Bankruptcy provides a debtor temporary protection from creditors while his financial affairs go through a reorganization. During the process, the debtor may need additional financing to keep a business going and to continue paying creditors under the bankruptcy plan. One method to keep the debtor's financing options open is to offer unpledged assets as collateral. Such a "roll-up" will give an unsecured creditor a higher, "priority" claim on the debtor's assets.
In personal bankruptcy, courts will not, in general, allow a debtor to take on additional loans. However, for a Chapter 11 business reorganization, the debtor may secure new financing in order to keep his doors open while the court-appointed trustee supervises a reorganization of the business. This approach gives creditors a better chance to see a return on their loans, and debtors a chance to generate more income and get back in the black.
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Roll-Ups and Debt
Of course, lenders need some collateral to secure any loan they make to a business in bankruptcy. A secured loan has a higher priority in the process, giving the creditor a better chance for full repayment. With the court's permission, a business in Chapter 11 may offer roll-up financing, in which it uses its own assets to secure new loans from a creditor, which become priority "administrative expenses" while the bankruptcy is in progress.
Conditions on Roll-Ups
Any new loan is subject to court approval, in any form of bankruptcy. But in general, a bankruptcy court will approve roll-up financing if it allows a business in bankruptcy better loan terms than those offered by other lenders. If it does, the result benefits the bankruptcy estate -- and all creditors -- by giving the debtor more financial leeway to repay his debts. It also helps the debtor avoid total liquidation of the business, in which creditors could expect no more than a partial repayment of their loans.
New Debt, New Priority
Roll-ups are not just practical for ongoing operating capital. If the debtor borrows enough to pay some or all of his "pre-petition" unsecured loans, a roll-up converts that debt into "post-petition" secured debt. In addition, the lender gains a stronger position in the bankruptcy and the ability to veto any plan of reorganization proposed by the trustee. The lender also gains a claim on all the assets of the debtor by virtue of the higher priority the law gives to the debt.
Founder/president of the innovative reference publisher The Archive LLC, Tom Streissguth has been a self-employed business owner, independent bookseller and freelance author in the school/library market. Holding a bachelor's degree from Yale, Streissguth has published more than 100 works of history, biography, current affairs and geography for young readers.