Having rolled up accountants, insurance brokers, dentists, and other localized professional services into nationwide practices, private equity firms have a new target: billboard lawyers. This spring, Fortress made headlines when it signed a $125 million investment deal with an Arizona-based personal injury lawyer.
The deal signals a new chapter in the long campaign to open litigation to outside capital. The evolving business of law is a big deal for an obvious reason: taxes, regulations, excessive government spending, and litigation are the four biggest growth killers. Last summer’s megabill made progress on the first three, but not the fourth. America’s runaway liability system continues to slam economic progress, cutting a percentage point off annual GDP growth and costing each American household over $4,200 in inflated insurance premiums.
Rising tort and commercial liability costs have coincided with the emergence of third-party litigation finance, or “TPLF,” which is now a $20 billion industry, steering capital from sovereign wealth funds, hedge funds, and pension plans into mass tort and other disputes for a cut of the return. TPLF proponents claim that outside capital improves legal services and allows small businesses to prosecute claims without having to tap their balance sheets. But critics fault litigation funders for driving up liability costs by funding dubious shakedowns and coercing plaintiffs in otherwise meritorious cases to turn down reasonable settlement offers that aren’t rich enough for the funders. A report commissioned by Citizens Against Lawsuit Abuse estimates that TPLF costs each American household over $600 annually in lost earnings and price inflation.
Federal lawmakers and regulators, meanwhile, have largely stayed on the sidelines. Since 2019, Congressional Republicans have repeatedly introduced legislation requiring parties in major federal lawsuits to disclose third-party funding arrangements tied to the outcome of a case. Although a growing number of states and federal courts have adopted similar disclosure requirements, the Congressional effort has been stymied by opposition from the burgeoning litigation funding industry as well as conservative organizations who contend that the federal mandate would chill free speech and undermine the ability of funders to back litigation targeting large companies that push woke agendas.
The biggest problem with the disclosure requirements, however, may be that they are focused on yesterday’s market. Their reporting mandates are designed to reveal when a funder has a financial stake in a particular lawsuit. But investors may be losing enthusiasm for wagering on the outcome of individual cases. In March, shares of Burford Capital, a publicly-traded litigation funder, plummeted 45 percent when the Second Circuit overturned a $16.1 billion judgment against Argentina, jeopardizing a multi-billion dollar recovery tied to Burford’s investment in the case.
Burford continues to pursue recovery in the Argentine litigation, but the industry’s challenges extend far beyond a single dispute. Shares of all four publicly traded litigation finance firms (Burford, Omni Bridgeway, Manolete Partners, and Litigation Capital Management) are down 60% - 95% since 2021 despite strong gains in the broader equities markets. New investment into privately held TPLF firms has reportedly stalled, while hedge funds have begun to acquire previously funded cases at steep discounts.
Those headwinds could help explain the industry’s growing interest in a different line of business: financing 24-hour call centers and other back-office operations for personal injury lawyers. Unlike litigation funding, which can tie up capital for years in uncertain court battles, service-based arrangements, like the deal that Fortress signed this spring, promise steadier revenue and a more scalable business model.
With federal disclosure legislation stalled and the litigation funding industry at a crossroads, the Trump Administration can still take an important step in the right direction by resolving a core issue that federal regulators have thus far ignored: taxation. Despite the emergence of a multi-billion industry fueled by public companies and private ones with access to sovereign wealth capital, the Treasury Department has never bothered to clarify the proper tax treatment of TPLF returns.
Without requiring new court filings or public reporting mandates, the Treasury Department can use its existing authority to ensure that TPLF returns are treated like other income generated from legal services and tax them as ordinary income rather than allowing funders to inappropriately claim preferential capital-gains treatment. This clarification would reduce tax incentives for speculative litigation, ensure that foreign funders are subject to appropriate U.S. withholding requirements, and preserve capital-gains treatment for genuine long-term investment rather than bets on legal outcomes.
As tax policy specialist and former Treasury official Jim Carter explained in a 2025 paper, litigation funders should already be paying regular income rates under the substance-over-form doctrine, an established tax law principle that Congress has effectively codified and federal courts have repeatedly used to focus on a transition’s economic realities, not the labels parties assign it for tax purposes. Fundamentally, the revenue stream from an award or settlement is ordinary in character, and all the third-party financier is doing is stepping into that income stream. Likewise, the revenue generated by providing marketing services to law firms — the new TPLF model — should be treated as ordinary business income.
Well before investment from PE firms, hedge funds, and sovereign wealth funds got involved in litigation finance, third-party funding was a familiar feature in American litigation. The initial TPLF funding mechanism was the now standard “contingency” fee agreement in which the law firm representing a plaintiff fronts the litigation costs in return for a piece of the recovery. When a case succeeds, the IRS has long counted the contingency fee paid to the law firm as income, not capital gains, consistent with how the federal government has taxed compensation for services since the inception of the income tax.
Like investor-funded cases today, contingency fee agreements were once highly controversial. They represented a departure from established common law prohibitions on third parties financing a claimant’s expenses—a practice the great English jurist Blackstone described as “an offense against public justice” perpetrated by “pests of civil society.” Those restrictions on outside litigation finance applied to lawyers and non-lawyers alike.
Shortly after independence, however, American jurisdictions began carving out lawyer contingency agreements from the common law’s prohibitions against the practice of investing in third-party litigation. Contingency fee arrangements remained prohibited in England until 2013 and Australia until 2020, which explains why non-lawyer litigation financing took earlier in these jurisdictions than the United States.
The widespread acceptance of contingency fees raised an inevitable question: if lawyers could invest in lawsuits, why couldn’t everyone else? A 1995 law review article foreshadowed today’s litigation-finance industry by asking whether lawyers were inherently better sources of case funding than other sources of private capital. States ultimately answered that question by permitting non-lawyer litigation funding. Yet one issue remains unresolved: the Treasury has remained silent on whether the returns of these outside litigation funders should be taxed as ordinary income or capital gains.
With the absence of IRS direction, many TPLF deals are commonly labeled as derivative contracts to give funders cover to claim capital gain tax treatment, according to current tax law scholars. Yet litigation funders do much of the same work that plaintiffs lawyers do at ordinary income tax rates: vetting claims for their potential value, weighing in on strategic decisions that will affect the outcome – such as the selection of expert witnesses and whether to take a settlement deal – keeping cases on budget, and even taking on the risk that they fail. It also means that non-U.S. based funders can generally avoid paying any federal taxes on gains from funding litigation in the U.S. because nonresident aliens and foreign corporations are generally exempt from capital gain taxation.
Congress could definitively shut the door on the tax preference for litigation finance by revising the tax code’s capital asset definition to exclude legal claims. But legislative action is not required to close the tax loophole. The Trump Treasury Department can eliminate it by clarifying that TPLF will be assessed based on its economic substance, not its labels.
We've had TPLF for two centuries in the form of contingency fees. Litigation funding may be evolving, but it's not going away. Policymakers need to start treating it like other industries and get the tax treatment right. Speculating on lawsuits and financing plaintiffs’ firms is a business, not a capital investment. The resulting gains are ordinary income and should be taxed accordingly.
