Pre-settlement funding, also known as a lawsuit advance, gives plaintiffs access to money before a case is settled so they can pay for expenses mounting during the legal process. But the arrangement is controversial, the laws are unclear and caution is warranted.
Filing lawsuits and litigating can be expensive and time-consuming. Even when a big verdict is handed up or a settlement is likely, it takes time before the money actually arrives. In the meantime, life’s expenses continue to mount.
There are options to fill this gap that go by several names: lawsuit advances, lawsuit loans, third-party consumer litigation financing, non-recourse advances, non-recourse loans and alternative litigation financing.
Whatever they’re called, these financial products are controversial and should be considered with caution, especially in states where they’re not strictly regulated.
A lawsuit advance or pre-settlement funding occurs when plaintiffs are advanced money from a court award before the final decision is made.
The company advancing this money will likely require documentation, including possibly medical records information from your attorney about your case.
Traditional banks and credit bureaus do not give loans based on expected settlements. However, a settlement advance company will.
If you win your case, the amount you were advanced, minus agreed-upon interest charges, will go to the company. If the case does not settle in your favor, you typically won’t owe anything.
The U.S. Chamber Institute for Legal Reform, a prominent critic of the practice, says the arrangement involves hedge funds investing money in lawsuits in exchange for a percentage of the settlement or judgement.
It says litigation funding started in Australia and spread to the United Kingdom, the U.S., Canada, Europe and Asia.
The most common criticism of these kinds of lawsuit loans or advances is that the fees and interest can be excessive. In some cases, they have even been called usurious.
In most states, these financial products are unregulated. They can be more expensive than credit card debt. One loan company disclosed on its website that its maximum annual rate was 98 percent, according to a report by CNBC. Another company charged a maximum rate of 26.9 percent in the first year of the advance.
A comprehensive 2018 study of these products described “a very complicated and circuitous” system with median interest rates of about 44 percent.
The study found that funders used “controversial techniques to calculate the amount due from the clients.” These techniques included various types of interest compounding, minimum interest periods and fees to add costs to the contract.
The Institute for Legal Reform, which is affiliated with the U.S. Chamber of Commerce, asserts that litigation funding creates more lawsuits and can unnecessarily prolong litigation.
The complaint is that plaintiffs may reject reasonable settlement offers if they have this funding.
Companies may also charge broker fees. One company charges 25 percent for what it calls a referral fee.
In some instances, critics say, litigation funders may take over or interfere with the consumer’s lawsuit.
States courts have split on whether to consider litigation advances loans. How they are classified carries legal implications both for the funder and the consumer.
A trade organization representing funders maintains that these products are not loans and shouldn’t be regulated like loans. They are different from traditional loans in several ways, including the fact that they are not required to be repaid if the settlement or court award doesn’t materialize if the consumer loses his or her legal case.
In addition, credit checks are not required for these advances because they do not involve monthly payments and they do not affect consumer credit ratings.
And in fact, some states consider the arrangements to be investments and not loans. But this can be a problem for consumers. That’s because state laws limiting interest rates, also known as usury laws, would not apply if the funds are not considered loans.
In states where the courts have considered these advances to be loans, usury laws apply.
This was the effect of a 2006 ruling by an appellate court in Texas, which found the lack of an absolute obligation to repay meant that the state’s usury law did not apply.
In 2003, the Ohio Supreme Court voided one of these contracts because the court considered it a loan that violated that state’s usury laws.
One law professor described the United States as having a “confusing patchwork of state laws on third-party litigation funding.”
Some states have enacted legislation to protect consumers in these transactions. The trade organization, the Alliance for Responsible Consumer Legal Funding (ARC), supports laws that provide specific protections, such as requiring plain English, transparent contracts that clearly show the consumer’s rights and obligations.
According to ARC, states with a high level of protection include Maine, Ohio, Oklahoma and Vermont. Indiana has legal protections, but also limitations on the availability of these financial products. ARC is critical of laws enacted in Tennessee and Arkansas.
ARC specifically advocates for laws that contain these provisions:
The American Bar Association’s Commission on Ethics 20/20 wrote a white paper saying these products fill a need. But the commission warned lawyers they should be on the lookout of red flags that point to ethical issues. Lawyers should ensure that their clients’ confidential information is protected and that the clients understand the terms of entering into agreements with the loan or advance providers.