Close the ‘Litigation Loophole’ to Boost American Business

COMMENTARY

While litigation can play an important role in ensuring accountability, it has increasingly become a tool for opportunists. Bad actor attorneys and financial speculators have learned to exploit the courts for profit, often to the detriment of the very plaintiffs they claim to support. The result is a civil justice system warped by outside money, where financial gain — not fairness — is the primary objective. 

It’s long past time for Congress to intervene on behalf of American consumers and taxpayers who are paying a steep price for this broken legal system. Costs are rising faster than both inflation and economic growth and each year with Americans losing over $1,600 each thanks to a hidden “tort tax” that drains household budgets, drives up costs for small businesses and weakens economic opportunity across the country. That amounts to more than $6,400 annually for a family of four. 

In fact, research from the U.S. Chamber of Commerce shows that tort expenses totaled $529 billion in 2022, equivalent to more than 2% of national GDP. This burden has fallen especially hard on small businesses that have borne tort costs at a rate seven times higher per dollar of revenue than their larger competitors — costing them a staggering $160 billion in 2021 alone.

One major driver behind this surge in tort costs is the proliferation of third-party litigation funding — an opaque, largely unregulated financial practice where outside investors bankroll lawsuits in exchange for a share of any award or settlement. They face virtually no disclosure requirements and are allowed to operate anonymously in most jurisdictions. In many cases, their take even exceeds what plaintiffs ultimately receive.

Perhaps most outrageous, however, is that these lawsuit financiers — which include several different types of foreign entities — currently enjoy special tax treatment under U.S. law. Their investments are structured such that they qualify for capital gains tax rates, and in the case of foreign entities, often avoid U.S. tax liability altogether. In other words, hostile foreign interests can quietly weaponize America’s courts against our businesses and pocket the profits — tax-free. That’s not just bad tax policy; it’s economic self-sabotage.

A recent GAO report confirms the problem is growing rapidly: the number of lawsuits involving TPLF doubled between 2017 and 2020. Left unchecked this trend will continue to drive up litigation costs, prolong disputes, and inflate the costs of goods and services for ordinary Americans. Fortunately, Congress now has a chance to act. 

The Tackling Predatory Litigation Funding Act, bicameral legislation introduced in the Senate by Sen. Thom Tillis, R-N.C., and in the House by Rep. Kevin Hern, R-Okla., offers a targeted, pro-growth solution. It would end the special tax treatment for TPLF profits by taxing them at ordinary income rates — just like the plaintiffs themselves pay — and begin the process of introducing long-overdue checks on such arrangements. 

Specifically, the bill creates a new tax category for profit earned through litigation financing agreements, eliminates the ability for funders to treat such gains as capital assets, and introduces mandatory withholding to ensure compliance. It also closes loopholes that allow foreign entities — including sovereign wealth funds — to skirt U.S. tax obligations entirely. In short, it ends the practice of letting our legal system get weaponized for tax-free foreign profit. Furthermore, foreign companies will be restrained from using proprietary information generated from discovery to obtain an unfair competitive advantage.

Equally important, this bill represents a rare opportunity to pair sound legal reform with sound fiscal policy. The Joint Committee on Taxation estimates the legislation would raise $3.5 billion over the next decade — revenue that could be used to help pay for President Donald Trump’s proposed “big, beautiful bill” of pro-growth tax cuts. That’s a win-win: lower taxes for working families and small businesses, funded by ending tax breaks for foreign litigants and litigation profiteers.

Support for TPLF accountability measures is building. Polls show that four in five voters — Republicans, Democrats and independents alike — oppose allowing foreign governments to invest in U.S. lawsuits against American companies. Voters instinctively understand what many in Washington are just beginning to grasp: transparency and accountability in our courts are long overdue.

The choice is clear. Washington can stand idly by while our legal system becomes a tax shelter for hostile governments — or it can act.

Passing the Tackling Predatory Litigation Funding Act would send a clear and timely message: America will no longer tolerate foreign profiteering in its legal system, and it will stand up for taxpayers, small businesses and the rule of law.

Dr. Paul Prentice is a retired professor of Economics and Business, and is a senior fellow of the Independence Institute. Prentice can be found on LinkedIn or X.