The biggest weapon that opponents of legal funding have in their arsenal is the vague resemblance between legal funding and loans. They use this weapon to push legislation couched in loan terminology, legislation that would subject legal funding to usury caps. In all of the half-dozen states that regulate legal funding, they've failed. Those states have recognized that legal funding is an investment, not a loan; usury does not and should not apply. If it did, the industry would not exist. For the powerful lobbies behind loan-centric regulation, that's the whole idea. This week saw movement on two bills that would regulate legal funding at the state level. The first, Indiana's SB373, classifies funding as a non-loan transaction and would benefit the industry and consumers alike. The second, Arizona's SB1403, classifies legal funding as a loan and is decidedly hostile. Both passed their initial committee hearings on Monday.
But there's a more insidious bent to the language of loans. It frames the conversation. When we discuss legal funding as an investment, we're talking about an opportunity for plaintiffs. When we discuss legal funding as a loan, we're talking about something darker, something predatory, something consumers need to be protected from. A little word goes a long way. This dichotomy was evident in Monday's hearings. In Indiana, Senators on the Civil Law committee quickly understood, to quote chairman Joe Zakas, that legal funding is "fundamentally different than a loan." When representatives from the Chamber of Commerce and Indiana Manufacturer's Association insisted that rate caps will benefit the free market, Senators Zakas and Greg Taylor rightfully pushed back. "We do have caps," Taylor emphasized, "but those are usury caps":
And those are typically [for] when it comes to paying penalties on defaulted loans... But when you initially go get a loan, you let the market... dictate where you are. And I would think the chamber, out of all the public interest groups here, would be supportive of that.
The Arizona hearing took a radically different tenor. Senator Kimberly Yee and her colleagues on the Commerce and Workforce Development Committee were already settled on the loan question - unsurprising, given that SB1403 has "lawsuit lending" in the title. They pushed back not against representatives from the Chamber of Commerce but those from ALFA. They rejected not the fiction that legal funding is associated with clogged courts and frivolous lawsuits, but the mathematical truth that rate caps will stifle the free market.
Here's the crazy thing, though. The people in the loan camp make their case on purely tautological evidence. Ed Roberts of the Indiana Manufacturer's Association testified, "It looks like a loan to me, [so] I'm gonna call it a loan." Almost that exact language was parroted by Representative Matt Lehman in his committee hearing two weeks ago. And the same line of reasoning came up in Arizona: because it resembles a loan, it's a loan; because the rates are sometimes high, it's predatory.
A question for the people who write our laws: a peach looks like an apple. Is it an apple?
Obviously legal funding is not so simple. Few financial products are. But our response to a difficult thing should be to understand it, not to reduce it. Yes, this is a nuanced issue; most important things are. But once we grasp why legal funding is not a loan, we might grasp why restrictive regulation is such a danger to consumers. Victoria Shannon devotes several pages to this very issue in her article in the latest Cardozo Law Review. Shannon is an Assistant Professor of Law at Washington and Lee University; she is also one of the foremost scholars on legal funding. She provides five straightforward reasons why the loan argument is baseless:
Unlike loan borrowers, plaintiffs who take legal funding have no absolute obligation to repay. If their cases loses, they keep the money. This is because technically the transaction is structured as a purchase of an asset, the asset being a stake in the plaintiff's claim.
"If the client loses the case," Shannon writes, "the funder cannot pursue the client's other assets." This distinction is particularly important in the context of payday loans, to which legal funding is often erroneously compared. If you fail to repay a payday loan, the lender will withdraw money directly from your bank account. Legal funders have no such power. Even if you win, their return comes entirely out of your settlement.
Legal funders take on every case knowing they might get paid back in six months, in ten years, or never. The risk is greater than in a traditional loan, and the rates are accordingly higher. "This is not a unique concept," writes Shannon:
For example, an unsecured credit card typically carries more risk than a secured loan, so regulations tolerate much higher interest rates on unsecured credit cards than allowed even on subprime mortgages, which are backed by collateral.
This risk is so great, Shannon observes, partly because legal funding is not a bilateral transaction. In the credit card example,
The credit card issuer and the debtor are making an agreement based on a promise by the debtor that he or she will repay the credit card charges at regular intervals. There is no third-party involved, and whether the debtor pays or not is based entirely upon the debtor's own choices. By contrast, the funder and the client are making an agreement based on what a judge or arbitrator will do at some future unknown date or on whether the client and the other side will settle at some future unknown date.
A funding agreement relies on more parties than a traditional loan: not only on the judge but on the defendant, on the jury. This multiplicity of parties brings us to Shannon's fifth reason:
In legal funding, the riskiest investments are typically in cases that have just commenced. These are also often the most important investments for plaintiffs, when they're in the greatest need. At this early stage, there is what Shannon describes as an asymmetry of information: "the client and funder do not yet have access to documents or evidence from the other side, so they cannot be completely sure the likelihood of winning on the merits or settling the case."
In blunter terms, this means that what looks like a slam-dunk case today might get totally upended in six months. Or two years. Or ten. Litigation is long and unpredictable; legal funders take on substantial risk so plaintiffs can get by in the meantime. The returns from successful cases pay largely for the time and manpower invested in unsuccessful ones.
Okay, we get it: legal funding isn't a loan. It's an investment. As venture capitalists empower startups, so do funders empower plaintiffs. So what? Well, there are three important conclusions we can draw from Shannon's framework:
Debt just isn't possible with legal funding. Even plaintiffs who win will never owe more than the recovery. The debt spirals associated with payday loans? They simply aren't in the cards for legal funding consumers. In fact:
Remember that many, if not most plaintiffs who take legal funding are unable to work after an accident or injury. Funding is most commonly used to pay bills - mortgage, tuition, gas, electric - that otherwise would not get paid. Except, perhaps, with payday loans...
Suppose you have a case worth $50,000, but you're not going to see that money for a year. Suppose you have medical bills in excess of $5,000 due last week. Suppose you're being offered a settlement of $10,000 - cash that could be in your pocket tomorrow. You could take the settlement, sure. You could also take $5,000 in legal funding, pay the bills, and still get that full settlement later. One of these options seems preferable, doesn't it?
The conversation around bills like SB1403 is flawed. Dangerously flawed. Lawmakers are working from the wrong premise: they're right to want to combat predatory lending, but legal funding is neither predatory nor lending. Before we try to protect consumers from a product, we should maybe, you know, try to understand what the product is. But by framing the conversation around loans, lobbyists neatly allow lawmakers to skip that step. Lawmakers know loans, they get loans; the hard work has been done for them. Any law that classifies legal funding as a loan will not protect plaintiffs. It will protect the insurance companies who for years have systematically underpaid injury claims with no one to hold them accountable. Now legal funding has arisen to hold them accountable: it is no longer viable to draw out litigation until a plaintiff has no other choice but to accept the low offer. These companies and the Chamber that represents them are very plainly terrified of a future where they must pay what they owe. And they should be. That future is fast approaching.
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