IS LITIGATION FINANCING A "SAFETY VALVE" THAT COUNTERACTS THE FORCES OF TORT REFORM? From American Lawyer: "Helping Underfunded Plaintiffs Lawyers -- at a Price,"by Alison Frankel--

The glossy brochures are irresistible. "The Power of Attorney Funding," proclaims the one from Counsel Financial Services, against a backdrop of a courthouse facade and an American flag. "We do what banks won't," reassures LawFinance Group Holdings, superimposing its pitch on the reassuring heft of a courthouse pillar. "We have what it takes to win."

The price of nonrecourse loans is high: some companies charge up to 37 percent annual interest. According to Plaintiffs' lawyer Christopher Seeger, "It's ridiculous how much they charge."

Looking for a silver lining, a law professor says that litigation financing might be considered a "safety valve in the face of tort reform, a counteracting force." I don't follow the argument. Tort reform is legislation that restricts the right to sue or to collect damages. You can't get around it by throwing more money at a case.

Using anti-tort-reform sentiment to sell expensive loans to plaintiffs' lawyers? It's a case of putting makeup on a pig. Underneath the makeup, it's still a pig.

Comments

[John Day]

Evan - I read the article and, like you, did not understand the professor's comments. These high-rate loans have nothing to do with tort reform but they have everything to do with business judgment - or the lack thereof - by the people who utilize them.

[Ted]

As I note in the trackbacked Point of Law post, a two-tier 37%/0% contingent nonrecourse loan isn't expensive. If the case has a 50% chance of success in two years, the expected return is negative. If the case is a 100% slam dunk, then that looks expensive, but if it's a slam dunk, where's the plaintiffs' bar and why won't it help a fellow member?

[mark]

This is an anon post, but hear me out:

A small firm I do a bit of work with went this route last year. Smaller advance of less than $150K. Firm had tough times at year end and partners didnt want the proc exam of a bank. Loan/advance was done and 120 days later the case settled.

They were happy. Looks like a win win.

[Tom]

It seems to me that this practice of offering nonrecourse loans, loans which don't need to be paid unless the attorney wins the case, violate the ethics opinions of most state bars regarding fee splitting. I don't know of any state bar that would allow fees to be paid based upon winning a judgement.
Am I wrong? Enlighten me.

[Evan]

Tom: I don't think that's right, generally speaking. In the litigation-financing situation, the amount the attorney-debtor owes is a fixed amount. Even though repayment might be contingent upon the outcome, that fixed amount doesn't change according to the amount of fees recovered.

Litigation-financing situation: "I promise to repay you $1 million at 37% interest. My promise to repay is contingent upon a successful recovery."

Fee-splitting situation: "I promise to repay you $1 million plus 37% of any fees recovered. My promise to repay is contingent upon a successful recovery."

Of course, if the litigation-financers are lawyers, the dynamic changes accordingly--then the second example might be okay, since to call something "fee-splitting" assumes one of the parties to the transaction isn't a lawyer.

Note: This explanation is off-the-cuff without research and might not be correct. If anyone else can enlighten us, that would be welcome. I do know, however, that since fee-splitting is an ethical offense that often leads to disbarment, I'm sure that the issue has been well-researched on both ends of the transaction, and that some of the various state bars have weighed in.

[Jeremy]

I'm an outsider to this blog, but I thought I'd chime in on this interesting topic. I guess what I don't understand is why is there such opposition to something that amounts to nothing more than an alternative way to finance a business? How is this much different than a bank (say, Citigroup) issuing senior, or even subordinated, debt to a manufacturing firm in order for them to conduct business? The only difference I see is the nature of the product, which in this case is more intangible because it is a service being provided instead of a product being manufactured.
The bank assigns an interest rate to the loan based on the risk it believes the loan carries relative to other loans it could make to borrowers. In this case, as it turns out, the loan is very risky because it hinges entirely on a successful appeal. If the appeal is not successful, no one (obviously including the lender) is not paid and capital is lost for good. Since interest rate is reflective of the implied risk of an asset, does it not seem that this type of lending should command a greater interest rate due to the notable level of risk being undertaken by the lender? I'm not a banker, just an MBA.

[Jeremy]

What the law professor means by "counterbalancing the forces of tort reform" is that there is relatively little risk for lawyers that want to take on this type of financing in order to do litigation work for their clients. If they lose because of restrictions put in place because of tort reform, then they haven't lost a dime. They don't have to repay the loan. In other words, they would be more likely to take cases in the face of more restrictions being put in place by tort reform. Of course, the banks will start to become much more selective in these types of deals if they aren't able to secure any assets from the borrowers because they keep losing cases. If you ask me, the market will decide whether or not this is a good vehicle for financing litigation. If it turns out to be too risky, banks won't lend. If it turns out to be lucrative, competition will enter and perhaps the rates will go down.

[Matt]

Wouldn't it be ironic if some of the same companies that fund so much tort reform propaganda had subsidiaries that were profiting off the funding of plaintiff's cases?

[Aaron]

These transactions are usually not characterized as loans, which may be subject to usury laws. They may be characterized as venture capital, for example. The companies offering the advances know how to evaluate a case and its likelihood of victory or settlement, and they moderate the size of any advance such that they are likely to recover both the advance and their "fees".

Ted asks where the plaintiff's bar is? Where should it be? I personally don't know any lawyer who has accepted this type of advance. Maybe it's more common in other states. Given that pretty much any other form of financing is cheaper (unless you dupe a firm into giving you an advance on a case that you don't expect to win), I don't see this type of financing as having much appeal.

[Ted]

The plaintiffs' lawyer in the story took a (contingent non-recourse) 37%-interest loan (with no interest after three years) because she felt it made her better off financially. It makes little sense for plaintiffs' lawyers to characterize the loan as "expensive", because if it really was, why aren't they calling up the woman and offering 10% or 20% or even 35% loans that would be less expensive and make both parties better off? There's a sound economic reason why that loan isn't cheaper.

[Kari Gray]

As a professional financial consultant firm who specializes in attorney funding, we have a clear picture of the issues involved. The nature of our business is clearly defined by our company's agenda, "Protecting Your Interest from Interest." With that being said our firm screens and only represents investment firms whose recovery rates are not "excessive" from what the market can bear. That being said, the real question is, "what is excessive"?

We all know each case has its own nuances as no two cases are the same and there is no 100% guaranteed win on any case for a variety of reasons. Now that being the case our firm commits to each of our clients our professional capability to assist each in securing non-recourse, recourse, pre & post settlement attorney & client funding. While this form of capital is most compared to traditional lending interest and criteria, the program delivers far more lenient recovery than any government regulated lender will ever offer, so aren't we really comparing "apples to oranges"?

That being said here is the real issue, if you don't like the return and feel you want 100% risk and monthly cash flow depletion, then traditional lending is your best option. But for an increasing number of plaintiffs and their attorney’s, higher recovery no risk funding is a preferred option because of the risk free factor, and since none of us gets to live our life backwards to know if recovery will occur and can we endure the more often times lengthy litigation process.

As for those individuals who find the recovery rates "usury", we find it ironic that the same individuals who complain freely and use words like "usury" about the return rates are eager themselves to obtain such if it was their opportunity to cash in on the financial hardship of another attorney or plaintiff. The is made clear when we have asked, “if this was your money and you were taking this type of risk, what would your rate of return be?” And it is at this defining moment when the “shoe being on the other foot suddenly begins to fit better.