New York Bankruptcy Court Approves Insider DIP Litigation Financing

The ability of a bankruptcy trustee or chapter 11 debtor-in-possession ("DIP" ) to obtain financing may be crucial to the success of a chapter 11 case as a means of funding operations or distributions under a plan of reorganization. As demonstrated by a ruling handed down by the U.S. Bankruptcy Court for the Southern District of New York, such financing may also be necessary and appropriate to finance litigation that can generate value for the bankruptcy estate, even if the financing is provided by corporate "insiders" of the debtor and must therefore be subjected to heightened scrutiny. In In re SPAC Recovery Co., No. 25-12109 (JPM), 2026 WL 18778 (Bankr. S.D.N.Y. Jan. 2, 2026), the court authorized a debtor whose sole asset was litigation claims to borrow money from insiders on a "priming lien" basis to fund the litigation, concluding that the loan was both necessary, beneficial to the estate, and fair.

Obtaining Credit and Financing in Bankruptcy 

Section 364(a) of the Bankruptcy Code provides that a "trustee … authorized to operate the business of the debtor" may obtain unsecured credit or incur unsecured debt in the ordinary course of business and that the resulting claims will be treated as administrative expenses. In addition, the bankruptcy court may authorize the trustee to obtain non-ordinary course unsecured credit or financing with administrative expense priority. See 11 U.S.C. § 364(b).

If such financing is unavailable, the court, after notice and a hearing, may authorize the trustee to obtain: (i) unsecured credit or financing with "super-priority" over other administrative expenses (section 364(c)(1)); (ii) credit or financing secured by a lien on unencumbered property of the estate (section 364(c)(2)), a junior lien on already encumbered estate property (section 364(c)(3)); or (iii) a lien on already encumbered estate property equal in priority to existing liens or a "priming" lien on already encumbered estate property, as long as the existing lien holder is provided with "adequate protection" (section 364(d)). A DIP has the same ability to obtain credit or financing in accordance with section 1107(a) of the Bankruptcy Code.

Factors that courts consider in determining whether to approve financing or credit under section 364(c) include whether:

• The debtor is unable to obtain unsecured credit under section 364(b) of the Bankruptcy Code (i.e., financing with administrative priority);
• The financing or credit is necessary to preserve the assets of the estate; and
• The terms of the transaction are fair, reasonable, and adequate, given the circumstances of the debtor-borrower and proposed lender. 

In re Republic Airways Holdings Inc., 2016 WL 2616717, at *11 (Bankr. S.D.N.Y. May 4, 2016) (citing In re Los Angeles Dodgers LLC, 457 B.R. 308, 312-13 (Bankr. D. Del. 2011)). To demonstrate that it has satisfied these requirements, a debtor need only show that "it has reasonably attempted, but failed, to obtain unsecured credit under sections 364(a) or (b)." In re Ames Dep't Stores, 115 B.R. 34, 37 (Bankr. S.D.N.Y. 1990). "The statute imposes no duty [on a debtor] to seek credit from every possible lender before concluding that such credit is unavailable." Bray v. Shenandoah Fed. Savs. & Loan Ass'n (In re Snowshoe Co.), 789 F.2d 1085, 1088 (4th Cir. 1986).

As noted by a leading commentator, "[t]he ability to prime an existing lien [under section 364(d)] is extraordinary, and in addition to the requirement that the trustee be unable to otherwise obtain the credit, the trustee [or DIP] must provide adequate protection for the interest of the holder of the existing lien or obtain such lien holder's consent." Collier on Bankruptcy ("Collier") ¶ 364.05 (16th ed. 2026) (citing cases). Such adequate protection is generally found to exist where the collateral is of sufficient value to fully secure both priming and existing liens. Id. at ¶ 364.05[1].

In assessing a request for approval of postpetition financing, courts will generally defer to a debtor's business judgment, provided the financing does not unduly benefit a party in interest at the expense of the estate. See In re LATAM Airlines Group S.A., 620 B.R. 722, 768 (Bankr. S.D.N.Y. 2020); In re AMR Corp., 485 B.R. 279, 287 (Bankr. S.D.N.Y.), aff'd, 730 F.3d 88 (2d Cir. 2013); In re Barbara K. Enters., Inc., 2008 WL 2439649, at *14 (Bankr. S.D.N.Y. June 16, 2008); Ames, 115 B.R. at 40. The business judgment rule "is a presumption that in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company." In re integrated Resources, Inc., 147 B.R. 650, 656 (S.D.N.Y. 1992). 

However, when a proposed transaction with a debtor involves "insiders," courts apply "heightened" or "rigorous" scrutiny in assessing the bona fides of the transaction. See In re LATAM Airlines Grp. S.A., 620 B.R. 722, 768 (Bankr. S.D.N.Y. 2020) (citing Citicorp Venture Capital, Ltd. v. Comm. of Creditors Holdings Unsecured Claims (In re Papercraft Corp.), 211 B.R. 813, 823 (W.D. Pa. 1997), aff'd, 160 F.3d 982 (3rd Cir. 1998); In re MSR Hotels & Resorts, Inc., 2013 WL 5716897, at *1 (Bankr. S.D.N.Y. Oct. 1, 2013)). 

If a transaction involves an insider, the insider bears the burden of showing the "entire" or "inherent" fairness of the transaction at issue. Id. (citing WHBA Real Estate Ltd. P'ship v. Lafayette Hotel P'ship (In re Lafayette Hotel P'ship), 227 B.R. 445, 454 (S.D.N.Y. 1998); In re L.A. Dodgers LLC, 457 B.R. 308, 313 (Bankr. D. Del. 2011); Papercraft, 211 B.R. at 823)); In re Innkeepers USA Trust, 442 227, 231 (Bankr. S.D.N.Y. 2010).

"Insider" is defined in section 101(31) of the Bankruptcy Code, which provides that, if the debtor is a corporation, the term "includes" the following:

(i) director of the debtor;

(ii) officer of the debtor;

(iii) person in control of the debtor;

(iv) partnership in which the debtor is a general partner;

(v) general partner of the debtor; or

(vi) relative of a general partner, director, officer, or person in control of the debtor.

11 U.S.C. § 101(31)(B). However, because the Bankruptcy Code's definition of the term is nonexclusive, courts have identified a category of "nonstatutory insiders" consisting generally of those individuals or entities whose relationship with the debtor is so close that their conduct should be subject to closer scrutiny than that of those dealing with the debtor at arm's length. See In re A. Tarricone, Inc., 286 B.R. 256., 262 (Bankr. S.D.N.Y. 2002). 

In determining whether a person or entity qualifies as a nonstatutory insider, some courts consider: (i) the closeness of the relationship between the debtor and the alleged insider; and (ii) whether transactions between the debtor and the alleged insider were conducted at arm's length. Id. at 262 (citing In re Emerson, 235 B.R. 702, 202 (Bankr. D.N.H. 1999). As noted by the court in Friedman v. Sheila Plotsky Brokers, Inc. (In re Friedman), 126 B.R. 63 (Bankr. 9th Cir. 1991), the relationship must be "close enough to gain an advantage attributable simply to affinity rather than to the course of business dealings between the parties." The alleged insider's degree of control over the debtor is relevant but not dispositive.

According to the U.S. Court of Appeals for the Third Circuit, when a creditor is able to control a debtor's actions to such an extent that the debtor becomes a "mere instrumentality," the creditor qualifies as a nonstatutory insider. See Schubert v. Lucent Technologies Inc. (In re Winstar Communications, Inc.), 554 F.3d 382 (3d Cir. 2009); see also Papercraft, 211 B.R. at 823 (even a minority shareholder can be considered an insider in this context if it exercises influence and control over the corporation through other means, including board seats or exclusive access to confidential information) (citing Nisselson v. Softbank AM Corp. (In re Marketxt Holdings Corp.), 361 B.R. 369, 387-88 (S.D.N.Y. 2007)).

SPAC Recovery

SPAC Recovery Co. (the "debtor") is a special purpose acquisition company ("SPAC") formed in 2018 under Delaware law. In 2020, the debtor raised approximately $140 million through an initial public offering ("IPO"), after which, under its articles of incorporation and federal rules, it had one year to complete the acquisition of a target company, failing which it was obligated to return the funding to its investors.

In 2021, the debtor identified North Atlantic Imports d/b/a Blackstone Products ("Blackstone") as a potential acquisition target. The debtor and Blackstone executed a business combination agreement (the "BCA") in December 2021, which was conditioned on the debtor securing adequate funds to close the acquisition. The debtor retained an investment banker, which engaged two lenders to finance the acquisition.

The debtor failed to close the Blackstone transaction before expiration of the one-year period, after which it was required to redeem its public shares and return the IPO proceeds to investors. This left the debtor with no ongoing business, employees, or assets, and triggered the debtor's default on $785,000 in promissory notes payable to Blackstone issued to facilitate the acquisition. 

In May 2025, the debtor sued Blackstone, its investment banker, the lenders, and certain other defendants in a New York state court seeking approximately $54 million in compensatory damages and $537 million in punitive damages stemming from the failed acquisition. In its complaint, the debtor alleged that the defendants misappropriated the debtor's confidential information in breach of their contractual and fiduciary duties and used the information to orchestrate an alternative transaction that excluded the debtor. To finance that litigation, the debtor entered into a litigation funding agreement ("LFA") with SPV Lit Fund, LLC ("SPV"), whereby SPV agreed to lend up to $675,000, secured by a first-priority lien on all proceeds of the litigation. All of the members of SPV were shareholders of the debtor. 

In separate New York state court litigation, Blackstone sued the debtor to enforce the defaulted promissory notes. In August 2025, Blackstone obtained a judgment against the debtor in that lawsuit for approximately $785,000.

Blackstone also sued the debtor in a Delaware state court to enforce the BCA's Delaware forum selection clause and to enjoin the debtor from litigating BCA-related disputes against Blackstone in New York. The Delaware court awarded Blackstone summary judgment in that litigation in September 2025, ruling that the debtor violated the BCA by suing Blackstone in New York, and enjoining the debtor from litigating those claims in New York.

In September 2025, the debtor filed for chapter 11 relief in the Southern District of New York. In its petition and schedules, the debtor disclosed that its CEO and sole director also held an indirect 12.4% equity interest in the debtor and, under the LFA, was entitled to 10% of the net litigation proceeds, capped at $2 million. The debtor further disclosed that SPV was its only prepetition secured lender and that the debtor owed SPV approximately $560,000. The petition listed the litigation claims against the defendants as the debtor's only asset. The debtor scheduled approximately $8.9 million in unsecured claims as "disputed," and identified the investment banker and the lenders as unsecured creditors, but with claims valued at zero dollars.

On the petition date, the debtor executed a DIP financing agreement with SPV whereby SPV agreed to provide $500,000 in additional litigation financing. The DIP loan was to bear interest at 10% per annum (with a 20% default interest rate) and would be secured by a first-priority priming lien on all of the debtors' existing and after-acquired assets. Events of default under the financing agreement included the removal of the debtor's CEO or a designated consultant. 

One of lenders objected to bankruptcy court approval of the DIP loan, arguing that: (i) the loan was tainted by insider self-interest because SPV, which was wholly owned by the debtor's shareholders, had no fiduciary duty to vet the terms of the loan; (ii) the loan served no "valid reorganizational purpose" aside from funding insiders' litigation against the lenders and the other defendants in the New York lawsuit; (iii) the debtor failed to demonstrate that the loan was fair to creditors or that alternative financing was unavailable; and (iv) the loan improperly allowed shareholders to convert their equity into super-priority debt while granting them complete control over the litigation and administration of the bankruptcy case to the detriment of the estate's genuine creditors.

The Bankruptcy Court's Ruling

U.S. Bankruptcy Judge John P. Mastando III agreed with the lenders that SPV—the proposed DIP lender—was an insider of the debtor because: (i) SPV's members were statutory insiders as the holders of roughly 25% of the debtor's equity as well as the debtor's officers; and (ii) SPV qualified as a nonstatutory insider due to its "unusually close" relationship with the debtor given the substantial overlap in ownership and management, and evidence indicating that the terms of the DIP loan were not negotiated at arm's length. SPAC Recovery, 2025 WL 18778, at *7. According to Judge Mastando, even if SPV did not actually exercise control over the debtor's voting or operations, such control is not necessary for a finding of insider status. Id. (citing In re Endo Int'l Plc, 2025 WL 2807873, at *30 (Bankr. S.D.N.Y. Sept. 29, 2025)).

Having determined that SPV was an insider and that the business judgment rule therefore did not apply, the bankruptcy court exercised "entire fairness" scrutiny to the proposed DIP loan in accordance with principles of applicable non-bankruptcy law (here, Delaware law), which requires proof that a transaction is the product both of "fair dealing" and "fair price." Id.

Although Judge Mastando found that the debtor had not established that the DIP loan was negotiated at arm's length, he concluded that the debtor had sufficiently shown fair dealing under Delaware law, which does not necessarily require arm's-length bargaining to establish fair dealing. Several aspects of the proposed loan, Judge Mastando explained, weighed in favor of a finding of fair dealing, including: (i) evidence demonstrating that no reasonable third-party funding was available given the absence of a true market for the debtor's only asset—i.e., a $54 million litigation claim; (ii) the record reflected that the debtor provided adequate procedural safeguards, including separate counsel for the debtor and SPV, full disclosure to creditors and other stakeholders of the material terms of the DIP loan, including its "protective-default provision tied to certain insiders," and the opportunity given to all parties to object to the proposed terms of the loan; and (iii) evidence that the debtor reasonably considered alternatives and obtained financing on reasonable terms.

According to the bankruptcy court, "entire fairness does not demand perfection; it requires only a procedurally fair negotiation process that is commensurate with the particular facts of the case. Id. at *9. 

The bankruptcy court also concluded that the pricing of the proposed DIP loan was fair, finding, among other things, that: (i) the $500,000 loan was "relatively modest in size" compared to the debtor's purported $54 million asset value; (ii) the loan was "tailored to preserve and prosecute the estate's principal asset," which would "languish and likely lose value" without the loan; (iii) the priming and super-priority status of the loan were common in litigation finding facilities and "calibrated to the practical reality that repayment depends on litigation recoveries" and reflected the significant non-diversifiable financial risk borne by the DIP lender; (iv) although the default provision protecting insiders from removal may have been unusual in a competitive DIP loan scenario, "that provision does not by itself render the transaction unfair—especially where, as here, the DIP facility is narrow in scope, fully disclosed, and directed at value preservation rather than asset transfer"; and (v) the absence of conventional market testing of the loan did not "transform a bespoke, high-risk litigation-funding price into an unfair one." Id. at 10. 

Judge Mastando also emphasized that, although the circumstances of the case before him were unusual, other courts have approved litigation funding DIP loans on comparable terms, even from insiders, in cases where the debtor's principal asset is litigation claims. Id. (citing In re FastShip, Inc., No. 12-10968 (Bankr. D. Del. Apr. 23, 2012) (Dkt. No. 63); In re The SCO Group, Inc., No. 07-11337 (Bankr. D. Del. Mar. 5, 2010) (Dkt. No. 1084); In re LP&D, Inc., No. 12-14894 (Bankr. D. Mass. Jan. 23, 2015) (Dkt. No. 172)).

The bankruptcy court accordingly approved the DIP loan.

Outlook

Litigation financing has been controversial in bankruptcy cases. Even so, as in SPAC Recovery, such financing has generally been approved if it satisfies the Bankruptcy Code's requirements for postpetition credit or financing under section 364 and otherwise applicable law (such as state law). See generally Collier at ¶ 364.04[4]. 

The ability to obtain DIP financing is frequently crucial to the success of a chapter 11 case, whether its aim is restructuring of the debtor's balance sheet or an orderly liquidation of the debtor's assets. 

SPAC Recovery is emblematic of the circumstances under which DIP litigation financing, even provided by an insider, can be both appropriate and necessary. Without the financing (or an alternative arrangement, such as the sale of its litigation claims), the administratively insolvent debtor would not have had the means to generate any value from its sole asset. Moreover, with no prospects of reorganizing or finding a source of cash to fund a liquidating chapter 11 plan, the debtor's bankruptcy filing would have been largely futile.

Key takeaways from the decision include the following: 

• Postpetition extensions of credit or financing on an unsecured, super-priority, secured, or priming basis may be approved by a bankruptcy court under the conditions specified in section 364 of the Bankruptcy Code.
• Financing (unsecured or secured) may be approved under section 364(c) if the debtor is unable to obtain unsecured financing with administrative priority, the financing is necessary to preserve estate assets, and the terms of the loan are fair, reasonable, and adequate.
• Financing secured by equal priority or priming liens under section 364(d) is extraordinary, and the trustee or DIP must show that it is otherwise unable to obtain financing and that the affected lender either consents or is adequately protected.
• In assessing a request for approval of postpetition financing, courts will generally defer to a debtor's business judgment, provided the financing does not unduly benefit a party in interest at the expense of the estate.
• The "business judgment" rule does not apply to proposed financing provided by an "insider" of the debtor. Instead, the transaction is subject to heightened scrutiny in accordance with the standards applied under applicable bankruptcy law to interested transactions, such as the "entire fairness" test.
• Insiders of a debtor can include both the "statutory insiders" delineated in the Bankruptcy Code and "nonstatutory insiders" who are in a position to exert control over the debtor or have a sufficiently close relationship with it.