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 that continues to run its affairs under Chapter 11 is a DIP. In this situation, the company submits a plan for reorganization with factoring receivables. It is permitted to manage in this way without oversight by a bankruptcy trustee Its reorganization plan usually includes proposed refinancings.
A debtor that files for bankruptcy is, in effect, seeking protection from creditors by the legal system. The rights available to a bankrupt debtor, including a DIP, usually vary between different jurisdictions. It is usually recommended that parties affected by these situations seek specialist legal advice.
It is possible for a DIP to not only continue operating assets subject to claim by creditors but also often acquire them from creditors at their fair market value, as assessed by independent valuation experts. This is especially true in cases where the debtor can confirm the asset is necessary for employment and to repay creditors.
Bankruptcy law has evolved over many, many years. It exists to protect debtors as well as creditors. Initially, the law was all about protecting the rights of creditors. Over the years, the evolution has been such that debtor rights have generally increased. Bankruptcy law can be traced back several hundreds of years to the early Florentine merchants in fifteenth century Italy. In those days, when enterprises failed, creditors had the upper hand. The law was firmly behind them. Little opportunity was given to debtors to recover from their default situation. Indeed, they were often goaled with no right of appeal.
Since those years, society attitudes and the legal system have progressively taken a more liberal attitude toward bankrupt debtors. Bankruptcy is now seen as an unavoidable consequence of modern business life. Commercial risk renders some bankruptcies an inevitable outcome, often more because of environmental situations rather than any personal failings. In order to encourage risk taking, the law has developed a framework to protect bankrupt debtors.
Nowadays, most national legal systems recognize that business risk is part and parcel of commercial life. Things do not always go to plan. The law acknowledges that some situations will develop where debtors will not be capable of fully honoring obligations to creditors. To deal with these eventualities, the law has developed protections not only for creditors, but also to allow debtors the chance to recover from their hardship as best they can.
One small example of this principle in action is debtor in possession financings. These funding arrangements are provided to entities that have declared themselves bankrupt with factoring receivables. When concluded in this context, financings are assigned special status under law. For example, any security offered in a DIP financing has senior ranking in a default scenario; it even stands ahead of equity.