The siren song of quick money is tempting for anyone. It sounds even more attractive for individuals desperate for money. "Cash Now!" advertisements have become ubiquitous for payday loans, tax refund anticipation loans, even structured settlements. But over the past 10 years a new, unregulated lawsuit loan industry has quietly gained a foothold in American civil justice. Automobile, homeowner and business insurance coverages are keys to their business models.
There are four types of lawsuit lending in which the key factor is the likelihood of obtaining a settlement:
- Loans to law firms
- Loans to medical providers
- Loans for B2B litigation
- Consumer lawsuit loans.
The first three are generally made to sophisticated business organizations, but consumer lawsuit loans can easily take advantage of unsuspecting or overwhelmed individuals.
Think of it as a payday loan for lawsuits. An individual has an auto accident and sues. A litigation financing company offers the plaintiff "cash now" while the lawsuit makes its way through the courts. And to sweeten the pot a little bit more, you only pay the loan back if you win.
Remember what your mother said about things that sound too good to be true? Consumers who use these financial instruments could pay a steep price. This applies not only to consumers who take out these loans, but also by every consumer who buys an insurance policy through increased claim costs.
Although there are many concerns about these financial products, they remain largely unregulated, with virtually no controls on fees or contractual obligations. As an example, while the average credit card rate was just under 14 percent in late 2010, it is not unusual for consumer lawsuit loans to charge more than 100 percent per year, according to a recent article in the New York Times. With no one looking out for the consumer, these unconscionable interest rates can quickly consume a plaintiff’s settlement, leaving the individual little in the way of compensation. The lawsuit lender becomes the primary beneficiary of someone else’s lawsuit.
The unsuspecting or overwhelmed consumer may not even realize the true cost of the loan. Lawsuit lenders talk about monthly rather than annual interest rates. Here is an example of what happens with what industry representatives have publicly called a "typical" rate: 4 percent per month, compounded monthly. This equates to 60.1 percent interest per year. A $1,500 loan, with a 60.1 percent annual interest rate on a $10,000 case, will become almost $6,155 for the lawsuit lender if the case goes 3 years. If the attorney takes a fairly typical 35 percent ($3,500), that leaves the plaintiff with only $345. The lender becomes the primary beneficiary of the lawsuit rather than the injured consumer.
That 60-plus percent interest rate is just what the lenders call typical. The New York Times recently reported, "Unrestrained by laws that cap interest rates, the rates charged by lawsuit lenders often exceed 100 percent a year, according to a review by The New York Times and the Center for Public Integrity. Furthermore, companies are not required to provide clear and complete pricing information—and the details they do give are often misleading."
Faced with the prospect of little if any gain from what would be an acceptable settlement except for the lawsuit loan, the plaintiff may feel compelled to gamble on an extreme settlement or jury trial. Ask the woman who rejected a $1 million settlement because of her lawsuit loan, only to lose at trial. Not only is this bad for the individual, it also drives up the general cost of litigation and is ultimately paid for by all consumers.
Lawsuit lending legislation attracted attention during 2010 when the American Legal Finance Assn. (ALFA) sought to have its model bill enacted in seven states. The model attempts to put a veneer of regulation on the industry. Rather than providing consumer protections, these bills seek to exempt the lawsuit lenders from the laws that govern other loans. The legislation attempts to avoid consumer loan regulation because the transactions are "nonrecourse," meaning the lender does not collect if the plaintiff does not win a settlement or judgment. In reality, the consumer owes the entire amount agreed upon in the contract if there is even one dollar of settlement or judgment. With lawsuit loans, a win is not always a win for the consumer.
Rather than screening out marginal cases, lawsuit lenders hedge their bets in the "litigation lottery" and stack the odds in their favor. The interest rates would make a loan shark blush. According to the model bill, the personal injury attorney gets his cut first, the lawsuit lender gets his cut next and the injured consumer always comes in last.
The "nonrecourse" feature, in which the plaintiff owes nothing if he loses the case, does not turn a loan into something else. If it looks like a duck and waddles like a duck and quacks like a duck, chances are it is a duck. These are loans that make the lawsuit loan company the primary beneficiary of someone else’s lawsuit, while adding nothing good to the civil justice process.
All Insurance Consumers Pay the Bill
When lawsuit loans do lead to their advertised result of increased settlement values (just look at lawsuit loan company websites), insurance consumers are the ones who pay the bill. Lawsuit loan representatives readily admit that their main targets are relatively small auto insurance claims and slip-and-fall accidents.
When you think about it, this is a smart business approach for lawsuit lenders. Small claim values may be easier for attorneys to negotiate with an insurance company. A small claim offers the chance to have a large percentage impact with relatively little dollar change. If a $10,000 claim becomes a $15,000 claim, it might not get much notice, but the claim value still goes up 50 percent. Finally, small claims offer the lawsuit lender multiple opportunites to score because of typically higher claim frequency in these ranges.
The result is that every automobile, homeowners and business insurance policy becomes a possible target for lawsuit loan companies, driving up insurance loss costs for the clients of every insurance agent and broker.
Last year, legislators introduced litigation financing regulatory bills in Kentucky, Nebraska, Minnesota, Illinois, Maryland, Delaware and New York. Business coalitions, centered on the American Tort Reform Assn. and the U.S. Chamber Institute for Legal Reform, educated legislators about the dangers of lawsuit lending. As a result, the ALFA model was enacted only in Nebraska. As this is written, lawsuit lending bills have been introduced in six states in 2011 (Arkansas, Indiana, Kentucky, Maryland, New York and Tennessee) and we expect to see additional bills.
Agents and brokers can do their clients a great service by getting involved and educating their state representatives and senators about the truth of lawsuit loans. They are local business leaders whose credibility with legislators can greatly influence the outcome of these bills.
