Critics of lawsuit loans see the industry as preying on an unsuspecting group of desperate plaintiffs. Some even call the business of providing upfront cash to litigants prior to settlement “lawsuit loan sharking”. These same critics deem the lawsuit funding business a burden on the judicial process and call for lawsuit loan regulation or outright ban on the practice. This post will address some of these criticisms and examine how lawsuit loan regulation might affect the freedom of market participants to decide for themselves what is in their own best interests.
Lawsuit Loan Regulation
Regulating certain enterprises protect the public in a measurable way and at an acceptable cost. Regulation requiring automobile drivers to obtain a license is one obvious example. The process mandates knowledge and skill and protects other drivers and pedestrians. The cost is simply the training and maintenance of the driver’s license.
Analyzing the benefits of regulation versus its cost ultimately determines whether a specific business is regulated. Determination of what group of individuals is benefited is part of this analysis. Regulation is normally designed to help the public in general and not specific interests – at least, that is how the regulation is “sold” to the public.
We can see how regulating certain industries protects the needs of the public. One such example is the production of electricity by utility companies. The service provides a general public need because everyone uses electricity. It would be unacceptable to allow utility companies to hold the general public hostage by threatening a service interruption in an effort to “extort” increased profits. The electric utility is thus regulated by the government which mandates specific rules for pricing, safety, etc. In return, the utility is allowed a monopoly for the production of electricity in a certain area. Thus, the public is protected from price gouging and the utility protected from competition. It’s a win-win!
To reiterate, the policy reason for this regulation is to prevent the industry from having too much power over the public for essential services. Pricing is a real issue because parties have no other option for the product or service. The public has an interest in making sure the pricing does not get out of hand. This makes sense, but it only makes sense when dealing with ESSENTIAL services.
When examining the need for regulation for non-essential services, where to draw the line becomes less clear. Regulating non-essential services requires some additional analysis. Lawsuit loans are financial transactions which may be essential for litigants in financial trouble, but they can hardly be characterized as “essential”. Critics thus need another reason . They call for regulation because they say the terms of these transactions are unfair.
Regulation because something is “unfair” is a very slippery slope. Who gets to determine what is “fair”? Do we listen to who is in the best position to decide or do we listen to anyone who cares to comment? Let us analyze the pricing issue in this regard.
Lawsuit Loan Pricing Argument and Effect on the Legal System
Lawsuit settlement loan opponents argue lawsuit loan terms are oppressive. But, as previously mentioned, public protection must come into consideration when discussing regulation as an option. In other words, there must be a compelling reason to protect individuals entering into lawsuit loan transactions. This reason must show the product or service is a necessity and the cost to consumers would be unfair without the regulation.
Unlike electric utilities, lawsuit funding companies deal in specialty financing. They serve litigants who need immediate cash now and purchase a portion of the potential proceeds of their lawsuit for cash. The transaction is structured as a sale of property rights. Lawsuit loans are NOT really loans at all because if the case is unsuccessful, there is no repayment (the term “loan” implies repayment at some point in the future). The amount of repayment is determined by how long the lawsuit takes to reach a resolution. “Use fees” are calculated as percentages of the contract amount and are determined according to the duration of the case.
Plaintiffs are not however, forced to enter into these transactions. They are not a necessity such as heating or electricity. In fact, all normal avenues of financial relief such as home equity loans, personal loans from friends and family, bank loans, credit card cash advances, etc. are also available to plaintiffs.
Although many plaintiffs enter into a lawsuit loan agreement only after examining other options, critics cannot accurately state that lawsuit funding clients have no choice. Clients could sell almost ANY of their possessions for cash. A portion of future lawsuit proceeds is just one such possession.
In other words, lawsuit funding companies do NOT hold a monopoly on purchasing assets. People buy and sell assets every day. These enterprises simply specialize in the purchase of a special type of asset – the future proceeds of a lawsuit.
Costs to Individuals
A lawsuit loan’s cost varies from case to case, depending on a host of factors. For example, the ‘cost’ for a car accident lawsuit loan may be different than for a medical malpractice case. Each case presents a unique set of facts and circumstances, legal standards, damages, and accordingly, the risk to investors is also different.
Another significant variable is the amount of time that elapses between the funding at the lawsuit’s ultimate resolution. A lawsuit which is resolved in 3 months has a lower cost than a similar lawsuit which settles several years after funding.
Evaluating the cost of a lawsuit loan must also weigh the cost to the client if he fails to obtain the money he seeks. Consider a plaintiff who wins a large jury verdict but still has to wait for the appeal to be decided. If the plaintiff cannot pay his bills in the meantime, he is faced with the possibility of losing his home. When we discuss the cost of a lawsuit loan, we must weigh this cost against the cost of losing his domicile, finding a new place to live, losing possessions and other hassles associated with his strained financial condition.
This plaintiff is in the best position to weigh the pros and cons of the lawsuit loan. He is intimately aware of his situation and because the costs are clearly defined in the agreement, he can make a determination whether a lawsuit loan serves his needs. If he feels a lawsuit loan is his best option, who is anyone else to disagree?
Costs to the Legal System
When the pricing argument fails, a critic’s second attack on the lawsuit loan business is that these agreements pose a risk to the legal system as a whole. Critics cite examples of how lawsuit loans prohibit the otherwise easy settlement of claims. They assert that because payoffs may become large over time, plaintiffs have little to no incentive to settle the matter after a reasonable offer is made. These critics argue this scenario is a strain on the judicial system since the matter must now be tried by a judge and/or jury when it would have been settled without the presence of the lawsuit loan.
By way of example, consider a lawsuit loan in a personal injury lawsuit where a pre-existing physical condition is uncovered during the discovery process. This condition obviously reduces the settlement value of the case because the plaintiff can no longer attribute the entire injury to the defendant’s negligence. Had this condition been known at the time of the lawsuit loan, the funding company most likely would have reduced their offer. Instead, the reduced value of the case may mean the client will not stand to gain much more from the settlement after all costs and liens are repaid. In this scenario, the amount of the funding lien could pose a problem. But also under this scenario, other claims such as medical liens, child support liens, bankruptcies and other claims could also hinder the settlement process.
These scenarios do occur but are the exception rather than the rule. In fact, because lawsuit funding companies understand the risks they are taking, they would likely compromise the amount of the payoff so that the case can be settled. Other than the plaintiff’s attorney, no one party wants a settlement more than a lawsuit loan company. For purposes of lawsuit funding, a closed file and repaid revenue affords the company the opportunity to fund additional clients and generate more profit.
Scenarios like described above are so infrequent that there is simply no way they could negatively impact a judicial system which resolves tens of thousands of disputes every month. Pointing to exception rather than the rule illustrates how little ammunition critics have to attack the lawsuit funding industry.
As we discussed, lawsuit loans serve a legitimate need as evidenced by the growth of the industry over the last decade. So who is calling for lawsuit loan regulation?
Most of the resistance comes from so called “citizens groups” lobbying for reform in the unregulated lawsuit loan marketplace. For example, the US Chamber of Commerce, which is a group of businesses, not people, is a strong opponent.
Consider that supporters of lawsuit loan regulation are the ones who will financially benefit from the regulation. Insurance companies, whose very tactics contribute to the litigation delays which prompted the emergence of the lawsuit funding business in the first place, would definitely benefit from regulation. Limiting the amount a lawsuit lender can charge limits the pool of customers eligible for a lawsuit loan approval. Cases which are currently “fundable” because of pricing flexibility will no longer be funded due to lack of flexibility.
I will leave it up to the reader to decide if the public interest is served by lawsuit loan regulation. One look under the surface however, may just reveal the true motives behind the call for regulation by “citizen groups”.
Thank you for your interest in lawsuit loan regulation and the lawsuit funding business.
Lawsuit funding, also known as settlement funding or lawsuit loans, are financial transactions in which the plaintiff of a lawsuit sells part of the future proceeds of the case, if there are any. The plaintiff assigns by contract a portion of his/her property rights in the future proceeds and the “funder” offers immediate cash as payment for the transfer. One provision in the agreement is that the contract be placed in the file and paid when the case is settled. Essentially the contract is a “lien” against the future settlement just as an attorney’s contingency fee is also a lien on the file. The idea is that all parties with a rightful claim on some of the settlement be made whole prior to the plaintiff receiving the remainder.
A lawsuit loan is only one potential lien that could be placed in the file jacket of a lawsuit. Below are a few examples of liens contained in litigation files.
1. Attorney’s Fee – Most personal injury plaintiffs represent clients on a contingency fee basis. That is, the attorney is only compensated if the lawsuit is successful. The fee usually ranges from 33% to 40% of the total recovery. This fee represents the first lien on the file and will be the first lien paid by plaintiff’s counsel in most circumstances.
2. Letters of Protection – Similar to the above, letters of protection are usually found in personal injury actions where there is extensive medical treatment. The plaintiff’s attorney will write a “letter of protection” to a doctor who will then provide medical treatment to their client, if needed. The attorney will “protect” the cost of the treatment with the proceeds of the settlement. While it is not certain how letters of protection relate to other liens, such as lawsuit funding contracts, in terms of priority, lawsuit funding companies use the amount of medical treatment and outstanding medical bills as they assess investment risk during underwriting. Often, letters of protection are negotiated down at the time of settlement, particularly if the attorney and medical provider routinely represent/treat the same individuals or the amount due and owing could inhibit settlement negotiations with the defendant’s insurer.
3. Federal Tax Liens – By law, the presence of Federal Tax Liens take priority over other liens in the file. These liens may attach to the proceeds of the lawsuit and possibly directly with the IRS as payment. In some instances, lawyers may be able to compromise these amounts in an effort to induce the plaintiff to accept a settlement offer. Nevertheless, tax liens are factored into the lawsuit funding underwriting process when necessary.
4. Child Support – Most state laws require child support liens be paid out of any lawsuit settlement. Many states mandate that child support be paid before other claims to the proceeds. In other words, a child support claim is superior to a lawsuit funding claim on the proceeds. The reason for this sequence is to protect the welfare of children first. Lawsuit funding operations use the presence of child support liens as a determining factor in whether lawsuit funding will be offered and for how much.
These and all other liens could possibly hinder settlement negotiations because a plaintiff may realize most of his potential settlement will be used to pay creditors. With no incentive to settle the lawsuit, attorneys may find themselves faced with the possibility of having to try the case before a judge and jury at considerable cost.
As a general rule, the lawsuit cash advance business is concerned with liens which take priority over lawsuit funding as a matter of law. Yet the total amount of claims against the proceeds is always considered with regard to the amount of funding available. The consideration of these liens is where lawsuit funding underwriters earn their keep as the appropriate amount of lawsuit funding is always in the best interest of all the parties involved in the transaction.
Thank you for your interest in the pre-settlement funding business.