Originally Published June 12, 2018
Regulation has been a hot topic in personal injury plaintiff financing for years now, with an increasing amount of states looking to regulate it. That shouldn't come as a surprise since most financial products in the U.S. are regulated and as the demand for plaintiff financing increases, scrutiny is sure to follow. Regulating innovative products can be genuinely challenging, though. That's been especially true for plaintiff finance for a few reasons:
- Many legislators' initial repugnance to an industry that "finances lawsuits" starts the funding industry off on an uneven playing field.
- The industry's typical pricing model makes it resemble a loan, even though courts have consistently ruled that it's not and no state that's regulated it has said that it is.
- The industry has a powerful enemy, big insurance, which views plaintiff financing as costing them money by giving plaintiffs more options and time to wait for a fair settlement offer.
- The product is complicated to understand and has many unique features. For example, it's the only consumer financial product where every consumer who gets it is represented by a lawyer.
To help policymakers, we put together 10 points we thought they should know before deciding how to regulate the industry.
1. Why do most people file lawsuits for their personal injuries?
Suffering a personal injury, due to no fault of one’s own, can be incredibly expensive: It can put people out of work and drown them in a sea of expenses. A lawsuit thus can be the best way — and often the only way — for victims to seek justice and attain compensation.
2. Why do people seek funding for personal injury lawsuits?
63% of Americans can’t come up with more than $500 in the case of an emergency. A personal injury isthat emergency. It’s not that injured plaintiffs don’t have money; they will when their case settles. The problem is that they need money now while they’re out of work because of what happened to them — to pay their rent, to buy groceries, to pay medical bills, etc. And we haven’t heard of any landlords or supermarkets who will accept IOU’s, payable when cases settle.
So unless they have a billionaire friend on speed dial, such as Peter Thiel or Taylor Swift, their only hope for justice is to leverage their case’s future value to obtain financing. Plaintiffs seek legal financing not so much to pay for their lawsuits as much as to pay for their lives while they’re out of work.
3. Why can’t plaintiffs get the money they need by settling their case?
Most plaintiffs are fighting not other individuals but large insurance corporations. These corporations typically “drag out” legal proceedings for years, forcing plaintiffs to settle early for low-ball offers just so they can pay their bills. Legal funding provides more options to plaintiffs.
Plaintiffs can now either…
Option A: Settle early by effectively selling 100% of their claim to the defendant insurance company.
Option B: Sell 10-20% of their claim to one of the 1000+ competing legal funders for an advance, and use the funds to patiently wait for a fairer offer for the other 80-90%.
Legal funding, in other words, allows plaintiffs to settle part of their case for money today.
4. Who opposes legal funding?
You can probably guess by now who would benefit if Option B is eliminated: Insurance.
Option A used to be the only option. Back then, liability insurance companies were the only ones authorized to “purchase” a plaintiff’s legal claim. But that’s no longer the case with legal funding, because it introduces competition for that claim. Thus insurance companies are responding to legal funding in exactly the same way that the taxi industry is responding to Uber and the hotel industry to Airbnb: Marshaling its resources to kill it through lobbying and legislation.
5. Okay, but how much does legal funding cost?
Plaintiffs who win a settlement do have to repay their funder an amount that can add up to double or even triple their advance over time. But because the average plaintiff only takes less than $5,000 as an advance, the total amount to be paid back is usually relatively small compared to what they would have given up by accepting a lower settlement offer. In that way, legal funding often pays more than it costs.
The legal funding industry is still maturing, and as more capital is introduced into this space and competition increases, rates will continue to decline.
6. This sounds more expensive than a loan…
Comparing legal funding to loans is comparing apples to oranges. Legal funding is more comparable to an investment. For example, if an investment wins, the investor usually wins big. If the investment loses, the investor loses its money without any backstop or recourse. And if the investment performs middle of the road, the investor usually does just okay.
The same happens in plaintiff funding. If a case settles for nothing, funders have no recourse against plaintiffs. If a case settles but for less than everyone expected, the plaintiff funder often gets a lot less than what’s listed contractually since there’s a finite pool of money from which to pay out. And if the case wins big, plaintiff funders get returns that are typically higher than that of loans (because of the risk of the first two scenarios).
7. Isn’t it bad to introduce a third-party into legal proceedings?
Third-parties are involved in legal proceedings all the time. As Eugene Kontorovich, a law professor, notes, “Anyone who donates to the ACLU or a Legal Aid fund is basically underwriting third-party litigation.” In fact, legal aid is remarkably similar to legal funding. They offer the same service, third-party funding, to the same group of people, plaintiffs who lack the resources to get a fair deal from our civil justice system.
Legal funders, moreover, are forbidden by contract to influence legal strategy. But there are third-parties who do influence strategy: Insurance companies. They step in on behalf of insured defendants. In fact, a hundred and fifty years ago, the public was skeptical of liability insurance, believing that it incentivized people to act more recklessly and distorted settlement offers. Today, liability insurance is ubiquitous, as it should be; no one should have their life ruined just because they made a mistake. If this holds true for defendants, it should be all the more so for victims. In fact, you can think of legal funding as “insurance for victims.”
8. Will legal funding incentivize frivolous litigation?
Legal funders lose their investment if a case doesn’t recover any money, so they are incentivized to only invest in what they believe to be meritorious cases. As scholars note, “Frivolous litigation makes for a worthless investment.”
Second, legal funding actually discourages a certain kind of frivolous litigation: frivolous defense. Richard L. Abel, a law professor, notes that the real crisis in tort litigation are “defendants who assert frivolous defenses, abuse procedure, file hopeless appeals… all to discourage legitimate claims and delay payment.” Legal funding is a free-market solution that holds defendants accountable. The easiest way to eliminate the need for legal funding would be for policymakers to force insurance companies to make early good faith offers.
9. Are legal funding consumers being taken advantage of?
Not only does this question condescendingly presume that legal funding consumers do not know how to calculate their options (see Q3), but it also overlooks the fact that they are always represented by counsel when they do so. If a plaintiff opts for funding, their attorney has to sign an agreement acknowledging that the client understands what they are getting. In that way, receiving legal funding involves much higher level of oversight than most situations in which consumers receive financing.
Many of the people who are pushing legislatures to regulate legal funding out of existence cite “consumer protection” as their main reason. But their efforts arguably leave legal funding consumers more, not less, vulnerable to the whims of liability insurance companies.
Here is a key question to ask:
If injured plaintiffs can choose, with advice of counsel, to sell 100% of their case to the defendant’s insurance company for a low-ball offer without the need for government to set minimum prices, then why should the government set minimum prices for what plaintiffs can sell a small percentage of their case to competing third-party investors for?
10. How should the government respond to legal funding?
We believe the government should regulate it. That may be a surprise based on the above, but there is one caveat. As an innovative product that has yet to mature, we believe that legal funding needs to be regulated in the right way.
Summers' proposal boils down to four guiding principles for regulating financial marketplaces:
Permission not prohibition: let new business models emerge. Regulators should allow new firms to operate and review data on the outcomes created by novel business models before writing new rules. Regulation is necessary but only when necessary.
Insist on transparency and disclosure: then let consumers decide. As new lenders serve parts of the market that have historically not had access to credit, high rates will draw regulatory scrutiny. Regulators should require full transparency and disclosure and see how consumers react to new products and prices before writing rules.
Maintain a level playing field: don't give incumbents an unfair advantage, but discourage business models based on unfair regulatory arbitrage. Regulators should strive to put entrants on equal footing with incumbents, but without sacrificing consumer protection.
Provide workable regulatory frameworks: to date, regulatory authorities have generally maintained appropriate attitudes towards innovative lenders. It will be important as the industry evolves and grows that regulators not create overhanging uncertainty or excessively burden those attempting to innovate.
We admire these principles because whereas many policymakers cry "consumer protection!" but make no effort to understand a product, whereas Summers' principles encourage us to understand and nurture innovation.
But his push for transparency is just as important: companies should make an effort to be understood, he cautions, so consumers know what they're getting into and regulators know what they're regulating. "The task of renewal of our financial system," concluded Summers, "is not primarily one for public policy. It is one of entrepreneurial innovation."
We agree -- except we think that in the case of legal funding, those two goals can be one and the same.
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