turbulent times of early 2009. "The only reason you need a rollup is that there's no third-party capital available for a DIP," says Mark Cohen, head of restructuring at Deutsche Bank AG. "Rollups are a sign of a fractured market."

While Aleris and Lyondell were able to persuade their existing lenders to commit new money by creating innovative DIP structures, dozens of other companies were forced to consent to more basic rollups of their debt through DIP loans. One debtor in particular, though, became the envy of all bankrupt companies.

General Growth Properties Inc., which owns and operates 200 malls in 44 states, entered Chapter 11 with a $375 million all-new-money DIP from equity holder Pershing Square Capital Management LP but ultimately found itself with three prospective lending groups. Interest in providing GGP with a DIP was so strong that the debtor held an auction to choose the best proposal, a rare scenario in the current market.

The Chicago company eventually chose a $400 million DIP from existing unsecured creditors led by Farallon Capital Management LLC. The loan can be paid back by converting outstanding debt to equity, a sign that the lenders see value in a reorganized GGP.

"The fact that there was a potential equity upside in the DIP set it apart," says David Feldman of Gibson, Dunn & Crutcher LLP, counsel to Farallon in the case. Though GGP had the Pershing DIP in place when it filed for bankruptcy, it did not draw down from the loan. Instead, it used some $209 million in cash collateral to fund operations during the first three weeks of its case as it solicited rival proposals.

"The company went out and cut a deal initially on a DIP that many parties believed was a rich deal for the DIP lender. That's why parties that had a stake in GGP felt that they could do better," says Feldman.

GGP was not the only debtor to enter Chapter 11 this year with a DIP loan not favored by other creditors. But unlike most, GGP had something to offer a third-party lender.

"The view was that there was enough equity in some of the properties and some significant unencumbered assets ... and [extra] cash on the balance sheet" to serve as collateral, Feldman says.

Despite the competition for its DIP, GGP still paid a steep price. The loan is priced at LIBOR plus 1,200 basis points and includes a 3.75% exit fee for Farallon.

Farallon and other participating lenders can convert outstanding amounts on the DIP into either 8% of GGP's fully diluted common stock or 9.9% of the common stock issued on the effective date of a reorganization plan, court filings show.

Similarly, ION Media Networks Inc., which filed in May, has the option to either pay back its DIP in cash or convert the facility into a 62.5% equity stake upon exiting bankruptcy.

Such equity conversions are a sign of the times. The conversions give debtors something extra to offer in exchange for a DIP and also help them avoid raising more cash in unfavorable markets to pay down the loan upon exiting bankruptcy.

But for those on the bottom of bankruptcy's pecking order, such as unsecured creditors, the innovation can increasingly take them out of the money, especially with valuations down virtually across the board.

Equity conversions in DIP agreements are "really not favored by the court because they come to the disadvantage of prepetition creditors who were hoping for some of the equity value," Barragate says. "You're taking something off the table."

Cohen says equity conversions in DIP loans are a product of debtors' inability to raise traditional third-party financing and does not expect to see them regularly as credit markets improve. "We're at the front end of what I think will be a very good part of the cycle," says Cohen.

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