2025 was a challenging year for the litigation finance market, as fears of tax changes in the Trump administration’s One Big Beautiful Bill Act threatened to materially impact returns. However, as those plans failed to survive the parliamentarian’s review, the final quarter of 2025 saw a significant spike in activity, and the appetite among private funds and other new sources of capital for investing in legal claims continues to scale.

Litigation finance sits at the intersection of law and finance and, while it has some similarities to other private credit and equity models, it carries unique complexities. These deals offer investors the prospect of attractive returns that are largely uncorrelated to other asset classes or the broader capital markets, but they sometimes fall apart because of trust issues, misunderstood terms, and delays.

The three pitfalls of litigation funding transactions

The typical litigation finance deal starts with the receipt of term sheets that lay out some material economic and noneconomic terms but, importantly, not all the particulars. Usually, these term sheets are highly negotiated, include an exclusivity period, and, on occasion, a break fee.

Once these term sheets are fully executed, funders start spending money to document the transaction and finalize the diligence. The clock to closing officially starts ticking. Sometimes litigation finance deals die because of reasons beyond anyone’s control (e.g., the diligence does not stand up to the funders’ expectations, the economics simply cannot work, or business conflicts are discovered).

But transactions often collapse because of one of three reasons:

• A lack of trust among the parties
• A misunderstanding of the deal terms
• Time (shout out to the old adage, “Time kills all deals.”)

With awareness and effort, these common issues can often be avoided.

Building trust

Skilled businesspeople and lawyers can protect against many risks in a transaction, but, at some level, there is always a leap of faith. Deal documents can outline clear obligations for each party and consequences for bad behavior, but no transaction is riskless.

Since litigation finance deals often last years, it is essential to build trust throughout the negotiation process and foster a sense of ongoing goodwill and teamwork. If one party is acting with opacity or is clearly resistant to fairness, distrust can creep in and lead to deal hesitancy or failure. Acting in good faith and with transparency throughout the negotiation process can help mitigate concerns.

Promoting trust starts at the term sheet phase. The financed party must be honest about any known flaws of an investment opportunity right from the outset. No opportunity is perfect, but funders don’t expect or require perfection. They do, however, expect forthrightness.

On the other side, funders benefit by laying out the complete economics and providing a sense of all the expected major sticking points that may be further addressed in more robust documentation.

For example, if the financed party has learned a material negative fact about the case to be funded that affects its merits, it should disclose that. If some claims are weaker than others or information has come to light indicating a lower likely recovery than initially expected, the financed party should disclose that, too.

There is nothing more likely to create problems for both parties than a late-stage unwelcome surprise in the deal terms.

A common understanding

In the litigation finance industry specifically, it is common that the recipient of funding does not engage in these types of deals on a regular basis. Therefore, the terms laid out in a term sheet can be easily misinterpreted or not fully understood by the user.

Well-developed term sheets can save deals. It is better to have the hard conversations upfront before fees are racked up and time ticks away. Specifically, funders should share an economic model to promote understanding. A discussion of ongoing obligations and events of default can also be helpful to ward off difficult conversations once the deal has already started to move.

Legal transaction structures are fluid, and no two deals look alike. In fact, there are very few document templates available for litigation finance deals because each one is highly tailored to fit a particular set of circumstances.

It is crucial to understand each participant’s motivation in a deal to promote alignment of interests, both in terms of economics and process. Discussing the expectations at each step of the investment at the start of the deal is essential to success.

In addition to understanding the economics, both parties would benefit from the financed party’s understanding of the various obligations it will be required to perform under the transaction, such as reporting, reimbursement of various expenses, and other covenants.

For example, financed parties will have to report on the case’s progress. They must agree to cooperate with the prosecution of the case, provide information to experts, prepare for depositions and testifying in court, and not take actions that could adversely affect the likelihood of success.

Many of these obligations are often new to the financed party and can seem daunting at first. A clear understanding of these obligations and what internal resources will have to be dedicated to complying with them will help avoid foot faults.

Time matters

Time is the ultimate deal killer. All dealmakers are humans and people can lose conviction and motivation as transactions drag on. Other opportunities may arise for funders that can cause a distraction, and funded parties can get cold feet, leading to distaste of already negotiated deal terms. It is to everyone’s benefit to move transactions along as quickly and efficiently as possible.

Nobody likes false deadlines but setting and communicating realistic timelines – and meeting them – is essential to deal success. Efficiently responding to due diligence requests and clearly communicating timing of deliverables can be powerful predicates for a positive working relationship.

Sometimes, a time and responsibility schedule helps everyone stay on track by laying out each deliverable, the responsible party, and the date by which the parties expect to receive it. Such a tool does not have to be inflexible and, while the time frames might be aspirational at times, the parties should aim to set achievable goals.

The lifespan of these investments can be long, often three to six years. Setting the right tone early can only help the ongoing working relationship and make the parties excited to close a deal and work efficiently toward the end goal.

Time is the ultimate deal killer.

The regulatory landscape

Going into 2026, several new pieces of legislation are poised to take effect that will impact the litigation finance market in the United States and require careful navigation. For example, new rules in various states oblige litigation funders to register with the state and make funding agreements discoverable.

Further, in California, a new law prohibits lawyers from sharing contingency fees with “alternative business structures.” It is key to any litigation finance transaction for all parties involved to understand any regulatory implications depending on the jurisdiction of the investment and underlying matters.

Conclusion

As new pockets of capital continue to enter the litigation funding market and activity looks set to rebound after stalling briefly in 2025, the year ahead should be a busy one. The unique structure of litigation finance deals can lead to challenges, however, so it is vital to keep common causes of deal failure in mind when embarking on new transactions.