Last week I discussed my new paper with Kobayashi, Law’s Information Revolution, which discusses how law’s traditional business of lawyers conveying legal expertise via advice to individual clients “is being challenged by the sale of legal information to impersonal product and capital markets.”
Today’s NYT discusses an aspect of this market — advancing money to clients against their possible recovery in litigation. Here the lawyers work not for the clients but for the finance firms. The article notes that “lenders pay lawyers to screen cases,” and discuss a personal injury lawyer who “took a job in 2007 screening applicants” for a litigation lender.
This is part of a broader market for financing litigation-related assets. As my article with Kobayashi notes:
Under the current model of financing law practice, lawyers self-finance the purchase and exploitation of these assets. Their compensation therefore reflects both the value of their services and the return on their capital investments. As with firms generally, human capitalists are not necessarily the best source of financing because they fail to take advantage of the benefits of risk diversification. It may make more sense for the financing to come from investors with diversified portfolios. In other words, in a fully competitive market the Capital Asset Pricing Model suggests that lower-risk diversified investors will outbid self-financed lawyers for investments in litigation assets.
But the Times story plays lawsuit loans as the next big scandal. It opens with the story of Larry Long, “debilitated by a stroke while using the pain medicine Vioxx” [the underlying merit of these claims is a subject for another day] who borrowed $9,150 from a lawsuit lender, Oasis Legal Finance. The price was half the loan amount if repayment was made within six months, with regular increases thereafter. By the time he got what the article says was his “initial settlement payment of $27,000” he owed $23,588.
The article describes moves to regulate the industry like other consumer lending. “A growing number of lawyers, judges and regulators say that the regulatory vacuum is allowing lawsuit lenders to siphon away too much of the money won by plaintiffs.” A personal injury lawyer describes this as “legal loan-sharking.”
The litigation finance firms say they’re investing in very risky assets whose payday may be far away. One company describes these as similar to venture capital investments. The firms don’t mind licensing requirements or disclosure requirements, but don’t want price caps. Some states are giving them what they want.
If the advances seem like loan-sharking, think again. The borrowers don’t pay unless they receive the settlement. The finance firms say they lose money in 5-20% of the cases. Indeed, in the Vioxx case, although the article describes the projected payouts in the Merck settlement as “relatively easy to calculate” — in Long’s case, about $80,000 — the finance company notes that eight of its 43 Vioxx borrowers failed to qualify and another seven got less than the amount the finance company paid.
In Larry Long’s case, the finance charges amounted to about $24,000 out of a total of $80,000 received. Long got an immediate payment that bailed him out of impending disaster, although given his financial straits it seems he may not have had a lot of options. A Nebraska state senator who sponsored a bill authorizing these loans says, “I tell them, go borrow from anybody you can before you have to use them. But the reality is, sometimes there’s no other place to turn.”
If the profits are greater than the risk, why aren’t more firms rushing in to claim market share by cutting prices? One reason is that the risk of oppressive regulation and litigation may be limiting competition and keeping prices high. The licensing requirements sought by the incumbent firms would, of course, limit competition further.
The NYT article doesn’t mention background that could be useful in judging this industry. First, it swallows hook line and sinker the characterization of these payments as loans. But as Oasis’s website points out,
IT IS NOT A LOAN. The transaction is a non-recourse purchase of a portion of the proceeds of a potential future case award or settlement. A loan is a transaction that always requires repayment. Our legal funding only requires repayment if the plaintiff receives a favorable cash settlement award. If the plaintiff loses their case, they do not repay the funded amount.
Notably, the website also makes quite clear that Oasis works exclusively through the plaintiff’s lawyer:
Once you’ve submitted an application online or by phone, we’ll contact your attorney by fax for documentation required to qualify your case for funding. * * * Assuming you’re approved for settlement funding or pre-settlement funding, we’ll tell you the amount of the cash funding at that time. Next, we’ll prepare and send to your attorney a Purchase Agreement. You and your lawyer will both read and sign the document. When the agreement is returned to our office, we wire the cash for your settlement funding or pre-settlement funding directly to the account you designate.
If this is lending, then what is the third or so of the settlement that the litigator takes off the top as a contingency fee? Suppose the client agreed to pay the lawyer cash on the line, win or lose, and then borrowed this from a third party, using the potential recovery to back the loan? The price of this outside loan (or more?) is effectively built into the lawyer’s contingency fee.
Oasis also provides a reason for borrowing that the NYT doesn’t mention:
In effect, Oasis Legal Finance levels the playing field. Defendants may have huge resources to mount their defense * * * Litigation finance buys you time by providing the money you need now. And it gives your lawyer more time to work on your case to get a fair settlement or a judgment at trial. * * *
Kobayashi and I point out the analogous benefits of litigation finance for business defendants: “[d]efendants’ access to the financial markets would better enable them to resist settling weak claims with high upfront discovery costs.”
In addition to the article linked above, I have blogged about the litigation finance industry — on financing lawsuits generally, and litigation hedge funds in particular. The latter post quotes an earlier NYT article that takes a much more favorable view of this part of the litigation finance industry:
If the claims are valid, then they may benefit from being litigated more effectively because the lawyers have more resources. “Having funding available for cases that are good cases, cases that from a God’s-eye point of view, so to speak, should’ve been brought, is a good thing,” Mr. [Anthony] Sebok said.
In other words, the NYT things it’s ok for the lawyers to get funded but not the clients. In fact, many have criticized lawyer-side litigation finance as a sure bet to stir up more inefficient litigation.
The truth is that both types of litigation finance may increase social welfare. As discussed in my writings linked above, litigation finance could reduce strike suits by providing a more efficient way to finance litigation. Moreover, just as litigation finance helps defendants resist strike suits as noted above, financing class action plaintiffs brings in a potentially powerful interest group on the other side of the trial lawyers — that is, the financiers — who may not be so ready to accept settlements that are better for the lawyers (whose contingent fee may not cover the risk of waiting for a higher offer) than for the clients. Right now Ted Frank’s Center for Class Action Fairness is the main bulwark against such settlements.
More generally, my article with Kobayashi urges policymakers to think carefully about the positive as well as negative aspects of the new “legal information industry” before regulating it. The new industry may have problems, but the current legal services industry is far from perfect. These imperfections help explain why injured litigants have to wait a long time — sometimes a very long time — to get paid, and therefore why they need the services of litigation financiers in the first place.
