Governor Gavin Newsom signed Assembly Bill 2305 this week, ahead of a September 30 deadline for action, and the statute's central move is a category choice. Rather than regulate investor money in litigation as a fee-sharing problem, California declared that a funder's interference in a case is the unauthorized practice of law.
That framing does the work. A fee-sharing rule governs how money moves between lawyers and outsiders. An unauthorized practice rule governs who may direct a lawyer's judgment at all, and it can reach conduct that never shows up in a fee arrangement.
The law, which adds Article 7.5 to the Business and Professions Code, applies to contracts entered into on or after January 1, 2027. It covers only litigation practices, though that term is drawn broadly enough to take in administrative proceedings, arbitrations and other adversarial forums. Transactional and advisory work sits outside it.
The line is control, not cash
Nothing in AB 2305 stops a funder from financing a case. Nonrecourse litigation funding remains lawful, and the statute goes further by protecting qualifying arrangements from fee-sharing challenges under Section 6156 and the California Rules of Professional Conduct. The conditions are where the legislature left its fingerprints: the agreement must state the amount or ceiling of the funding, cap the funder's return at a multiple of the funded amount or a specified interest rate, bar the use of the money for client solicitation or lead generation, and limit funding to fees or costs in specifically identified matters that are already underway or where counsel has been retained.
As the Holland & Knight alert on the statute puts it, the law permits capital to flow into a litigation practice while prohibiting that capital from carrying "any measure of control over the attorney's professional conduct."
The prohibited conduct list is long and specific. A corporate legal funder may not direct client selection, dictate the scope or financial terms of an engagement, steer litigation strategy or settlement decisions, control evidence and discovery choices, or influence when an appeal is filed. It may not pick counsel to maximize profit, tie its compensation to case outcomes in ways that undercut attorney independence, set budgets that constrain strategy, or impose return requirements that override a client's interests. Contracts that enable any of that are void, and the prohibition runs both ways: a firm may not sign an agreement that prevents an attorney from withdrawing when a funder interferes, that suppresses disclosure of the interference, or that penalizes anyone for reporting it.
A definition written to survive relabeling
The statute's answer to evasion is a definition. A corporate legal funder is any business entity, whatever its organizational form or the name on the door, whose primary purpose is raising or managing capital and that holds an ownership, service, financing or management relationship with a litigation practice. The Senate rewrote the bill before passage and added that term, along with the unauthorized practice characterization and the narrow funding safe harbor.
The definition matters because the obvious way around a ban on private equity ownership is to stop owning. A management services organization can contract with a firm for administration, technology, marketing and finance while holding no equity at all, and the money arrives as fees. The legislature drafted for that: a services arrangement counts, and so does a financing one, and the label the parties choose is irrelevant. Holland & Knight's read is that an MSO whose primary purpose involves raising or managing capital falls inside the statute regardless of how the relationship is described.
Two words carry the weight. Primary purpose is a test about what a business mostly does, not what it did once. A diversified investor with a litigation-finance arm, or a company whose capital-raising is incidental to an operating business, has an argument that it sits outside the definition. And the law reaches only interference, which is a fact pattern a court has to find, not a structure the statute can declare invalid on its face.
The enforcement problem is an evidence problem
Violations run through two channels. The State Bar of California can pursue discipline against an attorney, and an affected client may seek statutory damages of $10,000 per violation, or treble actual damages if that is greater, plus attorneys' fees and injunctive relief.
Both channels need the same thing first, which is someone who can see the agreement. Litigation funding agreements are private contracts, and confidentiality is a standard term, because the funder's pricing is its competitive information. The client is usually bound by the same confidentiality clause as the funder. So the statute's detection depends on the party with the least incentive to report, in circumstances where reporting means disclosing the terms of an arrangement the client agreed to.
Critics have made that point directly. The ABA Journal reported that the bill was sponsored by the Consumer Attorneys of California, a group with a strong interest in keeping outside capital away from defense-side practices, and observers including Axios and the Civil Justice Association of California have called the measure potentially toothless on the theory that investment continues through management arrangements that charge benchmarked fees rather than profit shares. The State Bar's existing ethics rules already bar third parties from dictating case strategy, which means some of the new statute restates an obligation that predates it.
The strongest version of the defense is that visibility is not the only mechanism. A rule that voids a contract and exposes the lawyer who signed it changes what a firm's own general counsel will approve. Compliance departments decline deals they cannot paper, and the statute gives them a reason to. Whether that deterrent reaches the arrangements the law was written to stop is the open question, and there is no enforcement record yet to answer it.
The state that tried the other approach has numbers now
California chose prohibition at a moment when the supervised alternative produced its first real evidence. Arizona eliminated its version of the American Bar Association's Rule 5.4 in August 2020 and began licensing alternative business structures the following January. Roughly 150 entities held licenses as of March 2026, up from two in 2020. KPMG Law U.S. received approval in 2025, becoming the first Big Four accounting firm with an ownership interest in an American law firm. Licensed entities accept oversight that traditional firms do not: a character-and-fitness style review, an in-house compliance lawyer, disclosure of ownership, biannual audits, and a standing committee that supervises the program.
Utah ran a different experiment, a supreme-court-supervised sandbox opened in 2020. Its alternative-business-structure phase closed at the end of 2024, and the narrower second phase is set to sunset in August 2027.
The evidence from Arizona is what makes the comparison interesting. Stanford Law School's Deborah L. Rhode Center reviewed five years of data in June 2025 and found "remarkably little evidence of consumer harm," with only two licensed entities or compliance lawyers facing formal disciplinary action, and its preliminary look at 2024 suggested lawyers at licensed entities were disciplined at rates below the broader Arizona attorney population.
That finding is suggestive rather than conclusive, and the caveats are substantial. Arizona is one state with a small licensed population, and a disciplinary docket measures lawyer misconduct, not client outcomes. The harms that worry critics of outside investment, such as a case steered toward a fast settlement because the funder wants its capital back, can be invisible from outside and may never generate a complaint at all. A client who settles for less than the case was worth is unlikely to know it.
Two theories of what protects clients
Read together, the states are running a test of two beliefs. The prohibition theory holds that the harm is the profit motive itself in case selection and settlement, and that disclosure does not neutralize it, so the arrangement should stay out of the profession. The supervision theory holds that outside capital is coming regardless, and that licensing it makes the terms, the owners and the conduct visible to a regulator who can act. Illinois and Colorado moved the prohibition way this year: Illinois passed a bill through its House in April that would bar entities controlled by private equity, hedge funds or management companies from interfering with attorney judgment, and Colorado's legislature passed a fee-sharing prohibition this spring.
One complication runs through all of it. Courts have long claimed inherent authority to regulate the practice of law, which is why the Illinois bill drew separation-of-powers objections from commentators and why Colorado's version included an explicit savings clause preserving its supreme court's authority. California's statute routes enforcement through the State Bar, which keeps the dispute inside the profession's own machinery and out of the branch conflict.
This article takes no position on which theory is right. What the record shows is that the two approaches measure different things. Prohibition produces a statute and an enforcement count. Supervision produces audit findings and disciplinary rates. Only one of those leaves a paper trail a researcher can read, which is part of why the Arizona data exists and the California data will not for some years.
What changes on January 1
The effective date gives the market a window, and the shape of that window matters more than it first appears. Existing contracts keep the terms they were signed with. New agreements and renewals after January 1 fall under the new rule, so a funder with a deal that expires in the first quarter has a reason to paper a replacement before the deadline, and a firm has the same reason to review what is already on its books.
The review list writes itself from the prohibited conduct. Anything in an agreement that touches client selection, engagement scope and pricing, strategy and settlement authority, counsel selection, budget controls affecting case management, or compensation tied to outcomes needs a second look from counsel. Not every advisory or approval right runs afoul of the statute. The test is whether a provision lets a funder substitute its return for the client's interests.
The companion bill matters too. AB 2039, also sponsored by the Consumer Attorneys, would strip an attorney's license on conviction for capping, which is the practice of paying people at hospitals, jails and accident scenes to steer clients, where the attorney acted knowingly for financial gain, with fines of $25,000 per violation. Together the two statutes signal a legislature that has decided the risk in legal services comes from money moving into the profession, whether that money arrives as ownership, as fees, or as a bounty paid at a hospital bedside.
The line AB 2305 draws is the one a court can locate in a contract: who decides. The part that critics say it misses is money that decides nothing on paper and shapes everything anyway. California wrote the rule down and handed it to the profession to enforce, and the question that will not be settled by the statute's text is whether the arrangements it outlaws are the ones clients were ever harmed by.
Primary sources
- Holland & Knight for the statute's structure, the corporate legal funder definition, the prohibited conduct categories, the nonrecourse funding conditions, the reciprocal obligations on firms, the management services organization analysis, and the enforcement remedies.
- ABA Journal for the bill's sponsorship by the Consumer Attorneys of California, the Senate and Assembly votes, the September 30 deadline, and the companion AB 2039 provisions on capping.
- Stanford Law School Deborah L. Rhode Center for the five-year review of Arizona's alternative business structure program, the consumer harm finding, the disciplinary action counts, and the 2024 disciplinary rate comparison.
- Arizona Administrative Office of the Courts materials and the Committee on Alternative Business Structures for the licensing framework, the entity count, the compliance lawyer and audit requirements, and KPMG Law U.S.'s approval.
- DLA Piper and the Illinois General Assembly for HB 5487's provisions, its House passage, and the separation-of-powers objections raised against it.
- Colorado General Assembly records for H.B. 26-1421, its passage in both chambers, and the savings clause preserving the state supreme court's authority.
- Axios and the Civil Justice Association of California for the criticism that the statute may not reach investment routed through management services organizations.