Litigation funding is a cash advance from a company with no stake in your lawsuit, given to you now in exchange for a share of whatever you eventually recover. The defining feature is that most agreements are non-recourse: if you lose the case, you owe nothing back. That structure makes it fundamentally different from a bank loan. It also makes it expensive, because the funder prices in the risk of walking away with nothing. For an individual plaintiff waiting on a personal injury settlement, the advance is typically under $10,000 and tied to the outcome of a single case.1U.S. Government Accountability Office. Third-Party Litigation Financing: Market Characteristics, Data, and Trends Commercial funding for corporations and law firms runs into the millions and is negotiated case by case; the rest of this article is about the consumer side, which is what most people mean when they ask about litigation funding.
How the Funding Agreement Works
The contract you sign is a funding agreement, and its core clause is the non-recourse promise. A typical agreement states that if no proceeds are obtained from the litigation, the funder receives nothing and the funded party owes nothing.2Securities and Exchange Commission. BioCardia, Inc. Litigation Funding Agreement – Section: 2. Funding The funder is betting on your case. If the bet loses, the funder eats the loss.
Repayment comes only from settlement proceeds or a court judgment. The standard mechanic requires your attorney to deposit any recovery into a trust account and pay the funder’s share out of that account before releasing your balance.2Securities and Exchange Commission. BioCardia, Inc. Litigation Funding Agreement – Section: 2. Funding To lock that in, most contracts include an irrevocable instruction signed by both you and your attorney, directing the lawyer to pay the funder from the trust account before anyone else touches the money.
The agreement usually says the funder has no authority over litigation strategy or settlement decisions. Whether that clause holds up under real pressure is debated in the legal community, but on paper the plaintiff and attorney keep sole control of the case.
What Litigation Funding Costs
This is where plaintiffs get hurt. Pricing varies widely and can consume a startling share of your recovery. Common structures include a flat percentage of the total settlement (often 20% to 40%), a multiple of the original advance (two or three times the amount), or interest that compounds monthly. Some agreements use a tiered schedule where the funder’s cut grows the longer the case takes.
Compounding is the piece that surprises people. In one documented case, a plaintiff who settled a workplace injury claim for $475,000 saw more than $81,000 in borrowed litigation costs balloon to nearly $137,000 after daily interest accrued. The longer a case drags, and many take years, the more the funder’s share grows. Public data on the returns funders actually earn is thin, and the Government Accountability Office has noted significant gaps in market data, including on the rates funders ultimately earn.1U.S. Government Accountability Office. Third-Party Litigation Financing: Market Characteristics, Data, and Trends
Read the contract carefully before you sign. Ask your attorney to calculate the total repayment at several timelines: six months, one year, two years, three years. If the funder won’t give you a clear repayment schedule upfront, treat that as information about the funder.
How Settlement Proceeds Get Divided
The payment order at settlement determines how much money actually reaches you. Proceeds move through a distribution waterfall. Attorney’s fees, usually a contingency percentage, come off the top. Case costs like expert witnesses and filing fees come out next. The funder then collects its return, meaning the original advance plus all accrued fees and interest. Whatever is left is yours.
Work through a simple example. Your case settles for $100,000. Your attorney takes a 33% contingency fee ($33,000). Case costs total $5,000. The funder is owed $25,000 on a $10,000 advance. You walk away with $37,000. If the case had taken longer and the funder’s share grew to $40,000, you’d be at $22,000. In cases with extended litigation and aggressive fee structures, some plaintiffs recover only a fraction of their settlement, and a few end up with almost nothing.
Risks Plaintiffs Underestimate
The non-recourse feature is genuinely valuable. The risks on the winning side are what people miss.
- Compounding erodes your recovery. Monthly or daily compounding means the funder’s share grows fastest exactly when the case takes longest, and delays are often outside your control. A case slowed by court backlogs or defense tactics costs you money.
- The funder owes you no fiduciary duty. Unlike your attorney, a funder has no legal obligation to act in your interest. Its goal is to maximize its return.
- Settlement pressure creeps in. Even when the contract says the funder cannot control settlement decisions, a growing repayment obligation can push a plaintiff toward or away from an offer regardless of what the contract says.
- Stacked advances multiply the problem. Some plaintiffs take additional funding as the case progresses, each with its own compounding terms. This can leave almost nothing from an otherwise strong settlement.
The trade-off is straightforward. Litigation funding is expensive because the funder loses everything if you lose. You’re paying for the funder’s downside. That trade makes sense for some plaintiffs and is financially devastating for others.
What Kinds of Cases Get Funded
Funders look for clear liability, provable damages, and a defendant who can actually pay. Personal injury claims from car accidents, medical malpractice, and premises liability are the most commonly funded consumer cases, because insurance coverage provides a reliable payment source. Employment disputes involving wrongful termination or discrimination can qualify, though funders scrutinize these more carefully because outcomes lean heavily on the administrative record. Civil rights claims against municipalities or large corporations may be funded when the defendant has accessible assets. In every case, funders evaluate defendant solvency, because a winning judgment against someone who can’t pay is worthless.
Some categories are generally off-limits. Criminal defense cases produce no monetary recovery to share in, so they aren’t funded. Family law matters like divorce and custody are excluded as well, because the financial outcomes are unpredictable and the ethical concerns significant. Workers’ compensation claims move through administrative systems that typically don’t produce the lump-sum settlements funders need.
Applying and Getting Paid
The application starts with your case file. Funders need enough information to judge whether your case will produce a recovery and how large it might be. For a consumer personal injury case, the documents usually include the filed complaint, your medical records and bills, the police or incident report, your contingency fee agreement with your attorney, any demand letter your attorney has sent, and a signed HIPAA authorization allowing the funder to verify your injuries and medical costs with providers.
Most of these live in your attorney’s file, so your lawyer handles much of the assembly. Underwriting review typically takes one business day to several days, depending on complexity. Attorney responsiveness is often the bottleneck. If approved, the funder sends an offer with the advance amount and repayment terms, everyone signs electronically, and money usually moves within 24 to 48 hours by direct transfer or check. In consumer funding, there are generally no restrictions on how you spend it. Rent, groceries, medical copays, whatever you need while the case is pending.
Confidentiality and Privilege Risks
Sharing case information with a funder creates a real risk that your opponent could later force disclosure of sensitive materials. Attorney-client privilege protects confidential communications between you and your lawyer, and pulling a third party into those communications can destroy the protection.
Courts have generally held that sharing attorney work product with a funder does not automatically waive work product protection, because the test is whether the disclosure substantially increases the chance that an adversary could obtain the information. If the funder keeps the material confidential, work product protection typically survives. Attorney-client privilege is more fragile. Some courts have found that disclosing privileged communications to a funder waives privilege entirely, while others have applied a common-interest exception to preserve it. Outcomes depend on the jurisdiction and the judge.
To limit exposure, your attorney should require a nondisclosure agreement with the funder before sharing any case analysis or investigative work. That NDA is evidence that everyone intended the information to stay confidential, which strengthens the argument against waiver. The funding agreement itself should carry consistent confidentiality terms. Your attorney also has an ethical duty to walk you through these risks before you agree to share anything, including the possibility that opposing counsel could try to compel discovery of communications among you, your lawyer, and the funder.
Regulation and Disclosure to the Court
Litigation funding is not specifically regulated under federal law.1U.S. Government Accountability Office. Third-Party Litigation Financing: Market Characteristics, Data, and Trends There is no federal licensing requirement for funders, no federally mandated interest rate cap, and no uniform disclosure obligation. Some states have consumer protection laws that cap the funder’s total recovery, require plain-language contracts, mandate registration, and give plaintiffs a rescission period to cancel. Other states impose no specific requirements at all.
Whether you have to tell the court about your funding arrangement depends on where the case is filed. There is no nationwide requirement to disclose funding agreements in federal litigation. Roughly a quarter of federal district courts have local rules broad enough to require parties to identify anyone with a financial interest in the outcome, and nearly half of the federal appellate courts have similar provisions. These rules generally require disclosure of the funder’s identity, not the full terms of the agreement, and their main purpose is to help judges assess whether they need to recuse themselves for conflict.
A growing number of states are also enacting mandatory disclosure requirements, and the landscape is changing quickly enough that you should ask your attorney about the specific obligations in your jurisdiction before signing.
Tax Treatment of the Advance and the Settlement
The IRS has not issued specific guidance on litigation funding transactions, and tax professionals describe the treatment as unsettled. A few things are reasonably clear.
The advance itself is generally not taxable income when you receive it. Because the obligation is non-recourse and contingent on the case outcome, it looks more like a debt than a payment. The tax consequences show up when the case resolves.
How the settlement is taxed depends on the type of claim. Damages received for personal physical injuries or physical sickness are excluded from gross income under federal law, whether they come through a judgment or a settlement. Punitive damages are always taxable. Emotional distress damages are taxable unless they relate to a physical injury, though you can exclude the portion that reimburses you for medical expenses related to emotional distress.3Office of the Law Revision Counsel. 26 USC 104 – Compensation for Injuries or Sickness Settlements from commercial litigation (breach of contract, patent disputes, employment discrimination) are generally taxable as ordinary income.
On deductibility, the fees and interest you pay the funder may be deductible if the underlying lawsuit relates to your business or trade. Personal interest is generally not deductible under current tax law. Businesses and law firms using commercial funding can typically deduct the costs as ordinary business expenses. Given the absence of formal IRS guidance and the complexity of these transactions, working with a tax professional who understands litigation finance is the only way to avoid a surprise at filing time.