Lawsuit Loans (Non-recourse Litigation Funding)
In recent years there has been dramatic growth in the industry known as lawsuit lending. The purported goal of this industry is to provide living and other expenses to plaintiffs in a lawsuit to make it easier for them to continue their litigation. However, their help comes with an exorbitant price.
Here’s how it works: a plaintiff borrows from the lawsuit lender and then later pays the loan back once he receives his settlement. Of course the plaintiff must pay back not only the principal but also the interest that has accrued. The interest rate charged on these loans is typically 2-4% per month compounded monthly which can translate to an annual interest rate of over 60%!
This practice has been known in the past as champerty, which is defined as “sharing in the proceeds of litigation by one who agrees with either the plaintiff or defendant to help promote it or carry it on. “ This practice had long been illegal under common law in many jurisdictions but many of those restrictions have been overturned or often ignored.
What is the impact of these lawsuit loans? First, they tend to raise the cost of litigation because plaintiffs now must not only recover their damages but they must recover a large additional amount to cover the interest. Second, it tends to make plaintiffs less likely to settle which would raise litigation costs for both sides as more cases go to trial. Of course, higher litigation costs will lead to higher insurance premiums and higher costs for all of us who pay those premiums.
Opponents argue that these arrangements are not really loans because they are non-recourse, meaning that the loans need not be paid back if the plaintiff loses the case. However, that is only true if the plaintiff loses the case at trial. If the plaintiff would reach a settlement before trial as usually is the case then the loan would need to be repaid. Therefore, a plaintiff may be better off to let a case go to trial and lose rather than to settle and receive little or nothing, or maybe even end up owing the “lender.”
The Kentucky Bar Association examined this practice in an Ethics Opinion released in 2011. The Bar Association did not prohibit lawyers from participating in these arrangements but it did issue several warnings about potential ethical pitfalls for attorneys. That Ethics Opinion may be found here.
Similar to what has happened in many other states, legislation was proposed in Kentucky in 2011 that was promoted as a regulation of the lenders and their practices. In reality, there were few protections for consumers and no penalties for lenders who were found to be in violation of the bill’s provisions. There were no regulations on the amount of interest to be charged and attempts to limit the interest rates were opposed by the proponents. Fortunately this bill did not pass in 2011.
There was no similar bill in Kentucky in 2012 but that does not mean that this issue has gone away. IIK will remain vigilant to oppose this bill along with many other business and consumer groups who have opposed it.