(Reuters) - I’ve talked over the years to a lot of plaintiffs who have turned to consumer litigation funders as their cases dragged on. None of them has ever done so except as a last resort. Litigation funders who provide capital to consumers charge higher interest rates than banks and most credit-card companies. They can do so, as you know, because their cash advances are non-recourse, which means plaintiffs don’t have to pay the money back unless they win their case, so the advances are generally exempt from state usury laws. That’s the policy justification, after all, for litigation funding: Funders deserve hefty returns on the money they advance to plaintiffs who end up winning because funders bear the risk of recovering nothing from plaintiffs who lose.
But what if funders aren’t really bearing risk? Does the policy justification for those high interest rates evaporate?
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Yes indeed, according to a new paper that provides the first-ever analysis of data from a particular subset of litigation finance: post-settlement advances.
Law professors Lynn Baker of the University of Texas, Ronen Avraham of the University of Tel Aviv and Anthony Sebok of Cardozo examined data on more than 225,000 funding requests to one of the largest consumer litigation funders in the U.S. between 2001 and 2016. (Sebok obtained the data from the unidentified funder after establishing a relationship over the course of several years. He and Avraham published a previous paper analyzing the funder’s data, which does not include the names of any individual clients, in 2018.)
The new paper, which Baker provided to me while it’s being evaluated for publication by several law reviews, contrasts data on cash advances to mass tort plaintiffs with those litigating one-off car accident claims. Broadly speaking, the analysis concluded that the funder actually made more money from motor vehicle plaintiffs than from mass tort plaintiffs – 60% median annual gross profits in car crash suits, compared to 55% from mass tort cases. Mass tort cases were a surer bet for the funder, with a smaller percentage of plaintiffs requesting “haircuts” from what they owed when their cases settled, and mass tort plaintiffs were charged a slightly lower upfront interest rate. At the same time, however, the funder was more likely, according to the paper, to obscure what mass tort plaintiffs would ultimately owe through the use of hidden fees and complex contract terms. Sebok and Avraham called in their previous paper for legislatures to prohibit such devices.
But the new paper’s most interesting analysis and controversial conclusion – involved about 4,700 post-settlement advances to plaintiffs in the end stages of their cases. Baker told me in a phone interview that she had been eager to look at information about post-settlement funding, which had never been analyzed in a systematic way even after the drama surrounding advances to NFL players in the concussion litigation. Drilling into the data from their funder, Baker said, she and the other researchers eventually realized that post-settlement cases had been categorized in a catch-all “other” category – which was itself a tip-off.
The funder, she explained, sorted pre-settlement cases by the nature of the underlying claim, but that factor apparently didn’t matter to the funder when it came to post-settlement advances. The reason, she and the other authors hypothesized, was because the only critical consideration for the funder in advancing post-settlement funds was the plaintiff’s expected net recovery. The key underwriting question was simply what the plaintiff’s lawyer said the settlement would be.
The funder’s median annual profit in those post-settlement cases was 68%, according to the study. That was higher than the returns in any pre-settlement category. The post-settlement contracts were also structured different from pre-settlement contracts, the paper found. Post-settlement recipients were charged a fixed amount, unlike the compounded interest in most of the pre-settlement cases, so the cost of the advance was more transparent to post-settlement plaintiffs. But according to Baker, Avraham and Sebok, post-settlement plaintiffs ended up paying a higher effective interest rate than pre-settlement clients – even though the funder bore almost no risk of default. According to the data, the “haircut” rate in post-settlement cases was only 3%, compared to 20% in the pre-settlement car crash cases.
And that data suggested that post-settlement plaintiffs were needier than plaintiffs who sought advances before their cases settled. Only 4% of the plaintiffs who received an offer from the funder turned it down, compared to 8% of the plaintiffs offered advances in pre-settlement car accident cases.
For Baker and her co-authors, the implication of the evidence is that post-settlement funding should be regulated differently than pre-settlement advances. “This is a different sector of the market,” Baker said. “There is no basis for charging a risk premium when there is basically no risk.”
Post-settlement advances to plaintiffs, the paper argued, should be subject to state usury law and loan regulation. “The fact that even fewer clients turn down the post-settlement funding than the pre-settlement funding … seems to underscore the direness of these clients’ need, their lack of alternatives, and therefore also their need for regulatory protection,” argued Baker, Avraham and Sebok. “Subjecting post-settlement funding to state usury laws would, in theory, provide these clients some protection by reducing the total amount they must pay for such funding.”
Baker and her co-authors acknowledged that their policy proposal could have a profound impact on a market that, as they concede, serves plaintiffs who are near desperate. Funders might not be willing to extend post-settlement advances if their interest rates were capped at 15%. But Baker said in our phone interview that even if some litigation funders decided to drop post-settlement deals with capped interest rates, other financiers would surely take an almost-sure bet of 15% returns.
“There’s no risk,” Baker said. “This isn’t a non-recourse advance because that implies risk.”
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