A Costly Label: Why a Litigation Funding Agreement Was Declared Void

By: Jeffrey M. Haber

For years, litigation funding companies have attempted to distinguish their products from traditional loans by labeling them “investments” contingent on the outcome of a lawsuit. A recent decision from the Appellate Division, First Department – Denemark v. New Ch. Capital, Inc., 2026 N.Y. Slip Op. 04553 (1st Dept. July 23, 2026) – underscores that courts will look beyond contractual labels and examine the substance of the transaction. If a funder is effectively guaranteed repayment regardless of the litigation outcome, the agreement may be treated as a loan, and subject to New York’s usury laws.

In Denemark, a litigation funder advanced approximately $200,000 to finance a matrimonial action in exchange for a purported assignment of a portion of any future divorce recovery. Although the agreement provided that it was “not a loan” and that repayment depended on a successful recovery, the First Department concluded that the transaction’s substance told a different story. By securing repayment through a UCC filing, escrow arrangements, personal guarantees, and provisions requiring payment in the event of reconciliation, death, or bankruptcy, the funder materially eliminated the risk that ordinarily distinguishes an investment from a loan.

Applying the long-standing principle that substance prevails over form, the Court held that the funding agreement was, in reality, a loan carrying an annual interest rate of nearly 19%, well above New York’s 16% civil usury prohibition. As a result, the agreement was declared usurious, void, and unenforceable as a matter of law.

Denemark v. New Ch. Capital, Inc.

In May 2018, while plaintiff’s divorce action was pending, plaintiff and defendant entered into a litigation funding agreement styled as a Purchase and Sale Agreement (“PSA”). Under the PSA, defendant advanced approximately $200,000 to fund plaintiff’s legal expenses in the matrimonial proceeding. In exchange, plaintiff assigned to defendant an interest in any proceeds recovered from the divorce action. The PSA defined “proceeds” as “the total recovery from the Claim,” which was defined as plaintiff’s right, title, and interest in and to any amount granted to plaintiff in connection with his pending divorce action, any appeal or settlement with respect thereto, and any related action.

Although the PSA stated that it was “not a loan” and that repayment was contingent on plaintiff obtaining a successful recovery, the agreement required repayment that increased over time at a rate equivalent to 1.58% per month, or 18.96% annually. The amount due escalated at regular intervals, meaning that the longer the matrimonial litigation continued, the greater plaintiff’s repayment obligation became.

Pursuant to the PSA, defendant was permitted to file a UCC financing statement to protect its interest. While the divorce action remained pending, defendant exercised that right by filing a UCC-1 financing statement against plaintiff’s real property located in Wallkill, New York. When plaintiff later sought to sell that property, defendant refused to remove the lien absent additional protections. As a result, the parties entered into an escrow agreement under which sale proceeds would be held (“Escrow Agreement”) and, upon defendant’s demand, distributed to defendant up to the amount allegedly owed under the PSA. The Escrow Agreement further provided that more than $318,000 was already owed to defendant, notwithstanding that the divorce action had not yet concluded.

The PSA and related Sweetheart Guaranty also provided defendant with multiple avenues for repayment independent of any successful recovery in the matrimonial action. The agreements required repayment in circumstances such as reconciliation between plaintiff and his spouse, plaintiff’s death, and certain bankruptcy-related events. In those situations, defendant remained entitled to recover the principal advanced together with accrued interest, even if plaintiff never obtained any recovery in the underlying divorce proceeding.

The matrimonial action ultimately settled in October 2022. Thereafter, defendant claimed that plaintiff owed more than $408,000 under the PSA. Plaintiff disputed the enforceability of the agreement and commenced the action seeking, among other relief, a declaration that the PSA was usurious, void, and unenforceable. Defendant counterclaimed for breach of the PSA and Escrow Agreement and sought recovery of the outstanding balance together with attorneys’ fees.

On March 7, 2023, plaintiff commenced the action against defendant seeking a declaration that defendant’s actions of usury, duress, and undue influence rendered the PSA void and unenforceable as a matter of law. Plaintiff also asserted that defendant breached the PSA by improperly interfering with the divorce action. Defendant answered and asserted counterclaims alleging plaintiff breached the PSA and escrow agreement and sought judgment of the balance owed under the PSA and an award of attorneys’ fees. Plaintiff subsequently moved for summary judgment on his claims and defendant cross-moved for summary judgment to dismiss the complaint and on its counterclaims for breach of contract and for attorneys’ fees.

The motion court denied both motions and found that there were questions of fact as to whether the repayment provisions of the PSA were truly contingent and whether the usury laws applied to the case. Further, the motion court found that there were issues of fact as to whether defendant inappropriately played an active role in the underlying divorce action by, among other things, filing the UCC financing statement. It also found issues of fact as to plaintiff’s economic duress claim because it was based on the UCC filing and “it [was] unclear if defendant was entitled to file a UCC while the possibility of payment was still contingent.”

On appeal, the First Department modified the decision and order to grant plaintiff’s motion for summary judgment on his usury claim, and to declare that the parties’ litigation funding agreement was void and unenforceable as a matter of law, and otherwise affirmed the order.

The Court’s Decision

As noted, plaintiff sought a declaration that, among other things, the PSA was usurious and void as a matter of law. The Court noted that “[t]o determine whether the agreement [was] usurious, [it had to] first consider whether, under the totality of the circumstances, the agreement was truly an investment contingent on plaintiff’s successful recovery in his divorce action, or if the transaction was, in reality, a loan.”[1]

“Upon careful review of the particular facts of this case,” the Court “conclude[d] that the parties’ litigation funding agreement constituted a loan.”[2] The Court explained that the “loan imposed an interest rate in excess of the maximum permitted under New York’s usury laws, rendering the agreement unenforceable as a matter of law.”[3] Accordingly, said the Court, “plaintiff’s motion for summary judgment on his usury claim seeking a declaration that the parties’ funding agreement [was] usurious and unenforceable should have been granted.”[4]

“A fundamental component of usury is the existence of a loan, ‘and where there is no loan, there can be no usury,” noted the Court.[5] “Litigation funding agreements are not loans,” said the Court, “where ‘repayment of principal is entirely contingent on the success of the underlying lawsuit’ and where the litigant ‘received [the advance] with no guaranteed obligation to repay, except from the proceeds, if any, recovered in [the lawsuit].’”[6] 

When faced with the question whether an agreement is a loan, explained the Court, “the court must consider the transaction ‘in its totality and judged by its real character, rather than by the name, color, or form which the parties have seen fit to give it.’”[7] Therefore, said the Court, “the nature of the underlying litigation, whether the agreement provides for recourse in the event the recipient files for bankruptcy, and whether there was a personal guaranty, among other factors, may be considered to determine whether a purported contingent agreement is in truth, a loan.”[8] 

Based upon the foregoing principles, the Court held that “the subject transaction [was] characteristic of a loan, not an investment.”[9]  “First,” said the Court, “paragraph 3 of the PSA permit[ted] defendant to ‘file a [UCC] financing statement in any jurisdiction it [chose] to protect its lien’ on plaintiff’s property.”[10] This provision did not expressly bar defendant from filing the UCC financing statement prior to plaintiff’s recovery on his claim, noted the Court. Defendant therefore filed its UCC-1 financing statement on the property, while plaintiff’s divorce action was pending. “The filing secured defendant’s lien on the covered property.”[11] From these facts, the Court concluded that the transaction was a loan: “The fact that defendant was permitted under the PSA to file a UCC-1 financing statement, a device used by lenders to secure collateral, presents the hallmark of a loan.”[12]

The Court found that the escrow agreement “entered into by the parties in connection with the UCC-1 filing [also] suggest[ed] that the PSA was a loan.”[13] The Court noted that the Escrow Agreement required that no more than 50% of the property sale proceeds be distributed to plaintiff’s then-wife, with the remaining proceeds paid to defendant, up to the amount owed under the PSA, thereby effectively earmarking the sale proceeds for repayment of defendant’s claim. “Further, the PSA tellingly declared that ‘the amount presently owed to [defendant] under the [PSA] [was] $318,309.52 through June 11, 2021,’ at a time when the Property sale had to yet to occur and the divorce action remained pending.”[14] “Plainly,” concluded the Court, “if the amount due to defendant was truly based on a contingent award in the divorce matter, there would be no funds ‘presently owed’ to defendant because the amount due would be based upon a future award.”[15]

Paragraph 9 of the PSA further undermined defendant’s characterization of the transaction as a contingent investment, said the Court.[16] It provided that a reconciliation between plaintiff and his spouse, or the discontinuance of the divorce action through alternative dispute resolution, would constitute a resolution of the claim requiring repayment of all amounts advanced by defendant. Consistent with that provision, the separately executed Sweetheart Guaranty required plaintiff, upon a “Trigger Event” – defined to include a voluntary reconciliation – to unconditionally repay the principal advanced under the PSA together with accrued interest. Thus, under this paragraph of the PSA, even if the divorce action ended without any recovery whatsoever, defendant remained entitled to repayment. “This potential outcome present[ed] yet another indicator that the transaction was a loan and not contingent on the divorce award,” concluded the Court.[17] 

Furthermore, said the Court, Paragraph 12 of the PSA, titled “Death of Seller,” required plaintiff’s estate to satisfy any amounts due under the PSA and expressly provided that the death of either plaintiff or his spouse constituted a triggering event under the Sweetheart Guaranty. The PSA did not limit that obligation to circumstances in which a divorce settlement or judgment had already been obtained. “Thus, as with a reconciliation, if plaintiff dies, the Sweetheart Guaranty is triggered, and his estate must promptly pay defendant the principal amounts advanced to plaintiff under the PSA plus accrued interest.”[18] “This provision,” concluded the Court, “as well as the provision in the PSA providing defendant with recourse in the event plaintiff files for bankruptcy, further demonstrate[d] how the agreement [lost] its contingent recovery cloak and assume[d] the characteristics of a loan.”[19]

“Finally,” the Court concluded that “considering the nature of the underlying litigation, the substantial assets involved in the divorce litigation as reflected in the record, and the matrimonial parties’ rights to equitable distribution in New York, the likelihood that the principal advanced would be ‘put in hazard’ was low if not nonexistent.”[20] “This is not to mention,” added the Court, “any influence the existence of the PSA, Sweetheart Guaranty, UCC-1 financing statement, and Escrow Agreement may have had on the outcome of the matrimonial settlement agreement as plaintiff allege[d].”[21] “In short,” held the Court, “it is difficult to imagine any scenario in this case where defendant would not be entitled to repayment of the full principal amount plus accrued interest.”[22]

Having found the transaction to be a loan, the only remaining question, said the Court, was whether the loan was usurious. The Court answered the question in the affirmative: “It is undisputed that under the PSA, interest accrued at 18.96% annually, which exceeds the legal limit.”[23] In so holding, the Court rejected defendant’s argument that Paragraph 27 of the PSA cured any usury concern. Although that provision stated that, if a court or arbitrator determined the PSA to be a loan rather than a purchase of an interest in the claim, interest would be reduced to the highest rate permitted by law, such a savings clause could not retroactively render an otherwise usurious transaction lawful.[24] Accordingly, the Court held that Paragraph 27 did not save the PSA from being declared usurious and unenforceable.[25]

Takeaway

Denemark reinforces several important principles governing contingent transactions under New York law. First, courts will look beyond contractual labels and examine the substance of a transaction. An arrangement described as an investment, purchase agreement, or contingent advance may nevertheless be treated as a loan if repayment is effectively assured.

Second, provisions that substantially reduce or eliminate the lender’s risk of nonpayment, such as security interests, escrow requirements, personal guarantees, bankruptcy protections, or repayment obligations triggered by events unrelated to the underlying recovery, weigh heavily in favor of characterizing the transaction as a loan rather than a true contingent investment.

Third, courts apply a substance-over-form analysis and evaluate the totality of the circumstances. The critical inquiry is whether the lender’s principal was genuinely placed at risk or whether the transaction was structured to secure repayment regardless of the success of the underlying claim or event giving rise to the funding arrangement.

Finally, Denemark serves as a reminder that once a transaction is determined to be a loan, it becomes subject to New York’s usury laws. If the effective rate of return exceeds the statutory maximum, the agreement may be declared void and unenforceable notwithstanding contractual language intended to avoid a usury finding.

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Jeffrey M. Haber is a partner and co-founder of Freiberger Haber LLP.

This article is for informational purposes only and is not intended to be, and should not be, taken as legal advice.

Unless otherwise stated, Freiberger Haber LLP’s articles are based on recently decided published opinions or litigation releases and not on matters handled by the firm. ___________________________________

[1] Slip Op. at *1.

[2] Id.

[3] Id.

[4] Id.

[5] Id. at *3, quoting LG Funding, LLC v. United Senior Props. of Olathe, LLC, 181 A.D.3d 664, 664 (2d Dept. 2020); see Seidel v. 18 E. 17th St. Owners, 79 N.Y.2d 735, 744 (1992).

[6] Id., quoting Cash4Cases, Inc. v. Brunetti, 167 A.D.3d 448, 449 (1st Dept. 2018).

[7] Id., quoting Abir v. Malky, Inc., 59 A.D.3d 646, 649 (2d Dept. 2009) see Adar Bays, LLC v. GeneSYS ID, Inc., 37 N.Y.3d 320, 334 (2021) (“When determining whether a transaction is a loan, substance — not form — controls”); In re Greenwich Retail Group LLC, 2026 WL 482170, 17, 2026 Bankr LEXIS 417, 50 (Bankr. S.D.N.Y., Feb. 20, 2026) (“If substance (not form) is to be determinative, as it is supposed to be, then a court must consider the scope and likelihood of the ‘risks’ that a party has allegedly taken, and whether such risks are real or instead are just disguised efforts to evade the usury laws”).

[8] Id., citing Kapitus Servicing, Inc. v. Ragtime Gourmet Corp./Joe-Le Holding Corp., 242 A.D.3d 638, 638-639 (1st Dept. 2025); Echeverria v. Estate of Lindner, 7 Misc. 3d 1019(A), 2005 N.Y. Slip Op. 05675(U), *9 (Sup. Ct., Nassau County 2005).

[9] Id. at *4.

[10] Id.

[11] Id. (citations omitted).

[12] Id.

[13] Id.

[14] Id.

[15] Id.

[16] Id. at *5.

[17] Id.

[18] Id.

[19] Id.

[20] Id., citing Cash4Cases, 167 A.D.3d at 449; Echeverria, 7 Misc. 3d 1019(A) at *9.

[21] Id. (footnote omitted).

[22] Id.

[23] Id. at *6 (citation omitted).

[24] Id.

[25] Id. (citation omitted).