Debtor-in-Possession Bonds

In a standard Chapter 11 case, the debtor remains in possession and operates the business without a bond. But the court can order a bond when a creditor or the U.S. Trustee files a motion showing the debtor poses a risk to estate assets -- for example, if the debtor has a history of financial misconduct, is moving assets in questionable ways, or is not maintaining adequate insurance. The bond is a middle ground: it protects creditors without the disruption of replacing management with a trustee. Courts also order bonds when converting a case from Chapter 7 to Chapter 11 if the debtor wants to regain possession.

A bankruptcy trustee bond covers someone appointed by the court to replace the debtor's management. A DIP bond covers the debtor's own management team while they continue running the business. The debtor has fiduciary duties to creditors under 11 U.S.C. Section 1107, similar to a trustee. The key difference is practical: DIP bonds are harder to obtain because the debtor is already in financial distress, which makes sureties cautious. Collateral requirements are more common, and premiums run higher than comparable trustee bonds.

This is the central challenge. The business is in bankruptcy because of financial problems, yet needs a bond based on financial strength. Surety companies address this in several ways: they may require collateral (cash deposit, letter of credit, or pledged assets) equal to 50-100% of the bond amount; they look at post-petition cash flow and business viability rather than pre-petition financials; DIP financing arrangements that inject new capital can support the bond application; and the involvement of experienced bankruptcy counsel and a viable reorganization plan helps significantly.

The bond guarantees the debtor-in-possession will faithfully perform fiduciary duties owed to creditors under the Bankruptcy Code. Specifically, it covers dissipation or waste of estate assets, unauthorized transfer of property outside the ordinary course, failure to maintain property insurance, failure to file required operating reports, self-dealing transactions not approved by the court, and failure to segregate estate funds from personal funds. It does not cover ordinary business losses, unsuccessful reorganization, or market-related declines in asset values.

The debtor pays the premium as an administrative expense of the estate, meaning it gets priority over most unsecured claims. However, because the bond benefits creditors, the court must approve the expense. If the debtor cannot afford the premium, this itself may be evidence that a trustee should be appointed instead. Some courts allow the premium to be included as part of a DIP financing budget.