How Litigation Finance Affects a Company's Financial Statements

The general accounting questions a CFO should raise before financing a claim, and why the characterization is not always straightforward.

Does litigation funding count as debt on a company's balance sheet? It depends on how the specific arrangement is characterized under applicable accounting standards, and this is genuinely one of the less settled corners of financial reporting practice — a company's auditors and accountants should evaluate the specific agreement's terms rather than assume a general rule applies uniformly across all funding structures.

The central accounting question is whether a specific funding arrangement is characterized as a liability the company must record, akin to debt, or as a sale of a contingent asset or partial interest in a claim, which would generally be reflected differently on the balance sheet, if at all, until the underlying contingency resolves. The answer typically turns on the same features that matter for legal characterization: whether the company has a genuine obligation to repay the funder independent of the underlying case's outcome, and who bears the risk of the case failing.

A non-recourse advance, where the company owes the funder nothing if the underlying case fails, has features that push toward treatment as something other than conventional debt, since a defining feature of debt is an unconditional repayment obligation the borrower bears regardless of any contingency. At the same time, the arrangement is not a clean sale of an asset either, since the company retains significant rights and interests in the underlying claim and its resolution. This dual character is precisely why accounting treatment for litigation finance transactions is assessed on a case-by-case basis under general principles rather than a single bright-line accounting rule written specifically for this asset class.

For a public company or one with audited financial statements, disclosure considerations extend beyond the balance sheet question itself: a material funding arrangement, or a material pending claim being pursued with funding, may itself require disclosure in financial statement footnotes or in a company's public filings depending on materiality and the applicable disclosure framework, independent of how the funding transaction is ultimately characterized for balance sheet purposes.

Because this area involves genuine judgment rather than a settled bright-line rule, and because the answer depends heavily on the specific agreement's terms, companies considering litigation finance for a material claim should involve their auditors or accounting advisors early in structuring the transaction, rather than treating the accounting characterization as a formality to be resolved after the agreement is already signed.

A CFO or controller beginning this evaluation typically starts by assembling the specific funding agreement alongside the company's existing accounting policies for contingent assets and liabilities, since the accounting characterization question cannot be meaningfully addressed in the abstract — it requires applying the company's existing framework to the actual terms of the specific transaction being considered. Companies that engage their auditors at the term sheet stage of a proposed transaction, rather than waiting until the agreement is fully negotiated and executed, generally have more flexibility to adjust specific terms if the auditor identifies a characterization concern, since renegotiating a term before signing is considerably easier than addressing an unfavorable accounting conclusion after the transaction is already in place.

The disclosure question is often easier to resolve procedurally than the balance sheet characterization question itself: most companies already have an existing materiality framework and disclosure committee process for evaluating whether a pending claim, transaction, or contingency warrants footnote disclosure, and a litigation finance arrangement or the underlying funded claim can typically be run through that same existing process rather than requiring an entirely new disclosure framework built specifically for this transaction type. Companies should nonetheless flag the funding arrangement specifically to whoever owns that disclosure process, rather than assuming it will be captured automatically alongside disclosure of the underlying claim itself, since the funding relationship and the underlying claim can present distinct disclosure questions.

Because this area continues to develop as litigation finance becomes more common among public companies and larger private businesses with audited financial statements, companies structuring a first transaction of this kind are well served by documenting their auditor's specific reasoning for whatever characterization is ultimately reached, since that documentation becomes a useful reference point for evaluating subsequent transactions and for responding to any future audit inquiry about the company's accounting treatment of litigation finance more broadly, rather than treating each transaction's accounting analysis as an entirely fresh exercise disconnected from the company's own accumulating practice in this area.

Because the accounting characterization question depends so heavily on the funding agreement's specific terms, companies negotiating a transaction are well served by looping in finance and accounting stakeholders during the term sheet negotiation itself, rather than presenting a fully negotiated agreement to the accounting team only after the legal terms are fixed. A term that legal counsel views as a minor point in the commercial negotiation — how repayment is triggered, whether any circumstance creates an unconditional obligation — can be the specific detail that determines the accounting characterization, making early cross-functional review considerably more useful than a late-stage accounting sign-off on an agreement whose material terms are no longer easily adjustable.

Companies that finance more than one claim over time are also well served by applying a consistent internal framework across those transactions, so that economically similar arrangements receive consistent accounting treatment rather than each transaction being evaluated as though no prior transaction existed. Maintaining this consistency, and documenting the reasoning connecting each new transaction back to how prior, similar transactions were treated, is a meaningful part of building an audit-ready record for a company that expects to use litigation finance as a recurring tool rather than a one-time arrangement.

This article describes general accounting considerations relevant to litigation finance transactions; it does not constitute accounting advice, and the treatment of any specific transaction should be confirmed with the company's own auditors or accountants under the applicable accounting framework.

Criterica Capital does not provide accounting advice, and agreements are structured by the provider to give companies the information needed for their own auditors to evaluate the appropriate characterization. Finance teams evaluating litigation funding can contact our institutional team for general information about how our agreements are structured.

Discuss your matter with our institutional team.