Who Owns the Recovery? The Hidden Priority Problem in Litigation Finance

Once litigation produces a monetary recovery, that recovery does not exist in a vacuum.

It may be subject to pre-existing contractual or proprietary rights.

A claimant may have previously granted security over:

• receivables;
• litigation proceeds;
• general assets;
• future assets;
• settlement proceeds;
• accounts;
• contract rights;
• or substantially all of its business assets.

A litigation claim may therefore be valuable while its eventual proceeds are already economically burdened.

This matters because litigation finance is fundamentally concerned with the funder's expected entitlement from a future recovery.

If another creditor has superior rights to those proceeds, a strong legal claim can become a weak financial asset.

Commercial negotiations can create a misleading sense of priority.

A claimant may tell a prospective funder:

“We have not previously funded this case.”

That is useful information.

But it does not answer the broader question.

The relevant inquiry may also include:

• Has the claimant granted an all-assets security interest?
• Has a bank perfected security over receivables?
• Has counsel obtained a charging lien?
• Has a creditor taken an assignment of proceeds?
• Has another party acquired part of the economic interest?
• Is the claimant subject to freezing or attachment orders?
• Are there tax or statutory claims?
• Has an insolvency proceeding changed the legal treatment of the asset?

Priority is determined by applicable law, documentation, perfection, notice, timing and the nature of the competing interests.

It cannot safely be inferred from the claimant's understanding alone.

One recurring issue in priority disputes is the difference between the name given to a transaction and its actual legal substance.

A document may say “assignment”.

It may say “sale”.

It may say “transfer”.

But courts may analyse the underlying economic arrangement differently.

A recent U.S. bankruptcy decision illustrates the principle.

In In re Reilly, a creditor relied on a pre-petition agreement described as an “Absolute Assignment” of rights to future payments. The bankruptcy court nevertheless concluded that the transaction functioned as a security interest rather than a true outright assignment. Because the interest had not been properly perfected, the creditor did not obtain the priority it expected. NDIL Bankruptcy Court

The significance for litigation finance is broader than the particular asset in that case.

An agreement's title does not necessarily determine:

• whether the transaction is a sale;
• whether it is secured financing;
• whether perfection is required;
• whether the asset remains part of an insolvency estate;
• or where the counterparty ranks against competing creditors.

That means legal-asset structuring must be analysed substantively, not descriptively.

A contractual right between claimant and funder may be valid between those two parties but still fail against third parties.

That distinction is critical.

Where applicable law requires a security interest to be perfected, failure to perfect can materially change priority.

The 2026 Hansen-Mueller bankruptcy decision provides a useful illustration outside litigation finance.

A surety argued that it had superior rights to certain proceeds under an indemnity agreement. The bankruptcy court found that the agreement created an Article 9 security interest, but the surety had not perfected that interest. A pre-existing secured lender therefore retained first-priority rights to the proceeds. neb.uscourts.gov

Again, the important lesson is structural:

A contractual entitlement is not necessarily the same thing as an enforceable priority position against third parties.

For litigation funders, that can make questions of security, perfection, registration and local-law formalities central to underwriting.

A funder may have a contractual right to receive a multiple of invested capital or a percentage of recovery.

But what happens if the claimant becomes insolvent before payment?

The answer may depend on how the funder's rights were structured.

Possible characterisations can include:

• unsecured contractual entitlement;
• equitable lien;
• perfected security interest;
• assignment of proceeds;
• partial economic-interest transfer;
• outright asset acquisition;
• trust interest;
• or another proprietary arrangement recognised under applicable law.

Those classifications can produce very different outcomes.

Older U.S. bankruptcy litigation involving litigation-funding arrangements has demonstrated that an assignment of future lawsuit proceeds may sometimes give the funder only an equitable interest that becomes meaningful when proceeds arise, while bankruptcy-law protections can intervene before that point. United States Bankruptcy Court

The lesson is not that every litigation-finance transaction will be treated the same way.

The lesson is the opposite:

priority depends heavily on structure and governing law.

This is why institutional litigation-finance diligence should not treat the legal claim separately from the claimant's financing arrangements.

A company may have:

• revolving credit facilities;
• secured term debt;
• receivables financing;
• factoring arrangements;
• shareholder loans;
• mezzanine debt;
• tax liabilities;
• litigation obligations;
• or other secured or unsecured creditors.

Some security documents are drafted broadly.

They may capture:

• choses in action;
• proceeds;
• accounts;
• general intangibles;
• after-acquired property;
• litigation recoveries;
• or substantially all present and future assets.

A litigation funder entering later may therefore find that the prospective recovery is already subject to a broader security package.

This is especially significant in distressed situations.

Priority becomes even more important when a claimant enters insolvency, restructuring, administration or judicial management.

At that point, questions that may once have seemed theoretical become immediate.

The relevant inquiry may change from:

What did the claimant promise the funder?

to:

What rights does the funder have against the estate and competing creditors?

Insolvency can raise questions about:

• whether the claim itself forms part of the estate;
• whether litigation proceeds are estate property;
• whether a transfer can be challenged;
• whether a security interest was perfected;
• whether a transaction can be avoided;
• whether payments are preferential;
• whether the funder is secured or unsecured;
• and whether an officeholder can continue, settle or sell the claim.

This is where legal-asset underwriting intersects directly with insolvency law.

One of the most dangerous assumptions in litigation finance is that carefully drafted contractual economics automatically protect the investor.

They do not.

A funding agreement can define:

• return multiple;
• waterfall;
• reporting rights;
• termination;
• settlement mechanics;
• and payment obligations.

But if the claimant lacks the legal ability to grant the expected rights—or if another party already holds superior rights—the contractual waterfall may not determine what actually happens.

This is why transaction documents should be tested against the underlying asset structure.

The questions are not merely:

What does the agreement say?

They are also:

Can the claimant grant those rights?

Do they attach?

Must they be perfected?

What law governs perfection?

Who else has competing rights?

What happens in insolvency?

Those questions determine whether the expected waterfall survives contact with reality.

Lawyers may also hold rights against litigation proceeds.

Depending on jurisdiction and circumstances, counsel may have:

• contractual rights;
• retaining liens;
• charging liens;
• statutory liens;
• contingency interests;
• or reimbursement rights.

Those interests can affect the economic recovery available to claimant and funder.

This is particularly important when:

• the claimant changes law firms;
• counsel is unpaid;
• multiple firms have acted;
• litigation has been ongoing for years;
• or contingency-fee arrangements exist.

A funder should therefore understand the counsel-payment structure rather than treating legal fees merely as future operating expenses.

Past legal services can create priority issues of their own.

A claimant may previously have entered into:

• litigation funding;
• legal expense financing;
• portfolio funding;
• receivables financing;
• settlement advances;
• judgment monetisation;
• or assignments of economic interests.

Even where earlier funding has nominally terminated, rights may survive.

These can include:

• accrued returns;
• success fees;
• termination payments;
• security;
• rights against proceeds;
• or continuing contractual claims.

This is one reason representations alone are insufficient.

Institutional diligence should seek documentary evidence of prior funding and its current status.

A new funder needs to know not only whether another financier exists, but whether that financier retains an economic claim against the same recovery.

The distinction between assignment and security deserves particular attention.

An assignment may transfer ownership of a right or economic interest.

A security interest, by contrast, ordinarily secures performance of an obligation.

But transactions can blur that distinction.

Courts may look at substance, including:

• whether the transferor retains residual economic rights;
• whether the transferee must return excess proceeds;
• whether the underlying debt remains outstanding;
• whether the asset reverts after repayment;
• whether the transferee bears true ownership risk;
• and whether the arrangement functions economically like collateral.

This is why transaction classification should not rest on terminology.

A direct purchase of a judgment is different from a loan secured against the judgment.

A partial acquisition of recovery rights is different from an advance repayable from proceeds.

A funder should know which transaction it is actually entering.

Cross-border matters make the analysis more difficult.

A claimant may be incorporated in one jurisdiction.

The legal claim may be governed by another law.

The litigation may be pending somewhere else.

The recovery may be paid into a different jurisdiction.

Assets may sit elsewhere.

Security may have been perfected under yet another legal regime.

That can create difficult choice-of-law and recognition issues.

For example:

• Which law determines ownership of the claim?
• Which law governs assignment?
• Which law governs perfection?
• Which law determines creditor priority?
• Which law governs insolvency?
• Where must security be registered?
• Will another jurisdiction recognise the interest?

These questions can materially affect whether a funder's expected rights are enforceable.

Even where no secured creditor has priority, litigation proceeds can become subject to judicial restraint.

A freezing order, garnishment, attachment or similar process may affect how recovered funds can be dealt with.

A claimant may technically win the underlying case yet remain unable to distribute the proceeds freely.

That means litigation-finance underwriting should consider not merely existing contractual encumbrances but also active enforcement proceedings against the claimant itself.

This is especially relevant where the claimant is already financially distressed.

A useful discipline is to build the expected recovery waterfall during underwriting.

That means identifying each potential layer between gross recovery and funder return.

For example:

Gross judgment or settlement

less

taxes or statutory deductions

less

enforcement and collection costs

less

counsel liens or contractual entitlements

less

secured creditor claims

less

prior funder or assignee interests

less

insolvency or estate-level obligations where applicable

equals

economically distributable recovery

Only then should the funder assess its contractual return.

This exercise can expose risks that would otherwise remain hidden behind the headline damages number.

This distinction becomes particularly important in large claims.

A claimant may describe a case as worth US$100 million.

But if:

• US$25 million is subject to secured debt;
• US$10 million is owed to counsel;
• US$15 million is subject to a prior assignment;
• US$5 million will be required for enforcement;
• and part of the recovery may be unavailable because of insolvency or tax issues,

the economic asset available to a new funder may be dramatically smaller.

A sophisticated funder therefore asks:

What portion of the recovery is actually capable of supporting this investment?

That is a better question than simply asking how large the claim is.

Priority diligence is sometimes perceived as something funders do only to protect themselves.

It also protects claimants.

A claimant that enters incompatible financing arrangements may create disputes that:

• delay settlement;
• prevent distribution;
• trigger litigation among creditors;
• complicate insolvency;
• or expose management to allegations of breach of duty.

Clear priority analysis at the beginning of a transaction reduces the risk of conflicting promises.

It can also help the claimant understand exactly what economic interest remains available to finance.

Priority is not static.

New liens can arise.

New creditors can emerge.

Counsel can change.

The claimant can borrow additional money.

Tax liabilities can accrue.

Judgments can be entered against the claimant.

Insolvency proceedings can begin.

Assets can be transferred.

Settlement structures can change.

That means priority should not be treated as a one-time closing exercise.

Material developments may require re-underwriting.

The funder's original position can change even if the underlying litigation remains legally strong.

The most visible questions in litigation finance concern merits and damages.

Priority is often less visible.

But it can ultimately determine who receives the money.

That makes it one of the most important structural risks in legal-asset investing.

An institutional funder should therefore be able to answer:

Who owns the legal asset?

Who owns the proceeds?

What security exists?

What assignments exist?

What liens exist?

What prior funding exists?

What creditors may rank ahead?

What happens if the claimant becomes insolvent?

What law governs priority?

How does the waterfall work?

If those questions cannot be answered, the investment has not yet been fully understood.

Litigation funding ultimately depends on converting a legal right into an economic recovery.

Between those two points lies the priority structure.

The strongest claim in the world cannot produce the expected investment return if the funder misunderstands who has superior rights to the proceeds.

That leads to a broader principle:

Do not underwrite only the probability of winning. Underwrite the legal path from judgment to possession of the recovery—and every competing right that sits along that path.

That is the hidden priority problem in litigation finance.