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 in the USA that continues managing its businesses under Chapter 11 is a DIP. In this situation, the company is required to submit a reorganization plan with invoice factoring. It is permitted to continue managing without the supervisory oversight of a bankruptcy trustee. In effect, the court allows it to act as its own trustee in bankruptcy.
The rights of a DIP who has been granted bankruptcy protection, and the rights of entities dealing with such debtors, may vary from jurisdiction to jurisdiction. Specialist legal advice is usually required to establish the prevailing legal framework.
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.
Contemporary bankruptcy law has evolved over many years to protect debtors from undue pressure by creditors. It can be traced back several hundreds of years to the early merchants in Florence during the 1400s. In that period, bankrupt debtors had few, if any, rights. Creditors held all the cards; unpaid creditors regularly called on the courts to grant them possession of all the remaining wealth of a bankrupt and have the individual jailed. No opportunity to recover from their hardship was afforded to debtors.
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.
One example of this principle is debtor in possession financing. This is highly specialist financing provided to entities that are under financial distress or have already formally declared themselves bankrupt with factoring receivables. Financings concluded in this context are given special treatment by the law. For example, the security pledged by a debtor to a creditor in a DIP financing is granted the most senior status in the event of default; it ranks more senior even than equity. Financing arrangements provided to an insolvent borrower may have some attractions to lenders because these arrangements are closely monitored by a bankruptcy court.