Key Takeaways
- PDNs tie repayment to lawsuit outcomes, not borrower credit: Payment Dependent Notes create debt-like structures where principal and returns depend entirely on case settlements. If cases fail, investors lose capital—no recourse to borrower assets beyond funded litigation.
- SPVs provide bankruptcy remoteness through legal separation: Properly structured Special Purpose Vehicles isolate litigation assets from platform operational risks. Independent directors, separate accounts, and arms-length transactions prevent consolidation during platform bankruptcy—protecting investor claims on case proceeds.
- European Waterfalls protect LPs from carry extraction before capital return: LPs receive 100% of contributed capital back before GPs take any performance fees. Contrasts with American Waterfalls where GPs earn carry on early winners even if overall fund underperforms—critical protection for capital preservation.
- Payment waterfalls determine loss allocation when settlements disappoint: Legal expenses first, investor principal second, investor returns third, plaintiff remainder fourth. Seniority provides some protection but doesn't eliminate total loss risk if cases settle below amounts needed for full principal repayment.
- Continuation funds enable institutional exits at portfolio scale: GPs roll aging fund assets into new vehicles, selling majority stakes to sophisticated buyers conducting comprehensive diligence. Omni-Ares structure: 150+ cases, 70% stake reportedly sold for approximately 3x cost basis—proving mechanism works at institutional scale.
- Fee layers compound to consume 30-40% of gross returns: Management fees (1-2.5%), performance carry (10-20%), platform fees, administration costs, and legal expenses all sit ahead of or reduce investor net proceeds. Understanding exact waterfall mechanics determines what you actually keep.
Why Structures Matter: The $100k Investment That Returned $0
You invested $100,000 in a litigation finance fund. Case projected $5 million settlement. After 4 years, case settles for $1.5 million—seems like a win. But after legal expenses ($600k), platform management fees ($120k over 4 years), other platform costs ($80k), and payment waterfall distributions to senior creditors ($700k for case-related expenses and obligations), nothing remains for your investor class. Despite the case "winning" with a $1.5M settlement, structural mechanics left you with $0. How? The structure determined who got paid when—and you were at the bottom of a waterfall that ran dry before reaching your position.
This scenario plays out repeatedly because most investors focus on case quality while ignoring structural mechanics. Understanding how litigation finance works at the asset class level matters—but understanding how your specific investment vehicle structures risk, controls distributions, and protects (or doesn't) your capital through legal entities determines what you actually keep when cases resolve.
This comprehensive guide dissects the structural mechanics professional investors evaluate before committing capital: Payment Dependent Notes creating debt-like seniority, Special Purpose Vehicles providing bankruptcy remoteness, European versus American Waterfalls controlling GP carry timing, continuation funds enabling institutional exits, and the payment priority cascades determining who eats losses when settlements fall short. If you're evaluating litigation finance access vehicles by wallet size, understanding these structures separates informed decisions from expensive mistakes.
If You Only Remember Three Things:
- SPVs are your bankruptcy insurance. Properly structured Special Purpose Vehicles keep your litigation assets separate if platforms fail. Commingled structures leave you as unsecured creditor—dead last in bankruptcy priority.
- European Waterfalls protect your capital before GPs get paid. Demand 100% capital return before carry starts. American Waterfalls let managers extract fees from early wins while you eat later losses—that's how GPs make money on funds where LPs lose.
- Payment waterfalls matter more than case quality. Your position in the distribution cascade determines what you keep. Legal expenses, platform fees, and senior claims eat into settlements before you see dollar one. Know where you sit in the waterfall.
Structures at a Glance
The Litigation Finance Structural Stack
Each layer builds on the previous—understanding the complete stack prevents expensive structural oversights.
Payment Dependent Notes (PDNs): Debt Without the Credit
Most crowdfunding platforms structure litigation investments as Payment Dependent Notes—debt instruments where repayment depends entirely on lawsuit outcomes rather than borrower creditworthiness or operating cash flows. This creates binary exposure: cases succeed and investors receive principal plus returns, or cases fail and investors lose capital with no recourse to assets beyond the specific funded litigation.
How PDNs Differ from Traditional Debt
Traditional Corporate Bonds: Issuer promises principal and interest payments from operating cash flows regardless of individual project outcomes. If Walmart issues bonds to finance new stores, bondholders get paid even if specific stores underperform—the promise runs to Walmart's full credit, not individual store profitability.
Payment Dependent Notes: Repayment comes exclusively from specified lawsuit settlement proceeds. No corporate credit backing exists. If the law firm goes bankrupt or plaintiff abandons the case, PDN holders have no recourse to other assets—only claims against the specific litigation's outcome.
Why Platforms Use PDNs
Seniority in Payment Waterfalls: PDNs create contractual debt-like priority where investors receive principal before plaintiffs or law firms. This seniority provides more downside protection than equity structures where all participants share proportionally from first dollar.
Regulatory Treatment: Structuring as debt notes rather than equity interests can simplify securities registration under Reg D or Reg CF exemptions. Debt instruments may receive more favorable treatment than complex equity participations in litigation outcomes.
Investor Psychology: "Notes" sound safer than "equity" despite similar risk profiles, creating comfort that principal has contractual priority—though that priority only matters if sufficient settlement proceeds exist to honor it.
The PDN Payment Waterfall
Typical PDN distribution hierarchy when cases settle:
Standard PDN Waterfall (in order):
- Legal Expenses & Court Costs: Attorney fees, expert witnesses, filing costs, deposition expenses (typically 15-30% of settlement)
- PDN Principal Repayment: Investors receive contributed capital back first before any profit distribution
- PDN Return/Interest: Investors receive contractual returns (often structured as interest or profit participation)
- Platform Performance Fees: If applicable, platform takes carry on profits above certain thresholds
- Plaintiff/Law Firm Remainder: Whatever's left goes to plaintiff and law firm per their contingency arrangements
Example calculation: Case settles for $2 million. Legal expenses consumed $600k. PDN investors put in $800k total. Distribution: (1) $600k to legal expenses, (2) $800k to investors (full principal), (3) $400k to investors as returns, (4) Platform takes $80k carry (20% of $400k profit), (5) $120k remainder to plaintiff/law firm. Investors receive $1.2M total ($800k principal + $400k return) on $800k investment = 50% gross return before taxes.
When waterfalls hurt: Same case settles for $1.2 million (not $2M). Legal expenses still $600k. Only $600k remains. Distribution: (1) $600k to legal, (2) $600k to investors (75% of principal), (3) Nothing left for returns, platform carry, or plaintiff. Investors lose 25% of capital despite case "winning."
Credit Enhancements Beyond Case Outcomes
Sophisticated PDN structures layer additional protections:
- Recourse Provisions: Claims against law firm assets beyond funded cases if outcomes disappoint
- Personal Guarantees: Partners personally guarantee minimum returns, backstopping case performance
- After-the-Event (ATE) Insurance: Covers adverse cost awards when plaintiffs lose, limiting downside
- Borrowing Bases: Funding limited to 20-40% of estimated case values, providing settlement shortfall cushion
For Investors Evaluating PDN Structures
Payment Dependent Notes sound safer than they are. The "note" terminology implies debt-like protection, but PDNs carry equity-like risk since repayment depends entirely on case outcomes—not borrower creditworthiness.
Critical PDN Due Diligence Questions:
- Where exactly do you sit in the waterfall? Demand written documentation showing payment priority—oral assurances mean nothing when settlement distributions occur.
- What credit enhancements exist beyond case outcomes? Recourse provisions, personal guarantees, ATE insurance, and borrowing bases provide backup protection. Their absence means 100% reliance on case success.
- How are legal expenses estimated and capped? Uncapped legal costs can consume entire settlements before investors see dollar one. Demand expense budgets with overage protections.
- What happens if cases settle below principal amount? Do investors share losses proportionally or does seniority provide some protection? Get this in writing before investing.
Reality check: PDN seniority only matters if sufficient proceeds exist. A first-priority claim on $500k settlement provides no comfort if you invested $1M. Focus on case quality and settlement probability first, payment waterfall position second—but never ignore structural mechanics entirely.
Special Purpose Vehicles (SPVs): Bankruptcy Remoteness Explained
Special Purpose Vehicles isolate litigation investments from platform operational risks through independent legal entities. Properly structured SPVs remain separate from bankruptcy estates if platforms fail, protecting investor claims on case proceeds even when platform companies become insolvent.
Why SPVs Matter: The Platform Bankruptcy Scenario
Imagine investing $50,000 through a crowdfunding platform in a commercial litigation case. Three years later, case settles for $200,000—your share should be $75,000. But the platform filed bankruptcy six months before settlement. What happens to your money?
Without proper SPV structure: Your investment sits in platform general accounts commingled with operating funds. During bankruptcy, you're an unsecured general creditor competing with landlords, vendors, and employees. Settlement proceeds get swept into bankruptcy estate. You might recover 10-30 cents on dollar after years of bankruptcy proceedings.
With proper SPV structure: Your investment funded an independent Delaware LLC created solely to hold that specific litigation. The LLC has its own bank account, independent directors, and no connection to platform operations beyond management agreement. Platform bankruptcy doesn't affect LLC ownership of litigation asset. Settlement proceeds flow to SPV, which distributes to LLC members (investors) per operating agreement. Platform's bankruptcy court has no claim on properly segregated SPV assets.
Elements of Effective Bankruptcy Remoteness
1. Independent Legal Entity: Delaware LLC/LP with narrow purpose restricted to funding specific cases and distributing proceeds—no activities unrelated to the litigation. Delaware's well-established corporate law (governed by the Delaware Limited Liability Company Act) provides legal clarity on entity separateness and bankruptcy remoteness.
2. Separate Bank Accounts: Dedicated SPV accounts with no commingling—investor capital and settlement proceeds flow exclusively through SPV accounts with independent tracking.
3. Independent Directors/Managers: At least one independent director not employed by or related to platform, preventing alter ego arguments.
4. Arms-Length Transactions: All platform-SPV transactions documented through written agreements at market terms—not vague administrative fees.
5. Substantive Consolidation Protections: Maintained corporate formalities prevent bankruptcy courts from consolidating SPV assets with platform estate.
When SPV Protections Fail
SPVs provide bankruptcy remoteness only if properly structured and maintained. Common failures:
Commingling of Funds: Platform uses SPV bank account for operating expenses or moves money between SPV and platform accounts without proper documentation. Courts treat this as evidence SPV lacked independent purpose.
Lack of Independent Decision-Making: All SPV decisions made by platform employees without independent director input. Courts may find SPV is mere instrumentality of platform.
Failure to Maintain Corporate Formalities: No separate financial statements, no board meetings, no documentation of decisions. Courts may pierce corporate veil finding no true separation existed.
Undercapitalization: SPV holds insufficient assets to cover its liabilities, existing only as shell entity. Courts may disregard corporate form if SPV was inadequately capitalized from formation.
Table 1: SPV Structure vs. Commingled Structure Comparison
| Feature | Proper SPV Structure | Commingled Structure |
|---|---|---|
| Legal Entity | Independent Delaware LLC with narrow purpose | Investor funds held by platform company |
| Bank Accounts | Separate SPV account, no commingling | Platform general operating account |
| Governance | Independent director(s), board meetings, documented decisions | Platform management controls everything |
| Asset Ownership | SPV owns litigation funding rights | Platform owns rights, investors are unsecured creditors |
| Platform Bankruptcy Impact | SPV assets remain separate, investors protected | Assets swept into bankruptcy estate, unsecured creditor status |
| Settlement Distribution | Direct to SPV then investors per operating agreement | To platform, then distributed if platform solvent |
| Investor Recovery if Platform Fails | High - Direct claim on litigation proceeds | Low - 10-30% as unsecured creditor |
European vs. American Waterfalls: When GPs Get Paid
The waterfall structure determines how profits split between limited partners (investors) and general partners (fund managers), creating fundamentally different incentive alignments. This matters enormously—it's how GPs can extract millions in carry from funds where LPs lose money.
American Waterfall (Deal-by-Deal Carry)
Under American Waterfall structures, GPs receive carried interest on each profitable investment as it resolves—regardless of overall fund performance.
How it works: Fund invests in 10 cases. Case #1 returns 5x ($5M profit on $1M invested). GP immediately receives 20% carry = $1M. Cases #2-10 subsequently lose money, losing $9M total. Fund overall performance: -$4M loss for LPs. But GP already pocketed $1M carry from Case #1.
Why GPs love it: Accelerated carry distribution. GPs receive performance fees as early winners resolve, providing immediate compensation without waiting for fund's entire lifecycle. Creates cash flow for GP operations from successful cases even if overall fund underperforms.
Why LPs hate it: Misaligned incentives. GPs get paid on early successes while LPs bear full losses from later failures. In extreme scenarios, GPs earn millions while LPs lose capital—particularly problematic in litigation finance where case outcomes are binary and losses can be total.
Clawback provisions: Some American Waterfall structures include clawback rights requiring GPs to return excess carry if final fund performance doesn't justify early distributions. But clawbacks are difficult to enforce, especially if GPs already spent the money or if GP entity lacks sufficient assets to satisfy clawback obligations.
European Waterfall (Whole-Fund Return First)
Under European Waterfall structures, LPs receive 100% of contributed capital back before GPs take any carried interest. Only after full capital return does profit-sharing begin.
How it works: Fund raised $100M from LPs. Cases resolve over 7 years generating total proceeds of $150M. Distribution: (1) $100M back to LPs (full capital return), (2) Remaining $50M profit splits per carry terms (typically 80% LP / 20% GP). LPs receive $140M total ($100M capital + $40M profit share). GP receives $10M carry. Both parties made money, incentives aligned.
Protection scenario: Same fund raised $100M but total proceeds only $90M. Distribution: (1) $90M to LPs (90% capital return), (2) GP receives $0 carry since LPs didn't get full capital back. GP made management fees over fund life (2% × $100M × 7 years = $14M) but no performance fees. LPs lost 10% but didn't pay carry on losing fund.
Why LPs demand it: Capital preservation priority. LPs must be made whole before GPs participate in upside. Aligns GP incentives with LP capital protection rather than cherry-picking early winners for rapid carry extraction.
Why it's becoming standard: Sophisticated institutional LPs (endowments, pensions, family offices) increasingly refuse American Waterfall terms. European structure is table stakes for institutional capital—GPs wanting access to this capital adopt LP-friendly terms.
Hybrid Structures and Variations
Modified American Waterfall: GPs receive deal-by-deal carry but subject to "true-up" at fund end. If overall fund performance doesn't support carry paid, GPs must return excess through clawback provisions. Provides some accelerated carry benefits while offering LP protection. Burford Capital's annual reports provide institutional examples of waterfall structures in practice.
Tiered Carry Structures: Carry percentage increases as returns exceed certain thresholds. Example: 10% carry on returns between 8-15% IRR, 15% carry on 15-20% IRR, 20% carry above 20% IRR. Incentivizes GPs to maximize returns beyond baseline hurdles.
Catch-Up Provisions: After LPs receive preferred return (hurdle rate, typically 8-12%), GPs receive higher carry percentage (often 50% or 100%) on next tranche of returns until GP "catches up" to their target carried interest on all profits. Then reverts to standard 80/20 split on excess returns.
Waterfall Example: $100M Fund Over 7 Years
Scenario A: Fund Returns $150M (50% Profit)
American Waterfall (Deal-by-Deal):
- LPs receive: ~$130M (depends on specific deal timing)
- GP carry: ~$20M (20% of profits as deals resolve)
- GP management fees: $14M (2% × $100M × 7 years)
European Waterfall (Whole-Fund):
- LPs receive: $140M ($100M capital + $40M of $50M profit)
- GP carry: $10M (20% of $50M total profit after capital return)
- GP management fees: $14M
Scenario B: Fund Returns $90M (10% Loss)
American Waterfall (Deal-by-Deal):
- LPs receive: ~$80M (after GP took carry on early winners)
- GP carry: ~$10M (from profitable deals before later losses)
- GP management fees: $14M
- LP loss: 20% | GP earned: $24M total
European Waterfall (Whole-Fund):
- LPs receive: $90M (all available capital)
- GP carry: $0 (no carry until LPs made whole)
- GP management fees: $14M
- LP loss: 10% | GP earned: $14M (fees only)
For Investors Evaluating Fund Terms
Waterfall structures determine whether your interests align with fund managers. European Waterfalls protect capital return before profit-sharing—American Waterfalls let GPs extract carry while you eat losses.
Non-Negotiable Terms for Sophisticated LPs:
- Demand European Waterfall or modified American with robust clawback: Full capital return before GP carry begins. If GP insists on American structure, require enforceable clawback with escrow provisions.
- Verify hurdle rate protections: 8-12% preferred return is standard. Lower hurdles mean GPs earn carry on mediocre performance. Higher hurdles protect LPs.
- Understand catch-up provisions: If present, ensure they're reasonable (50% catch-up, not 100% which gives GP all profits in catch-up zone).
- Document everything in side letters: Verbal assurances mean nothing. If GP promises "LP-friendly terms," get European Waterfall structure in Limited Partnership Agreement.
This is where sophisticated LPs separate from novices: Accepting American Waterfall structures in litigation finance (with binary outcomes and total loss potential) is a classic LP mistake. European structure is table stakes for institutional capital—demand it or walk.
Continuation Funds: Institutional Exit Mechanisms
Continuation funds represent the most sophisticated liquidity mechanism in litigation finance, enabling institutional-scale exits through portfolio roll-ups into new vehicles sold to deep-pocketed buyers. The landmark Omni Bridgeway-Ares $320 million transaction exemplifies how this structure works at scale.
The Continuation Fund Mechanics
Step 1 - Asset Identification: GP identifies aging fund assets approaching end of fund life but cases haven't resolved. Instead of forced liquidation at unfavorable pricing, GP proposes rolling assets into continuation vehicle.
Step 2 - New Vehicle Formation: GP creates new fund (Continuation Fund) that will purchase co-investment interests from original funds. In Omni case: Fund 9 established as continuation vehicle to acquire interests from Funds 2/3, Funds 4/5 Series I, and one balance sheet investment.
Step 3 - New Investor Solicitation: GP markets continuation fund to institutional buyers capable of conducting comprehensive due diligence and deploying $200M+ capital. Ares Management emerged as lead investor after 6-month evaluation.
Step 4 - LP Election: Original LPs receive option to: (a) Cash out at negotiated valuation receiving liquidity for partially-realized investments, or (b) Roll over into continuation fund maintaining exposure while new investor provides capital for others cashing out.
Step 5 - Transaction Close: New investor (Ares) acquires majority stake (70% in Omni case) for agreed consideration (~A$320M). Original GP typically retains minority stake (30%) and continues as fund manager. Proceeds distributed to cashing-out LPs.
Why Continuation Funds Work for Litigation Finance
Diversification Reduces Binary Risk: Omni's 150+ cases across multiple jurisdictions and case types mitigates single-case outcome volatility. Buyer can underwrite portfolio-level returns with statistical confidence impossible for individual case secondaries.
Sophisticated Buyer Conducts Deep Diligence: Ares spent 6 months evaluating 400+ completed cases, portfolio valuation methodology, and Omni's organizational capabilities. This reduces information asymmetry—buyer knows what it's buying, seller receives fair pricing reflecting actual portfolio quality.
GP Retains Skin in Game: Omni's 30% retention and continued fund management aligns incentives. Unlike retail secondary sellers who exit completely (signaling negative private information), Omni remains invested—reducing adverse selection concerns.
Scale Justifies Due Diligence Cost: $200+ million transaction merits $1-2 million due diligence spending (legal fees, forensic analysis, internal resources). This level of buyer investigation becomes economically viable only at institutional scale—unaffordable for $50,000-500,000 retail transactions.
Premium Valuations for Quality Portfolios: Ares reportedly paid approximately 3x Omni's original invested capital—substantial premium demonstrating that well-managed, diversified litigation portfolios can command institutional pricing far exceeding the discounts often seen in retail secondary markets.
Why Retail Investors Can't Access This Structure
Continuation funds require institutional scale and sophistication unavailable to retail crowdfunding investors:
Portfolio Size Requirements: Viable continuation funds need $100M+ in aggregate portfolio value to attract institutional buyers. Retail positions of $10k-100k can't be rolled up into vehicles achieving this scale.
GP Leverage and Relationships: Established fund managers with institutional track records can approach Ares, Blackstone, Apollo for continuation fund discussions. Crowdfunding platforms lack these relationships and credibility for $200M+ transactions.
Due Diligence Standards: Institutional buyers demand comprehensive data rooms, historical performance analytics, and granular case-level documentation. Retail platforms often lack systems providing this level of transparency and reporting.
Economic Misalignment: Transaction costs for continuation funds run $2-5M (legal, advisory, due diligence, structuring). These costs only make sense spread across $200M+ transactions—they're prohibitive for smaller retail portfolio roll-ups.
Fee Layers and Total Cost of Ownership
Understanding litigation finance structures requires mapping every fee layer between gross case outcomes and net investor proceeds. Fees compound to consume 30-40% of gross returns before reaching investor pockets.
The Complete Fee Stack
Layer 1 - Legal Expenses (off the top): Attorney fees, expert witnesses, court costs, depositions—typically 15-30% of settlement proceeds before any investor distributions begin.
Layer 2 - Management Fees (annual drag): 1-2.5% annually on committed capital (private funds) or invested capital (crowdfunding platforms). Compounds over multi-year holding periods. 5-year hold at 2% = 10% total capital consumed by management fees.
Layer 3 - Platform/Administration Fees: Crowdfunding platforms may charge 0.5-1% annually for platform operations, investor relations, reporting, and compliance. Private funds embed these in management fees but costs still exist.
Layer 4 - Performance Carry (from profits): 10-20% of profits above return thresholds. Crowdfunding platforms typically 10-15%, private institutional funds 20% (above 8-12% hurdles).
Layer 5 - Deal-Specific Costs: Due diligence expenses, legal structuring, SPV formation costs often passed through to investors reducing net returns by additional 0.5-1.5%.
Worked Example: $1M Investment Returning 100% Gross
Fee Impact Calculation (5-year hold, case doubles to $2M):
Starting Investment: $1,000,000
Gross Settlement Proceeds: $2,000,000
Less: Legal expenses (25%) = -$500,000
Remaining for distribution: $1,500,000
Less: Management fees (2% × 5 years) = -$100,000
Less: Platform fees (1% × 5 years) = -$50,000
Net to investors before carry: $1,350,000
Profit before carry: $350,000
Less: Performance carry (20% × $350,000) = -$70,000
Final net to investors: $1,280,000
Net Return to Investors:
28% total return over 5 years = 5.1% annualized
Despite case doubling (100% gross return), fees consumed $720,000 (36% of gross proceeds) leaving investors with 28% net—barely above inflation over 5-year period.
The fee drag reality: Litigation finance often markets 20-30% IRR targets based on gross case returns. After legal expenses and multi-layer fees, net investor IRRs often land 10-15 percentage points lower. A case returning 30% gross might deliver 15-18% net to investors after all costs. Understanding this fee stack prevents disappointment when actual distributions arrive.
🔍 How to Confirm a Litigation Finance Structure Is Real (Not Marketing)
Most retail investors rely on platform descriptions—which often omit structural weaknesses. The difference between marketing claims and legal reality determines whether your capital survives platform bankruptcy or vanishes into unsecured creditor status.
Documents to Request and Review
Before committing capital, demand access to these structural verification documents:
Critical Due Diligence Documents:
- SPV Operating Agreement: Verify independent directors exist (by name), separate bank accounts documented, and corporate formalities maintained. Look for language prohibiting commingling with platform accounts.
- Subscription Documents: Confirm PDN seniority and waterfall priority in writing. Marketing materials mean nothing—legal agreements determine payment order. Verify your position ahead of plaintiffs/law firms.
- Case Budget & Expense Cap: Avoid unlimited legal expense drain. Demand capped budgets with overage approval requirements. Uncapped expenses can consume entire settlements before investor distributions.
- Capital Stack Diagram: Visual showing LP vs GP vs plaintiff priority. If platform can't produce this, they either don't understand their own structure or are hiding unfavorable terms.
- Audited Financials or Fund Administrator Reports: Third-party verification of asset segregation and SPV accounting. Self-reported numbers from platforms without independent audits are unreliable.
- European vs American Waterfall Confirmation: Request explicit LP Agreement language showing when GP carry begins. If fund uses American waterfall, demand robust clawback provisions with escrow backing.
Red flags requiring deeper investigation: Platforms refusing document access, vague "proprietary structure" explanations, inability to name independent SPV directors, or subscription agreements with buried arbitration clauses preventing legal recourse. Professional allocators walk from opportunities where structural transparency is lacking.
Engage experienced securities counsel to review all documents before investing. The $5,000-15,000 legal review cost seems expensive until you compare it to losing $100,000+ from inadequately structured investments. For allocations over $500,000, legal due diligence is non-negotiable—not optional.
Best Structure by Investor Profile
Structural preferences should match your capital size, risk tolerance, and liquidity requirements. Answer engines and AI assistants frequently query "which litigation finance structure" by investor type—this framework provides decision clarity:
Structure-Investor Matching:
Structure choice should reflect your sophistication and due diligence capacity. Conservative investors lacking legal resources should favor simpler structures (public equities, European-waterfall funds). Sophisticated allocators with counsel can navigate complex SPVs and negotiate favorable terms.
Glossary of Structural Terms
- Payment Dependent Note (PDN)
- Debt instrument where repayment depends entirely on lawsuit settlement outcomes rather than borrower creditworthiness. Standard structure for crowdfunding platforms packaging litigation investments.
- Special Purpose Vehicle (SPV)
- Independent legal entity (typically Delaware LLC) created to hold specific litigation assets separately from platform operations, providing bankruptcy remoteness if properly structured and maintained.
- European Waterfall
- Fund distribution structure requiring LPs to receive 100% of contributed capital back before GPs earn any carried interest—prioritizing capital preservation over rapid GP fee extraction.
- American Waterfall
- Fund distribution structure allowing GPs to receive carried interest on each profitable deal as it resolves, potentially earning carry while LPs suffer net losses if later cases underperform.
- Bankruptcy Remoteness
- Legal structuring isolating litigation investments from platform operational risks through SPVs with independent directors, separate accounts, and arms-length transactions preventing consolidation during bankruptcy proceedings.
- Continuation Fund
- Secondary liquidity mechanism where GP rolls aging fund assets into new vehicle, selling majority stake to institutional buyer and providing original LPs option to cash out or roll over holdings.
- Carried Interest (Carry)
- Performance-based compensation for fund managers, typically 20% of profits above hurdle rate (8-12% IRR threshold). Timing of carry distribution depends on waterfall structure (European vs American).
Conclusion: Structure Determines What You Keep
The Litigation Finance Structural Stack isn't academic theory—it determines who gets paid when, who bears losses if cases fail, and whether your capital survives platform bankruptcy. Even perfect case selection won't save you if Layer 2 (SPVs) lacks proper segregation, Layer 3 (PDNs) sits junior in waterfalls, or Layer 4 (distribution rules) favor GP extraction over LP protection.
Key Structural Principles:
- PDNs create debt-like seniority but don't eliminate binary risk—priority claims mean nothing if settlements fall short
- SPVs provide bankruptcy remoteness only if properly structured with separate accounts, independent directors, and maintained formalities
- European Waterfalls protect 100% capital return before GP carry—non-negotiable for sophisticated LPs
- Continuation funds enable institutional exits at scale but remain unavailable to retail investors
- Fee layers consume 30-40% of gross returns—verify the complete stack before investing
Before committing capital, demand structural verification documents: SPV operating agreements, subscription documents showing waterfall priority, audited financials proving asset segregation. The $5,000-15,000 legal review cost prevents $100,000+ losses from inadequately structured investments.
For frameworks on evaluating litigation finance fundamentals and choosing vehicles by wallet size, our complete guides provide institutional-grade analysis covering case evaluation, due diligence, and exit strategies.
This article is for informational purposes only and does not constitute legal, tax, or investment advice. Litigation finance involves significant risk; consult qualified professionals before making any investment decisions.