The Lawsuit Loan

By Aaron Larson

April, 2005

Contents

• Pre-Settlement Lawsuit Funding
• Is Pre-Settlement Funding Appropriate?
• The Ethics of Lawsuit Loans
• Legal Issues
• Conclusion

A pre-settlement lawsuit loan will ordinarily be offered as a non-recourse cash advance. This type of lawsuit financing is extended to the plaintiff in return for a promise that the advance will be repaid at the conclusion of the litigation. There are usually substantial fees associated with lawsuit funding, and it is wise to discuss any pre-settlement funding options with your lawyer.

With "non-recourse" funding, a plaintiff does not have to repay the advance in the event that the lawsuit is unsuccessful. The lawsuit financing company recovers only in the event of a settlement or verdict in the plaintiff's favor. Further, the plaintiff will only have to repay the advance in the amount of the plaintiff's share of the settlement or verdict, even if that share is smaller than the advance received.

Pre-Settlement Lawsuit Funding

In a typical lawsuit funding scenario, an injured person will contact a lawsuit financing company, perhaps at the suggestion of an attorney. The financing company will then contact the injured person's lawyer, and will obtain information about the lawsuit. The financing company will analyze that information, and attempt to determine both the plaintiff's chances of succeeding in the lawsuit, and the amount the plaintiff is likely to recover. The injured person is offered a cash advance on the basis of that analysis, agreeing to repay the advance plus additional fees out of any eventual verdict or settlement. The fees required will typically be a flat fee, or a fee that accrues on a monthly basis as long as the loan is outstanding.

These advances are offered on a non-recourse basis, meaning that the injured person will not have to repay the cash advance in the event that the litigation is not successful. Similarly, if the eventual verdict or settlement is smaller than the lawsuit funding company anticipated, the amount the plaintiff must repay will never exceed the plaintiff's share of the ultimate verdict or settlement. As described below, these non-recourse advances are not characterized as loans.

The amount a lawsuit funding company will offer to a plaintiff will vary significantly depending upon the company involved, and the facts and nature of the lawsuit. Most lawsuit funding companies will offer pre-settlement cash advances of between $500 and $25,000. A few offer larger amounts, usually up to $100,000.

The fees associated with lawsuit loans vary depending upon the type of case and the policies of the lawsuit financing company. Some companies will offer a pre-settlement advance on a fixed fee basis. Others companies charge a fee from the date the funding is issued, sometimes as high as 15% per month, and the fee is assessed on a monthly basis until the pre-settlement advance is repaid.

Recall when negotiating your pre-settlement lawsuit loan that, although the high fees are premised upon the risk to the lender, lawsuit financing companies select cases very carefully in order to minimize their risk. You will not be offered pre-settlement, non-recourse funding unless the company believes that you will recover sufficient money from your lawsuit to repay the advance and any fees. You should seek offers from several pre-settlement funding companies, and select the funding offer which has the lowest cost and best suits your needs.

Is Pre-Settlement Funding Appropriate?

Lawsuits can take a very long time to resolve, even when everybody involved in the suit knows that a substantial settlement or verdict will ultimately result. Prior to verdict or settlement, even where the plaintiff's lawyer is advancing court costs and other expenses associated with the lawsuit itself, the injured plaintiff needs to have enough money to survive. Where an injured plaintiff cannot work, has a reduction in income, or has significant medical bills or other expenses, the plaintiff may require funds before the lawsuit is resolved.

Given that pre-settlement lawsuit funding carries substantial fees, injured plaintiffs should consider other sources of money before choosing a lawsuit loan. It will typically be cheaper, when possible, to obtain a personal loan, mortgage, or to borrow money from friends or family.

Where a lawsuit loan is determined to be an appropriate option, consult with a number of lenders in relation to the loan, and choose the lender which offers the most favorable terms.

The Ethics of Lawsuit Loans

It has long been the case that lawyers are barred from lending money to their own clients, out of concern for creating a conflict of interest. When a lawyer becomes a client's creditor, the conflict of interest that results may interfere with the lawyer-client relationship.

In some states, lawyers are prohibited from signing contracts with lawsuit financing companies, and some lawyers will refuse to sign contracts. In such circumstances, the lawsuit financing company will typically require the plaintiff to sign a contract requiring the client to instruct the lawyer to repay the balance of the lawsuit loan and any associated fees to the lender out of any eventual verdict or settlement, asking the attorney only to sign an acknowledgement of the client's instruction.

Florida prohibits lawyers from participating in a pre-settlement lawsuit funding company's evalaution process. As a consequence, as the lender cannot ordinarily obtain sufficient information to determine the risk associated with lawsuit funding without consulting the plaintiff's lawyer, it is unlikely that non-recourse lawsuit funding will be available.

Legal Issues

Every state has laws against usury, the charging of an excessive interest rate. As the fees associated with pre-settlement lawsuit funding are quite high, most lawsuit financing companies will characterize the funds they provide as an "investment", as "venture capital", or as a "cash advance", instead of describing the money as a loan. The contract will not be to repay the amount received, but will instead promise to pay the lawsuit financing company a portion of any eventual verdict or settlement. As it is possible that no settlement or verdict will result from the lawsuit, this type of non-recourse lawsuit funding is technically not a "loan". No matter what happens, the injured plaintiff will keep the cash advanced by the lawsuit financing company.

Some states have been skeptical of these arrangements. For example:

Michigan: Where lawsuit funding was extended to an injured plaintiff after liability had been established, and there was no question but that the plaintiff would recover some amount of money as a result of the litigation, a court held that the lawsuit financing arrangment was in fact a loan. The court expressed that as the plaintiff's recovery was guaranteed, the lawsuit funding company's extension of funds was no longer contingent, and thus constituted a loan subject to state usury laws.

Ohio: A court discharged a lawsuit loan on the basis of the common law doctrine of "champertry", which prohibits a party from selling an interest in a lawsuit. The court opined that the lawsuit financing company was seeking to profit from the injured woman's lawsuit, and that lawsuit funding could create a disincentive to settle where the plaintiff would have to pay the entire amount of the settlement to the financing company.

In relation to concern about the lawsuit financing company profiting from a plaintiff's lawsuit, it could be pointed out that the plaintiff's own attorney will profit from the lawsuit if the case is being handled on a contingent fee basis. With regard to the concern about disincentives to settle, it is possible that if a plaintiff cannot obtain a lawsuit loan the plaintiff will be forced into an early settlement for substantially less than the case is worth.

Some have expressed concern that the availability of a lawsuit loan might result in plaintiffs filing frivolous lawsuits. This is unlikely, given that lawsuit financing companies want to be repaid, and carefully scrutinize the merits of a case and the probability of recovery prior to offering pre-settlement lawsuit funding. Further, it is in the strongest cases where the plaintiff has suffered the most serious injuries and disabilities, and might otherwise be forced to accept an inadequate settlement, that pre-settlement financing has the most value.

Conclusion

Pre-settlement lawsuit funding is best treated as a final option, where the plaintiff has immediate financial needs and no other funding options are available. Due to the cost and fees associated with lawsuit loans, any decision to accept lawsuit funding should be made cautiously and in consultation with counsel.

When seeking pre-settlement lawsuit funding, it is good policy to request offers from several lawsuit financing companies, so as to obtain the lowest possible fees.