Is Financial Assistance During a Court Case a Lawsuit Loan?

By Heather Morton | Vol . 22, No. 11 / March 2014

NCSL NewsDid you know?

  • Litigation funding agreements are made between a plaintiff and a third party not involved in the legal case to assist with living and medical expenses, and only require repayment if the plaintiff settles or wins a court award.
  • Four states currently regulate lawsuit funding contracts.
  • Third-party litigation funding can be used in individual personal injury cases or larger, commercial litigation cases.

Civil litigation can be very expensive if someone has suffered harm and wants to seek damages through the court system. Since the late 1990s, some businesses have offered plaintiffs money to help with their living expenses during their court cases, with repayment contingent upon the plaintiffs’ success in court, similar to contingency fee agreements used by law firms. But policymakers and others have raised questions about whether this financial assistance in lawsuits helps or hurts consumers and the justice system.

How does an individual lawsuit financing transaction work? In a typical individual lawsuit financing transaction, someone who has suffered a personal injury and is pursuing a legal claim on a contingency fee basis seeks financial assistance from a third party during the case’s progression. The financial assistance could be for living or medical expenses, rather than legal costs. After reviewing the eligibility of the pending claim to verify that the claim has merit and is likely to succeed, the lawsuit financing company will advance the funds to the consumer. The consumer will repay the funds if and when the lawsuit is won or settled. During the course of the financing, funding fees will accrue, and these fees can increase based on the time it takes to resolve the underlying legal claim.

How does a commercial litigation financing transaction work? In larger, commercial litigation financing transactions, the funding companies will advance the litigation funds in exchange for a pro rata share of the proceeds that result from the underlying lawsuit. In the larger cases, the litigation funding companies may be specialized investment firms or hedge funds. The larger, commercial litigation cases could involve class action or mass tort claims.

Are third-party lawsuit financing agreements considered loans? That is the question state legislators and other policymakers are grappling with. Groups like the American Legal Finance Association argue that litigation funding should not be considered a loan because the funds are advanced on a “non-recourse” basis—meaning that if a financing client does not receive a court award or settlement, the funding company is not repaid. In contrast, if the transaction is considered a loan, then the advanced funds would have to be repaid whether the client wins or loses the court case.

In a 2013 decision, the Colorado Court of Appeals ruled that these transactions do constitute a loan as defined in the Uniform Consumer Credit Code, because the funds advanced by the financing companies involved in the case create contingent debt. The Colorado Supreme Court decided in January to review the Court of Appeals’ ruling.

Whether or not these transactions are loans, a group like the American Tort Reform Association and the U.S. Chamber of Commerce argue that third-party lawsuit financing hurts consumers and undermines the integrity of the civil justice system. They point to the funding fees, which typically run 2 percent to 4 percent per month, compounded on an annual basis, which can reduce the amount consumers receive as a result of their litigation or settlement. And, these funding arrangements insert a third party into personal injury cases, which could compromise the interest of the litigants and lead a plaintiff to reject a settlement offer for the chance to receive a larger court verdict, because the plaintiff needs to repay the funds received in the financing agreement.

Supporters of third-party financing, like the American Legal Finance Association, disagree that these transactions interfere with the litigants’ decision-making. In most of the financing agreements, the funding amount equals approximately 10 percent of the estimated net value of the case—a small percentage of the case’s anticipated value that does not place an undue burden on the plaintiff’s willingness to continue the case or the final verdict.

State Action

Four states—Maine, Nebraska, Ohio and Oklahoma—have enacted legislation regulating third-party litigation funding agreements. All four states require that the contracts and disclosures must be in writing. Maine’s statute prohibits a litigation funding provider from assessing fees for any period of time exceeding 42 months from the date of the contract. Nebraska’s statute limits the time to 36 months from the date of the contract. Ohio’s and Oklahoma’s statutes do not have limitations on the time fees may be assessed.

In 2014, legislation to regulate third-party finance companies is pending in 12 states: Alabama, Georgia, Illinois, Indiana, Iowa, Kansas, Missouri, North Carolina, Oklahoma, South Carolina, Tennessee and Vermont. Alabama S.B. 231, Illinois H.B. 2300, Kansas S.B. 233 and South Carolina S.B. 788 would categorize a consumer lawsuit lending agreement as a loan. In contrast, Illinois H.B. 2301 and Missouri S.B. 542 would not categorize the agreements as loans and are similar to Nebraska’s 36-month limitation on the fee assessment. North Carolina S.B. 648 would prohibit third-party financing. Tennessee S.B. 1360 would limit lawsuit funding transactions to three years and limit the fee, which shall be calculated to include any underwriting and organization fees, interest and any other charges, fees or consideration, to not exceed an annual percentage rate of 25 percent. Oklahoma S.B. 1515 amends its existing provisions to put in place a maximum administrative fee for violations by consumer litigation funders.

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