Study: Mass tort plaintiffs paying dearly for loans, regulation needed
By Daniel Fisher
Litigation funders charged their clients more than 60% a year in interest on loans against mass tort cases and earned even more on loans to plaintiffs who had already agreed to settle their cases, a new study involving thousands of actual case files found.
The study adds rigorous analysis to a field that became notorious after a federal judge invalidated hundreds of high-interest loan contracts involving football players who borrowed against their NFL concussion settlements.
The study, the first of its kind using a large database from one the largest U.S. litigation funders, reveals how lenders take advantage of exemptions from usury laws in most states to charge rates that are much higher than other forms of credit such as home-equity loans or credit cards. The typical lawsuit loan was for less than $10,000 and paid back in a little more than a year after the client settled his or her lawsuit.
Funders defend their rates by noting they receive nothing if the plaintiff gets nothing – making their products different from traditional loans that are governed by usury laws.
The study’s authors – Ronan Avraham of the University of Tel Aviv, Lynn Baker of the University of Texas and Anthony Sebok of Cardozo Law School – conclude that more regulation is needed, including clearer disclosure of lending terms on the front end. They also say states should impose interest-rate curbs on loans against settled cases, since they involve virtually no risk. The lender in their study earned a 68% annual profit on such loans.
“While some may argue that the risks faced by the Funder justify making a median gross profit of 55-60% annually in pre-settlement cases, the same justification does not exist for post-settlement cases,” the authors write in “The Anatomy of Consumer Legal Funding.” “Because the rate of default and eventual haircuts in these cases is very low — which means that the non-recourse advances on paper are not non-recourse on the ground — we see no reason why funding in such cases should not also be subject to usury laws.”
To compile their data, the authors were given access to 225,552 loan files from 2001 to 2016 from an unnamed company they described as one of the largest litigation funders. The files included would-be borrowers with 71,782 auto-vehicle cases and 8,536 mass-tort cases. Litigation funders are picky, and only lent against 55% of motor vehicle cases and 60% of mass torts.
In both types of cases, the funder typically extended no more than 10% of the expected settlement value, which was a median of $127,000 in mass torts and $25,000 in car accidents. The median pre-settlement mass tort loan was $5,000 and auto accident loan was $2,000, with the averages double in both cases due to a minority of high-dollar loans.
The typical mass-tort loan had a stated interest rate of 2-3% per month but the lender boosted its return with other features including compounding, which exposed a growing balance to that monthly charge, and “interest buckets,” a sort of prepayment penalty that requires borrowers to pay interest in six-month increments. The lender also charged $350 or more in fees that generated interest over the course of the loan, bumping the final total owed by 7-9%.
If the lender was able to collect on those terms, returns would have exceeded 68% a year. But the loans are non-recourse, meaning if the plaintiff doesn’t win a settlement the lender gets nothing. And many plaintiffs also negotiated “haircuts” or reductions in principal that further drove returns down to a median of 55% a year for mass torts and 60% for auto accidents. A little more than half of mass tort loans were paid back in full and the lender made some profit 93% of the time.
The study’s authors noted the funder “inserts hidden and complicated terms in its contracts that make it impossible for clients to understand the actual interest rate they eventually will be charged.”
“We believe lawmakers should regulate these contracts, banning any unnecessarily complicated provisions and requiring that the effective interest rate and total amount due after every one-month period be straightforwardly disclosed in a standardized format,” they wrote, while not suggesting lawsuit loans should be eliminated entirely. Since plaintiffs are unlikely to be able to borrow elsewhere, the authors said, some form of lawsuit lending should be available so they can cover living expenses while they wait for their cases to settle.
No such protection should be extended to post-settlement loans, however, the authors write. Post-settlement loans were closely scrutinized in the wake of the NFL concussion settlement, where 27 different funders lent to 1,000 players after the agreement was approved. A federal judge in Philadelphia in 2018 voided contracts with RD Legal Funding, saying the players were by definition cognitively impaired and the loans violated settlement terms prohibiting the assignment of proceeds to third parties.
“We see no reason that post-settlement LPTF (litigant third-party funding), which presents virtually no risk of repayment to a funder, should have the same exemption from state usury laws or similar consumer protection that pre-settlement LTPF has long enjoyed,” the authors state.
Maryland and Colorado consider litigation finance to be a loan subject to state usury laws and Tennessee capped rates at 10%. Maine, Ohio, Oklahoma and Vermont have passed laws requiring greater disclosure. A New York state court held LawCash to the state’s 16% usury limit in a labor case because it was a “sure thing” and “almost guaranteed.”
“It is ludicrous to consider this transaction anything else but a loan,” the judge wrote in that 2005 decision.
The authors also note ethical questions swirling around the involvement of plaintiff lawyers in litigation finance. Some lawyers discourage their clients from borrowing against their cases and ethics rules don’t require them to advise their clients on loans.
But the fact lawyers appear to negotiate “haircuts” to the amount owed in many cases, they may have an obligation to do so for every client. This is an especially important question in mass torts, where a lawyer may represent hundreds of clients and is supposed to treat every one of them equally.
To fix this potential problem, the lawyers suggests loosening the rules in most states prohibiting lawyers from lending cash to their clients in addition to funding their cases under a contingency fee arrangement. Lawyers could presumably borrow at lower rates than individual plaintiffs and pass the savings through to their clients, the authors suggest.