What Is Litigation Funding and How Does It Work?
Litigation funding is when a third party funds a lawsuit in exchange for a share of the plaintiff's profit. For individuals and businesses facing lengthy, expensive lawsuits, this arrangement can mean the difference between pursuing a valid claim or abandoning it due to financial constraints. Litigation financing levels the playing field between the plaintiff – whose funds are limited – and the liability insurance carrier, which has a seemingly endless supply of funds available to it.
The idea is that a good legal claim is like an asset. It's worth money, but there's risk. The case is worth money only if you win in court. So if you lose, investors are out all their money. This structure creates an incentive system where funders carefully evaluate cases before committing capital, as their returns depend entirely on successful outcomes.
The Core Mechanics of Litigation Funding
Businesses and law firms use money from a third-party finance provider to pay for commercial litigation and arbitration. Funding comes in many forms (fees and expenses, monetization or advance of entitlement, single matter or portfolio) and does not impact control, which remains with the claimant. Capital typically is non-recourse, not debt, meaning the investment and return are paid only on a successful resolution.
The non-recourse nature of litigation funding is crucial to understanding how it differs from traditional lending. Litigation funding does not work like a traditional loan. They're considered non-recourse. This means if you don't receive a recovery from the lawsuit, you won't be required to pay back the lender. This removes the financial risk for plaintiffs and law firms in a way that traditional bank loans cannot provide.
The funder finances the litigation (or otherwise provides funds) in exchange for a portion of the recovery of the lawsuit. In this way, the funder is investing in the litigation similar to how other firms invest in companies or bonds.
Who Uses Litigation Funding?
Litigation funding serves both individual plaintiffs and large corporations. Judges may find it helpful to think of litigation finance as comprising mainly two types of funding: consumer and commercial. Consumer funding arrangements typically involve an individual person as the plaintiff, such as in personal injury or divorce proceedings. Commercial funding arrangements cover business-to-business disputes, class actions, and mass tort litigation.
The claimant may urgently need funds or have another reason that makes a contingency-fee arrangement untenable. For businesses, litigation funding offers additional strategic advantages. Litigation can be capital-intensive. Working with a third-party funder means a business can avoid financial uncertainty and associated costs. As a result, corporations can retain core working capital within the business and invest funds directly into activities related to business development and value creation.
Common Types of Litigation Funding Structures
| Funding Type | Primary Use | Who Receives Funds | Key Characteristic |
|---|---|---|---|
| Plaintiff Financing | Individual plaintiffs and their attorneys | Direct to plaintiff or law firm | Funds litigation costs and expenses |
| Law Firm Financing | Contingency fee law firms | To the law firm for multiple cases | Finances attorney fees and case costs |
| Portfolio Funding | Multiple cases in one transaction | Law firm managing portfolio | Diversifies risk across many matters |
| Defense-Side Financing | Defendants in commercial disputes | To defendant or defense counsel | Supports defense of substantial claims |
Law firm financing involves a transaction in which a law firm with one or more contingent fee engagements obtains financing. Litigation funders extend financing to law firms who are engaged on a contingency basis on several cases. The funders pool the cases into a "portfolio" and provide financing to the law firm in exchange for a portion of proceeds that the law firm may receive from the portfolio of cases.
Funders may finance individual cases or portfolios of cases, which mitigates some risk through diversification. All payment obligations to the financier (except in the event of a default by the funded party) are contingent upon a successful outcome in the underlying matter(s).
What Litigation Funding Covers
Litigation finance firms are willing to front funds to your law firm to be spent on litigation costs with the intention of seeing a return on their investment at the conclusion of the case. Litigation finance firms put funds directly into the hands of attorneys to hire experts, and ensure that they have the cash on hand to keep the trial going as long as it takes to get the plaintiff the settlement they deserve.
Funded expenses typically include:
- 💰 Expert witness fees and testimony
- 💰 Discovery costs and document review
- 💰 Depositions and legal research
- 💰 Court filing and administrative fees
- 💰 Portions of attorney fees in some arrangements
- 💰 Case-related travel and investigation costs
Litigation finance companies can make funds available in a segregated account so that law firms bill against those funds, rather than through the business, keeping the ongoing expenses off the company's balance sheets until resolution of the matter. In this way, businesses do not have to carry and report expenses on an ongoing basis but will only have to do so at the end of the dispute.
Key Advantages and Considerations
Not all companies have the financial resources to pursue litigation, even if they have a strong claim or case. Litigation finance helps to solve this problem by providing the required financial resources. This opens access to the legal system for parties who might otherwise lack the means to fight.
For law firms, litigation funding reduces the burden of advancing case costs. Litigation finance allows law firms to represent clients on a contingency basis without having to bear all of the risk of the contingency relationship. Litigation funders bear a portion of the risk by paying the law firm for a portion of the legal fees that are incurred in exchange for a portion of the legal fees that the law firm is entitled to receive in its contingency fee cases.
However, parties should understand the trade-offs involved. When a funder invests in a case, they take a portion of any eventual recovery. Litigation funders work with the plaintiff's legal team to understand the details of a case and decide whether a funding arrangement would be the best option for all parties. Thorough evaluation by both the funding company and the client ensures alignment on expectations and terms.
The Approval and Underwriting Process
Funding companies conduct substantial due diligence before approving litigation funding. They assess the strength of the legal claim, the quality of the legal representation, the opposing party's ability to pay, and the likely timeline to resolution. Litigation-financing companies are better suited for this type of lending than banks are, because such companies have the expertise to evaluate the strength of a given case or portfolio of cases.
A reputable litigation finance company will implement a demanding due diligence process. This careful evaluation protects both the funder's investment and ensures that only reasonably strong cases receive backing, which counteracts concerns about frivolous litigation.
Legal Protections and Confidentiality
Attorney-client privilege prohibits the disclosure of communications between a client and attorney to the opposition. In addition, work-product immunity protects the materials that attorneys and third parties prepare ahead of litigation from discovery. Courts have often ruled that litigation finance transactions preserve these protections. This means that the relationship between a party and their litigation funder generally remains confidential and protected under existing legal privileges.
When Funding Is Right for Your Situation
Litigation funding makes sense in several scenarios. When a business or individual has a strong legal claim but lacks the capital to pursue it fully, funding enables access to justice. When a law firm wants to take on promising cases without depleting its operating reserves, funding provides flexibility. When litigation will be lengthy and expensive, funding removes pressure to settle prematurely due to financial constraints.
Reasons parties seek litigation funding include a lack of funds sufficient to pursue the case with its preferred counsel; a desire to limit the impact of litigation expense on company financial statements during the pendency of litigation (litigation financing is usually "off balance sheet"); a desire to hedge risks associated with an adverse outcome in the litigation by partially monetizing the claim at the outset of the litigation; and the desire to generate liquidity for some working capital need by leveraging an asset (a legal claim) not reflected on the plaintiff's balance sheet.
Litigation funding represents a significant evolution in how legal claims are financed and pursued. By enabling parties to access capital without taking on traditional debt, third-party funding has democratized litigation for individuals and law firms that might otherwise lack resources to fight. Understanding how it works, what it covers, and when it makes sense helps plaintiffs and legal teams make informed decisions about whether to pursue this financial strategy for their case.