The Litigation Finance Reckoning: Why Trapped Capital is Forcing GPs to Choose Between Fees and Fiduciary Duty

Litigation finance built its pitch on an appealing premise: legal outcomes are uncorrelated with broader markets, so investors could earn attractive, diversifying returns by financing lawsuits in exchange for a share of the recovery. For a decade, capital poured in. The market has roughly doubled in size, and by some estimates now approaches $20 billion in assets. But a decade in, a less flattering story is emerging — one about what happens when an asset class built on illiquidity meets investors who eventually want their money back.

The Trap

The core problem is straightforward: litigation takes longer than anyone underwrites for. Appeals, procedural delays, and multi-year trial calendars mean that cases routinely stretch years beyond their projected timelines. That's a problem for return math, but it's a bigger problem for fund structures with fixed lives and LPs who were promised an exit.

As positions age past their intended holding periods, they become what we've called "zombie assets" — capital that isn't dead, but isn't producing distributions either. It sits on the books, marked at some estimate of intrinsic value that grows harder to defend the longer the case drags on.

Here's the part that doesn't get discussed enough: the GP's incentives don't change just because the underlying assets have stalled. Management fees are typically charged on committed or invested capital, not on realized performance. A large fund holding a book of aging, illiquid claims can still generate substantial annual fee revenue for the manager — regardless of whether a single dollar has come back to LPs in years. That creates a structural incentive to hold rather than crystallize a loss, to extend rather than exit, and to solve liquidity complaints with side-car vehicles that let the GP retain economics rather than confronting the portfolio directly.

Why the Math Is Changing

That arrangement worked as long as capital kept flowing in behind it. It's not working anymore. Early-stage investors are pulling back, dry powder across the sector is thinning, and some traditional funders are reportedly running low on cash. Distressed-debt buyers have taken notice: recent reporting indicates litigation claims are trading at valuations as low as 10 cents on the dollar, with some transactions structured so the buyer takes on the asset for free in exchange for a contingent payout if the case eventually wins. That is not a market functioning normally. That is a market where sellers have run out of alternatives.

Two Variables, One Underwriting Problem

Part of what got the industry to this point is a underwriting flaw baked into the asset class from the start: most litigation finance positions require underwriting two largely independent variables simultaneously — outcome risk and duration risk.

Outcome risk is the question everyone focuses on: will the case win, and how much will it recover? Duration risk is the quieter, more corrosive variable: how long until that outcome is realized and paid.

The problem is that these two risks compound rather than average. A strong case with a long timeline can produce a worse risk-adjusted return than a mediocre case that resolves quickly, because time itself erodes IRR, ties up capital that could be redeployed, and extends the period during which fees accrue against a position that isn't producing cash. Pre-settlement and pre-judgment claims carry both variables in full, which is precisely why they are hardest to price accurately and most prone to becoming trapped.

Post-settlement and post-judgment positions are structurally different. The outcome variable has already resolved. What remains is a narrower, more tractable question: timing and collection. That distinction matters enormously for anyone trying to underwrite this asset class today, because it separates claims that are genuinely mispriced due to temporary illiquidity from claims that are cheap because the legal risk hasn't been resolved.

The Reckoning

GPs are now facing a decision they've been able to defer for years: keep collecting fees on a book that isn't producing liquidity, or make the hard call to sell distressed positions at a discount and return capital to LPs. Dry powder doesn't last forever, and at some point, an exit strategy stops being optional.

For investors willing to do the underwriting work — particularly around the post-settlement and post-judgment tranche, where outcome risk is generally off the table — this dislocation is creating one of the more interesting entry points the asset class has produced since its inception.

About Tower 3 Investments

Tower 3 Investments delivers consistent returns through post-settlement and post-judgment litigation investments, serving institutional investors and sophisticated allocators seeking uncorrelated, asset-based lending alternatives.

Ready to explore post-settlement/judgment litigation finance opportunities? Contact Tower 3 Investments to learn how our specialized approach to funding settled or post-judgment cases can enhance your alternative investment portfolio.

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Roni Dersovitz is the founder of Tower 3 Investments, LLC, a firm offering investment opportunities in Post-Settlement/Judgment Litigation Funding. Mr. Dersovitz has 14 years of experience as a practicing personal injury attorney and has managed portfolios of litigation based receivables since 1998. To learn more about access to differentiated returns through litigation finance, visit www.Tower3Investments.com or contact us at info@Tower3Investments.com.