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Best Practices

Regulation

7 Best Practices for Legal Funding Contracts

March 3, 2017
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7min read

Contracts are a core part of every legal funding business. At the end of the day, everything you do, all of your capital, originations and potential clients are put at risk unless you have properly drafted, legally enforceable contracts in place.

Contracts are not only a legal and business tool, but they are also one of your top marketing tools. Key stakeholders -- plaintiffs, attorneys, paralegals -- see and interact with your contract on every transaction. As the face of your business, contracts not only need to be legally sound, they also need to be clear, accurate, and consistent.

Balancing the need for your contract to be both a legal instrument AND a marketing tool is not easy, and let's not forget that your own team also needs to be able to understand, generate, and discuss your contract.

With these three priorities-legal security, marketing, and facilitating the operation and interaction of your teams-it's no surprise that we field a LOT of questions from funders about contracts and contract drafting. While there is little standardization across the industry, and every company's contract will be slightly different, there are a number of best practices every legal funder should follow.

We've worked with funders and lawyers in the funding world to bring you this article, which will cover some of the basics and best practices funders should follow when drafting or improving their legal agreements.If you find it helpful, reach out and let us know.

If you find it helpful, reach out and let us know. It's a dense topic so we may start a short series on contract drafting based on the feedback!  

4 Crucial Concepts You Can't Overlook

1. Governing Law - Home Court Advantage

In any business deal, there is always a chance that things might go south. To protect yourself if a dispute results in litigation, every contract should have a variation of the "governing law" provisions. The bottom line: you don't want to get dragged into court in a random state or get stuck dealing with local laws you (or your lawyers) are not familiar with. Hiring local counsel is expensive and time-consuming! Often located in the "miscellaneous" section of an agreement, these provisions will usually include the following:

  • "Choice of law" provisions: Ensure that the substantive law of a designated jurisdiction will govern the dispute regardless of where the dispute is adjudicated; and

  • "Forum/venue selection" clause: Sets the particular state or court where a lawsuit will be addressed.

Choice of Law:  You and your lawyer can't possibly know the laws of all 50 states, so it's common sense that you would generally elect the laws of the state in which your company is incorporated or does the majority of its business. Your goal is to pick a jurisdiction that is comfortable and favorable to you. States vary in how protective they are of consumers and businesses. New York, for example, has a robust history of corporate law, and the sophisticated courts there can help businesses quickly adjudicate litigation. Some states are very protective of lenders, others of borrowers.   

Courts are fairly lenient when it comes to enforcing your selection, but you can't just randomly pick a jurisdiction. Modern courts follow the general rule that governing law provisions are presumptively enforceable as long as there is: (i) some relationship between the transaction and the governing jurisdiction; or (ii) another reasonable basis for choosing the law for a particular jurisdiction. 

Forum Selection:  I'm sure you can appreciate the importance of litigating somewhere convenient to you and your business. There are also some benefits to litigating in a forum that is well known to you and your counsel - you want the "home court advantage," where your attorneys are more familiar with the local law and courts. (Good lawyers know which courts, and even judges, would be more favorable to their side of the issues.)  

2. Draft in a State Law State of Mind

  You aren't done thinking about state law just yet! As you well know, regulation of the funding industry varies at the state level. 

There is a myriad of state rules and regulations, and many are aimed squarely at funding contract drafting. It's crucial that you strictly comply with the rules for any state in which you fund. A contract that outright cuts against state funding laws will not be enforceable, wasting your time and money.

Some states mandate that a certain concept or entire passages must be worded exactly as in the statute. Some laws even go as far as requiring a particular font or format for those sections (i.e. font size, all caps, etc.) and dictate the page they must appear on.

For example, Indiana has several strict contract drafting rules, as discussed at length in a prior article. To illustrate, in every Indiana funding contract, each of the following disclosures must be included "clearly and conspicuously" in 12-point bold font:

(i) on the front page, under appropriate headings, the total funding amount, itemization of charges and repayment schedule based on 180-day pay periods; and

(ii) in the body of the contract, a specific notice stating the plaintiff's right to cancellation as well as a general notice informing the plaintiff that the funder has no role in deciding whether, when, and how much the case is settled for.

As another example, Ohio has a similar set of rules, but as you can see, the "mandatory language" varies slightly.

You can find a routinely updated list of pending and passed funding legislation here, but be sure to do your own thorough research on local laws for any state in which you plan to fund.       

3. Use as Few Contracts as Possible

Once you do your research on the states where you may fund, you will realize how often different state regulations overlap or vary in nonmaterial ways.

Ask yourself: how can I create the fewest number of different contracts to cover as many states as possible?

The goal is to create a small number of favorable contracts that comply with the regulations of multiple states. We learned from years of funding experience that less is more; it's much easier to operate nimbly and accurately with fewer (better) contracts.  

Cover multiple states with each contract.

To the extent possible, you can create a small number of agreements to cover your bases across the United States. It's okay to be overinclusive! For example, there is no harm in using a contract that covers Indiana's properly formatted first page disclosures in another state that is silent on mandatory first page disclosures. Many of the funding regulations are aimed squarely at transparency - which, as you know, Mighty strongly supports - and won't adversely affect your bottom line.

Perhaps the most important substantive difference to look out for are limitations on what your company can charge a client. For example, Indiana limits fees to an annual rate of 36% on the funded amount and a service charge not exceeding 7% of the funded amount. Such fee caps are one good reason to limit a contract to fewer states.  

Use just one contract per state/group of states.

Whether drafted for multiple states or not, before you make a second (or third...) version of your "Ohio Funding Contract," give it some serious thought. If you do end up making multiple versions, carefully label each in the file name and footer, so you don't end up confused later on as to why you created that "Ohio January Funding No-Cap 6-Month Bucket 3.3%" agreement used twice.  

Make sure to stay on top of changing regulations in the jurisdictions you fund.

As you have read in many of our articles, the industry continues to evolve. Don't get caught unaware with a suddenly unenforceable contract.  

Stay in control of your own documents.

Be wary of attorneys asking to make changes to your contracts. As one funder told us, "We ended up having problems with nearly every attorney that wanted to changes our contracts."

Look very closely at any proposed changes with a critical eye. This can add unnecessary complexity to your (hopefully well-oiled) process and may create funding servicing issues if everyone doesn't understand and keep track of such changes.  

4. Quality Control and Automation

Once you have your contract templates in place, it's extremely beneficial to figure out how best to automatically deploy them each and every time. It is a tremendous waste of time and resources to constantly be reformatting and double-checking documents.

Even more compelling, the better your ability to automate your agreements, the less chance of fatal errors. It sounds obvious, but making errors with certain details, such as party names and your financial information/math, can scuttle a deal entirely.

It should also go without saying: triple check your math across all parts of the contract!

This includes the payment summary, rates/APR, detailed payment schedules and more. You need to make sure particular numbers are accurate. 

You should have blank spaces in your contracts for client reference numbers, and figures so that you don't erroneously mix up data.

Having accurate, reliable software to help you automate any portion of your agreement involving dollars and payment is paramount. In terms of automation, ideally, you can set up your system so that such data (especially that involving money/math!) is automatically populated in every location it is needed. For example, if you list the initial funding amount three times, once you enter it the first time have the other two instances automatically populated.

3 Rules for Marketability

  The first part of this post dealt with the first two functions of your contract:

  1. Legal protection
  2. Ensuring your team can efficiently and accurately interact with your contract

The third function of your contract is its role as a marketing tool. Keep these three pointers top-of-mind to make sure that your contracts reflect positively on you, and represent your business well when it's in front of plaintiffs, attorneys, and paralegals.  

1. Consistency is King

Your contract should be consistently formatted throughout, and ideally, you should carry the same general format through all of your company's various contracts.

It's not a heavy lift. To start, use the same font, in the same size, throughout the document.  Some variation is okay. Just be consistent!  If you use a larger font or a different format for headers, for example, stick with it on every header.

When clients receive a contract with three different fonts and randomly varying sizes, it looks like you pieced it together from random documents off the Internet (something some funders actually do, believe it or not!).  People may assume you are unsophisticated and even distrust the contents of the document if it doesn't look like it was thoughtfully put together.  

2. Use Sections and Headings

Make sure your contract is divided into logical sections with informative, useful headings.

Using clear and concise headings (and subheadings) will take your reader by the hand and lead him or her smoothly through your document. It will be easier for plaintiffs, paralegals, and attorneys to read (or more realistically, skim) and quickly find pertinent information.

It's common for people to get overwhelmed by dense legal contracts. By following even these simple steps, you will help ease that strain and increase your odds of successful fundings.  

3. Defined Terms

In addition to headers, nearly every legal document has one thing in common: defined terms and definitions. They are a powerful tool to improve the readability of a contract and exist to make contract provisions more concise, reduce risks of ambiguity, and make contracts more consistent and accurate as a whole.

You can have a separate section for definitions at the beginning of your contract or define terms in the body of the contract as they come up. It's a stylistic choice, but consider making the terms stand out by consistently bolding or underlining them throughout.

The overarching general rule: don't create a defined term unless you will use it more than once, and once you create it, use it each time the definition is appropriate.

The first letter of the defined term should be capitalized and utilized in the rest of the document by consistently capitalizing it as defined. If you can't avoid using a term before it's defined, use this type of language following the capitalized word: "[Term], as defined below in Section/Paragraph [X]".

The following, which you will recognize as a variant of the ubiquitous preamble that appears at the beginning of most legal contracts, has several examples of appropriately defined terms:

This Plaintiff Non-Recourse Financing Agreement ("Financing Agreement"), dated as of the August 1, 2016 ("Effective Date"), is between Jane Doe and John Smith (collectively, "Plaintiff") and Your Funding Company, a Delaware corporation with a mailing address of 25 Main St., New York, NY 10001 ("Company").

 

CONCLUSION

Without an airtight, professional, and transparent contract, you'll never truly be set up for success as a legal funder. These 7 best practices are a good start to better contracts, but the rabbit hole goes so much deeper.

If you have some thoughts on contracts or would like us to write on the topic further, drop us a line or write a comment below!

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