Litigation funding is an area of specialty finance in which plaintiffs tap into the potential value of pending lawsuits to access cash before their lawsuit is settled.  Litigation Funding, by conservative estimates is a $2.3 billion industry in the U.S.

Lawsuit funding works by lenders advancing funds to acceptable plaintiffs prior to the end of the litigation and in return, the lender receives a portion or possibly, all of the future proceeds of any settlement.  Because of this, lawsuit funding is also known by some as “plaintiff funding.” Plaintiffs and attorneys should note that repayment for lawsuit loans comes directly out of any settlement a plaintiff may receive, and they do come with interest.  A plaintiff could lose out on much or all of their settlement, due to the repayment of the lawsuit loan, so it is an important decision.

The lawsuit funding industry began in the late 1990's, and today more and more plaintiffs are seeking cash from a portion of their case prior to settlement.  Regulation of lawsuit funding industry varies by state, and litigation funders are still largely left to self-regulate.   The American Bar Association, “ABA” in 2020, provided some guidance by adopting Best Practices for Third-Party Litigation Funding.  But even the ABA guidelines are vague and state that, “these Best Practices should not be read as recommended standards of professional conduct or as a basis for attorney discipline…  Jurisdictions.…may have standards that differ (perhaps materially) from these Best Practices …”

Accordingly, attorneys should learn about the lawsuit funding industry, how it works, what problems it seeks to solve, and how to effectively manage client expectations.  Below we discuss some general concepts of what attorneys should know about litigation finance. As lawsuit loans carry interest, often very high rates of interest, they are important decisions not to be made lightly by clients and involve the input of an attorney. They also vary by jurisdiction so an attorney involved in lawsuit funding needs to learn the rules for the applicable jurisdiction.

A  Very Brief History of and the Purpose of Litigation Funding in the US.

Lawsuit funding arose in response to personal injury litigants’ need for cash during the legal process and the US market traces its origins to Australia and the UK.  As many attorneys already know, clients may have an immediate need for financial support that cannot be met by their counsel, and attorneys in many jurisdictions cannot loan clients money due to ethics rules.  Plaintiffs unable to work due to their injuries, often find themselves unable to make ends meet.  Lawsuit loans, also known as settlement loans or lawsuit funding, are an avenue to solve certain litigants’ short-term cash flow problems. Though any loan, especially one being considered when the borrower is under duress such as during an ongoing lawsuit, should be considered carefully.

Personal injury victims often have to face insurance companies and their team of defense lawyers in court.  Cases can drag on for years and because plaintiffs may not be earning what they were prior to the accident, many accept ill-advised settlement offers simply because they cannot hold on financially.   Crowded court dockets only make the situation worse for plaintiffs.

Lawsuit loans can solve this dilemma by offering access to cash to pay for pressing financial needs.  Plaintiffs may be better able to withstand the delays inherent in the legal process.  But with all loans, it is an important decision that should not be made lightly.

Many clients utilize lawsuit funding to pay for groceries, utilities, rent, mortgage payments, insurance premiums, and medical treatment.  These specialty financial instruments can be a  flexible option for qualified litigants in their time of need. But an understanding of the lawsuit funding industry, lawsuit lenders underwriting practices, and repayment provisions and processes are important to make an informed decision about litigation funding. 

How Are Lawsuit Loans Structured?

Plaintiff funding is structured as an assignment of property rights.  The property assigned is the potential future proceeds of a lawsuit.  Because lawsuit loans are structured in this manner – as a purchase of future proceeds – lawsuit loans are only repaid if the lawsuit is successful.  And while lawsuit loans don’t need to be repaid by plaintiffs if they lose their case, they do have to be repaid if the plaintiff wins their case. Lawsuit loans do come with interest, which can be quite high given the lender's risk and a plaintiff could lose out on much or all of their anticipated settlement.

If a plaintiff loses the case, the portion of the settlement purchased by the lender is essentially worthless.  There is no commitment to repay the advance if the plaintiff loses the lawsuit. Funding contracts are “non-recourse” loans in that the funder generally has no recourse to pursue repayment from the plaintiff personally. Whether a debt is considered to be recourse or nonrecourse may vary from state to state, depending on the relevant state law and the structure of the loan document.

Further, it is this structure that removes these transactions from the application of state usury laws.  Usury laws apply to traditional loans because repayment is implied under all circumstances other than default.  In the event of a default, the creditors' recourse is to pursue the debtor in the courts of law.

Although pending lawsuits are not traditional collateral, they do have value. In non-recourse litigation funding,  the lawsuit funding companies risk is a total risk of loss.  That is, if a case is lost, the funding company loses the entirety of its investment.  Thus, pricing for lawsuit loans reflects the risk to the lawsuit funding company. Lawsuit loans don’t need to be repaid if the plaintiff loses their case, but lawsuit loans do need to be repaid with interest if the plaintiff wins, and the interest rates reflect the lenders' risk of total loss and can seriously deplete or even eliminate the plaintiff’s settlement payout.   For these reasons, it is unlikely lawsuit loans could be offered at rates that comply with state usury laws.

For litigants and investors alike, the structure of lawsuit loans (as assignments of property rights) makes it possible to market them to the public.

Who Invests in Lawsuits Loans and What Type of Cases Are They Interested In?

Litigation funding enterprises gather money from a variety of sources ranging from private equity firms to private individuals.  Some litigation funders earmark investment dollars for large litigation projects such as product liability class action settlements.  Examples of these include transvaginal mesh or hip implant products or widespread sexual abuse cases.

Other types of lawsuit funding investors pool money to invest in smaller cases.  A typical smaller case might involve an automobile accident.  Car accident lawsuits are the bread and butter of the lawsuit funding business because liability, damages, and insurance coverage are usually documented. 

Larger lawsuit funding companies are interested in all types of plaintiff cases in which lawyers have a contingency fee arrangement with their client, including automobile cases, slip and falls, premises liability, and other physical injury-type cases.  Others might include civil rights cases, wrongful termination, medical malpractice, wrongful death, and employment-related cases such as Jones Act or NY scaffolding cases.

Investors desire the attorney to have a stake in the case’s outcome either in the form of time and/or case expenses.  Attorney’s fees are generally not considered for funding by most of the lawsuit funding industry.

What are the Prerequisites for Obtaining Lawsuit Funding?

Generally, a candidate for lawsuit funding loans has:

• an attorney
• the attorney is paid only if the case is successful (or a contingency fee arrangement)
• a viable claim to attach
• a defendant who can pay damages (like a defendant who has insurance coverage).

If the above criteria are met, the plaintiff’s loan goes through an underwriting process by legal professionals at the lawsuit funding company.  If the case type and investment amount meet the company’s current risk criteria, the case is approved for funding.  A loan contract is then drafted and offered to the plaintiff for consideration.

A key prerequisite of litigation funding is the cooperation of the plaintiff’s attorney.  A plaintiff’s attorney(s) are expected to participate in the funding process and normally provide requested documents; field phone calls with a lawsuit funding underwriter; sign off on the funding contract; and agree to repay the lawsuit funding advance to the loan company when the case is successfully resolved and a settlement is received.  

How Long Does the Lawsuit Funding Process Take?

A settlement loan can take 12 hours to process or take a week or longer.  The answer depends on how quickly the required information gets to the funding company and the complexity of the case.  Lawsuit funding companies have streamlined the process as much as possible. Once a funder receives sufficient information to evaluate the case/claim, an underwriting decision generally comes within a business day or two.

What Types of Cases are Good Candidates for Funding, from the Lender’s Perspective?

Personal injury cases, like auto accidents and premises liability, are the bread and butter of litigation funding. Some companies fund medical malpractice, product liability, discrimination, and wrongful termination cases.  Others have more exotic tastes and finance clients with Qui Tam (whistleblower) cases or mass torts such as hip implant lawsuits. 

Auto accidents and your more routine negligence cases make up most lawsuit funding transactions.  This is primarily because liability is generally easy to ascertain, damages are easily documented by lost wage information and/or medical records and there is normally an insurance policy in place to compensate injured victims. 

Are Litigation Loan Transactions Regulated? 

For the most part, lawsuit loans are not regulated in any meaningful way.  Some states have regulated the industry by requiring licensing.  Other states have effectively banned the lawsuit loans by capping the amount that can be charged below what funding companies are willing to accept to stay in that market.  Some lawsuit funding companies adhere to “best practices” recommended by New York.  Those practices deal with disclosures on the amounts due and payable when the case is ultimately resolved. 

State legislatures are considering the issue. The Federal Government and Consumer Financial Protection Bureau (CFPB) have yet to offer guidance.  Since the the litigation funding business is still growing, it is likely only a matter of time until we have meaningful regulation of the lawsuit funding business. As mentioned previously, the ABA’s 2020 Best Practices do not carry the weight of law and since lending laws are always changing, attorneys should always research the law in the lawsuit’s relevant jurisdiction, before recommending any litigation funding.

Are Lawsuit Settlement Loans a Good Idea?

As mentioned above, lawsuit loans exist in a largely unregulated marketplace.  When the industry was in its infancy, companies did not have enough return history to accurately gauge pricing.  Accordingly, there were some firms were charging very high rates and fees for the use of their money. 

The market has evolved, and market participants are now engaged in a more competitive marketplace.  The competition resulted in pricing reaching current levels where loan businesses can earn a profit and find customers who will agree to their terms. Most often, you will find companies charging approximately 3% per month (36%) per year for lawsuit funding.    

Lawyers who sign off on lawsuit loans, often do so because they address clients’ financial needs when that need cannot otherwise be met.  Many customers look to lawsuit lenders when no other alternatives are available.  They’ve already exhausted short-term loans from friends and/or family, tapped out their savings, etc.  Any loan under stressful circumstances, such as during a lawsuit, should be thoughtfully considered.

Further, there are no restrictions on the use of the money.  Many use the funding to pay bills.  Others utilize the money to pay for medical treatment when there isn’t available insurance coverage. 

Every personal situation is different.   As with any loan, litigation funding arrangements should be spelled out in writing, in clear terms, that make it clear who is responsible for paying the lawsuit funder, from what source, and when.  The interest rates should be clearly spelled out and it should be clearly communicated to plaintiffs that lawsuit loans deplete or even eliminate the plaintiff’s settlement payout.  

This submission does not necessarily reflect the opinion of the National Law Review or National Law Forum. LLC or provide legal advice.