Monday, January 17, 2011

Lawsuit Lenders

Litigation finance is a complicated subject. On the one hand, it truly helps litigants and their attorneys when a lawsuit costs too much, or a litigation is too drawn out, health costs are out of hand. In cases where a plaintiff might not be able to afford to hang on to make a fair settlement, defendants might bully or simply delay their way out of the problem. On the other hand, there may be lawsuits that should never be filed that are funded, or drawn out with these loans. From the defense bar's point of view, the lenders are underwriting cases that should not be moving forward. And on the other other hand, as Tevye might say, the lenders are under- or unregulated, and often seem to take high interest rates, with insufficient notice to the borrower.

According to an article at, dated June 4, 2010, the U.S. is late coming to this business. Third party lending to finance litigation first arose in Australia, and then spread to the United Kingdom. This article traces the rise of the U.S. market in litigation finance to the collapse of the derivatives and mortgage-backed securities markets. The money that had been funding those suddenly was looking for new investments at high returns, and is finding it in litigation finance. The article does a nice job of analyzing recent changes in the law of champerty, which until recently barred interests in the outcome of lawsuits. Although the legal bar to third party investment in litigation has been removed in most states, there seems to still be some ethical queasiness. The article includes a link to a report by the Institute for Legal Reform, on Third Party Litigation Financing (which attributes to attorneys from Skadden, Arps, Slate, Meagher & Flom), which argues against lawsuit loans. They fear that the firms that now make loans on individuals' civil cases will soon be financing mass and class actions and personal injury actions, opening the floodgates of high-risk, high-expense litigation. They also raise the specter of unjustified litigation being funded by the loans. But the author of the article balances the report with interviews from attorneys from other silk stocking firms, such as Cadwalader, Wickersham & Taft who are seeing an uptick in their business due to litigation finance in a very poor economy.

The Boston Globe ran an article that led me to the New York Times, where the full article was originally published by Binyamin Appelbaum on the business and abuses of lawsuit lenders. The article is part of a series on the topic, which has been a collaboration between the Times and the Center for Public Integrity, a non-partisan, journalism non-profit in Washington, D.C. (here is a link for their investigation, "Betting on Justice: Borrowing to Sue.") The problem is that the companies that lend to individuals who are involved in lawsuits but find their daily expenses require a cash infusion are not regulated much at all. They often charge interest rates that would be usurious in any other loan setting (sometimes 99-100% compounded interest in the first year). And they do very little to inform the borrower of the cost of the loan.

The individuals who take these loans may feel they have few options if they want to maintain their suit. The Center for Public Integrity reports that a civil lawsuit may cost between $15,000 and $100,000, depending on whether there is complex scientific evidence to be presented. The costs of the suit, added to living expenses and the costs incurred by treatment of injury or illness exceed most individuals' capability to pay. And people do not understand what they are signing up for. Often the details of the contract are hidden in fine print or vague, or minimized by the loan officer. These may amount to contracts of adhesion, where the individual has very little negotiating power or feels they have very little ability to shop for alternative sources. Advertisements emphasize the ease and speed of the loan, and loan officers are instructed to never mention the cost of the loan unless directly asked. Some of the stories reported misleading information about the interest cost on the contracts.

The lawsuit lenders fight against being classified as traditional lenders, according to these articles, because they point out that, if the litigator loses the suit, they are not required to repay the loan. They say they take more of a risk, and should be able to charge higher rates accordingly. But there is a growing backlash among the judiciary and legislators against the industry.

James N. Giordano, chief executive of Cambridge Management Group, a New Jersey lender, compared the deals to venture capital. “It’s as if your buddy came up to you and said, ‘I’m starting a business, I need $25,000 — and, by the way, you may never get your money back,’ ” he said.

Lawsuit lenders, however, are much better than venture firms at picking winners. Lenders pay lawyers to screen cases, looking for slam-dunks like Vioxx. Three of the largest companies each estimated that they rejected about 70 percent of applications. Oasis said it had approved about 80,000 of 250,000 applications in recent years. To further limit losses, companies say they generally lend no more than 10 or 20 percent of the amount they expect the borrower to win.

Companies say they still lose money in a significant share of cases, from 5 to 20 percent, although there is no way to verify those numbers.

But courts in several states — including Michigan, New York and North Carolina — have ruled in recent years that individual borrowers did not need to repay lawsuit loans, finding that the apparent risks did not justify the outsize prices. The rulings have encouraged lenders to avoid judicial scrutiny. Dimitri Mishiev, who runs Alliance Claim Funding, another Brooklyn lender, said that while his prices were fair, he tried to invest only in cases he expected to be settled before trial. (snip)

The industry’s pursuit of regulation on its own terms began in Maine in 2007.

Sharon Anglin Treat, a lawyer and state legislator, had proposed a bill making clear that lawsuit lenders were subject to state consumer protection laws. She said she could not understand why the industry should be allowed to charge higher rates than other lenders. (Maine passed P.L. Ch. 394, “An Act to Regulate Presettlement Lawsuit Funding." I hope you can get the link to work -- I am missing a plug-in.)

Oasis, LawCash and other companies persuaded other legislators to reverse the intent of the bill, instead making clear that the rules did not apply to lawsuit loans. Both Ms. Treat and Mr. Hirschfeld said the debate turned on the testimony of three Maine residents who had benefited from the loans. “These are powerful companies that have lots of money, and they brought in people with these sob stories,” Ms. Treat said.

Supporters of lawsuit lending next turned its attention to Ohio, where the state’s Supreme Court had declared lawsuit lending illegal in 2003. This time, Mr. Hirschfeld said that the industry asked lawyers throughout the state for examples of clients who had suffered because they were not able to borrow money. Both chambers of the legislature voted unanimously in 2008 to legalize the loans. (see brief article here by attorney Mark Bello announcing in summer, 2009, Ohio House Bill 248 effective August 27, 2008, Ohio Revised Code § 1349.55) (Mark Bello turns out to work for Lawsuit Finance, and blogs at Lawsuit Finance Blog) (Ohio's Supreme Court had first declared litigation finance barred by champerty, in Rancman v. Interim Settlement Funding Corp.,
99 Ohio St.3d 121, 2003-Ohio-2721). Last year, Nebraska followed suit, passing a bill sponsored by State Senator Steve Lathrop, a trial lawyer.

“My own personal view of these groups is that I discourage clients from using them,” Mr. Lathrop said during the final debate. “I tell them, go borrow from anybody you can before you have to use them.”

“But,” he concluded, “the reality is, sometimes there’s no other place to turn.”
(from the N.Y Times article)An article in The Metropolitan Corporate Counsel May,3 2010 by Tiger Joyce reports that the American Litigation Finance Association was lobbying in six states that they could identify: Illinois, Kentucky, Maryland, Minnesota, Nebraska and New York for legislation in their interest. I will cover Illinois below. Kentucky does not seem to have passed a bill yet. I would guess the statute would probably be codified either at Chapter 360, Interest and Usury, or Chapter 367, Consumer Protection, which, in Kentucky has many detailed subdivisions. I cannot find that Maryland has passed a bill yet. Maryland's statute would probably show up in Commercial Law, 12-301 - 12-317, Maryland Consumer Loan Law -- Credit Provisions, or perhaps the usury provisions 12-101 - 12-127. Minnesota's legislature has a wonderful website, and I looked through it for a bill on the topic. There does not seem to be any pending bill filed yet. The best guess for where a statute would be codified if it ever passed would be Chapter 334, Money, Rates of Interest, or possibly in Chapter 332, Collection, Credit Services, Consumer Protection, which has 332.52 - 332.60, Credit Services Organizations. I cannot locate the Nebraska statute, despite what the article above says. Here is the section of the code where it will probably reside: Chapter 45, Interest, Loans, and Debt. Likewise, I cannot locate a New York statute specifically on lawsuit finance, but expect it would reside in New York Code, General Obligations, 5-501 - 5-531.

In Illinois, I found an article at Legal Newsline dated January 7, 2011, by Jessica Karmasek, stating that the Illinois legislature had voted down the so-called "Lawsuit Loan Shark" bill, SB 3322. Even one of the bill's co-sponsors ended up voting against it, after word got out about the terms. Lawsuit lenders would have been exempt from Illinois consumer loan regulations, and instead be under the laxer Department of Professional Regulation. In addition, newspapers began comparing the interest rates in the bill to payday loans, and legislators began to feel more uncomfortable about the terms. The official title of the bill was the Non-Recourse Civil Litigation Funding Act, and another criticism was fear that it might encourage frivolous lawsuits, and would be detrimental to job creation.

There is a lead article, LITIGATION FUNDING: CHARTING A LEGAL AND ETHICAL COURSE, Julia H. McLaughlin at 31 Vermont Law Rev. 615 (no.3, 2007). At the other end of the literature spectrum, here is an e-zine article at Legal Affairs dated September - October, 2004, "Litigation by Loan Shark," by Daniel Brook. He tells about a desperate litigant/borrower, and a visit he made to the lender, Plaintiff Support Services, which then had offices in Getzville, N.Y. (near Buffalo).
PSS was founded in 1992 by Ken Polowitz, a mortgage banker who realized that there was an untapped lending market in cash-strapped plaintiffs awaiting potentially massive settlements. Unlike DiSalvo's loan sharks, Polowitz's company charged fixed interest rates rather than a percentage of the final settlement.

In 2000, Joe DiNardo, a Buffalo-area personal injury lawyer, purchased PSS from Polowitz. At the time, its portfolio of cases was worth roughly $1 million, meaning that if every case were settled successfully at that moment, the company would collect $1 million in principal and interest. Leaving the practice of law to take over PSS was a forced career change for DiNardo. In the mid-'90s, his personal injury firm was earning nearly $5 million in gross receipts. But in 1997, DiNardo came under federal indictment for tax evasion and for bribing and tampering with government witnesses. According to federal prosecutors, DiNardo conspired to pay upwards of a hundred thousand dollars in kickbacks to a union leader in exchange for case referrals of union members injured on the job. (In a brazen and convoluted scheme, DiNardo tried to write the kickbacks off as a tax-deductible business expense.) Ultimately, DiNardo copped a plea, taking a tax evasion conviction and house arrest to escape jail time. (snip)

The company's chief underwriter, Helen Jones, says PSS invests in about 6 out of every 10 cases it analyzes. Yet even after winnowing down the investment opportunities, there is always risk. The case could go to trial in front of an unsympathetic jury, or a plaintiff claiming to be injured could be spotted playing a round of golf.

When settlement checks go out, the lawyers are paid first, the litigation finance company second. If the company is owed more money than the client wins, it's out of luck (though not as out of luck as the client, who ends up with nothing). To avoid this lose-lose situation, PSS tries to advance only up to 10 percent of what it estimates the case is worth. When company officials meet with a client, they use a computer program to project the interest on the cash advance, which accrues rapidly. At the company's office, I was shown a spreadsheet for a hypothetical client who had received $8,500 in monthly cash advances over six months. Less than two years after the first advance, the client owed PSS nearly $14,500—$8,500 in principal and nearly $6,000 more in interest.

PSS PRIDES ITSELF ON DOING EVERYTHING ABOVEBOARD, and the PSS clients I spoke with confirmed that the company is upfront about the interest rates it charges and what that means in real dollars.
Author Brook tells a horror story about a lawyer whose plaintiff client refused his advice to accept an offered settlement of $1 million because she calculated that after she paid off her lawyer and the loan company, she would have nothing left herself. She insisted on $1.2, took the case to trial and lost everything. Of course, she did not explain her reasoning until afterwards. This is a risk I had not even considered until I read that article!

The scales of justice, in the case, are a nice metaphor for the balancing of benefits and risks in this new development.

1 comment:

Marie S. Newman said...

I first heard about this trend from a faculty candidate who discussed it during a job talk last fall. Frankly, my first reaction was horror. But when I thought the concept through, I realized it could provide access to the courts for people who might not otherwise have access. Sure, there are a number of downsides, but there are opportunities as well. Thanks for a very thorough post on the subject, Betsy.