Lawsuit Loans: Lifesaver or a Total Scam? – Part 1
Litigation Funding and Lawsuit Loans: An Important Resource, or a Total Scam?
Nowadays, it is very well known – by clients and Bronx personal injury lawyers alike – that an injured person can quickly obtain a “lawsuit loan” against the proceeds of their case. Indeed, a robust industry has sprung up in recent years, seemingly out of nowhere, to provide these loans to injured people. The loan companies advertise heavily and solicit business directly from lawyers because it is a profitable business. Competition to loan injured clients money against the proceeds of their cases is extremely stiff. Predictably, because of the high profits that are collected by the loan companies, even Wall Street banking and trading firms (such as hedge funds and private equity funds) have begun to invest in and provide capital to loan companies that provide these high-interest “lawsuit loans” to injured individuals. “Lawsuit loans” are provided in many different contexts; this article addresses their use by, and impact upon, individual personal injury and medical malpractice plaintiffs, and leaves out any discussion of the use of such loans in other contexts (such as in mass torts/class action lawsuits, wherein “lawsuit loans” are used to fund attorney expenses).
What is a “Lawsuit Loan” and How Does it Work?
“Lawsuit loans” in the personal injury context appear quite simple, but that simplicity – and even calling them “loans” at all – is somewhat deceptive. These loans basically work as follows: A person who has been injured due to the negligence of another person files a lawsuit. The approximate value of their case can be determined based upon several factors, which may include, but are not limited to, the injuries sustained (pain and suffering), medical bills incurred (those which have already been incurred, and those which may be incurred in the future), lost earnings and lost employee benefits, and the ability of the defendants to pay for the harm they have caused (which is most often measured by the amount of insurance coverage available to pay a settlement or judgment). If the injured person needs to obtain money immediately (for example, to cover their living expenses which they can no longer pay because they are injured and cannot work), he or she will ask their attorney to reach out to a “lawsuit loan” company to obtain a loan. The “lawsuit loan” company will then provide the injured person with a contract, which gives the loan company the right to collect a certain amount of money (which usually includes the principle amount of the loan, plus certain fees and interest) out of the settlement of the injured person’s case in exchange for an immediate cash payment. When the injured person’s case settles, or when a final judgment is entered, the injured person’s attorney repays the loan according to the contract out of the money collected from the defendants directly (indeed, the money owed to the loan company never even enters the hands of the plaintiff, but is funneled directly back to the loan company before the plaintiff receives his or her share of a settlement or judgment); if the case is not successful, the injured person does not have to repay the money advanced to them through the loan.
On its face, a “lawsuit loan” looks like any other loan: money is advanced to the owner of an asset (in this case, a personal injury or medical malpractice claim) in exchange for a right to repayment, and the asset is used as security to ensure repayment of the loan. However, “lawsuit loans” are not “loans” in the truest sense of the word because repayment is not required if the personal injury case underlying the loan is not successful. “Lawsuit loans” are thus more accurately described as investments in the outcome of a personal injury case (much like an option contract on a share of stock), rather than a true loan; the loan company is betting on the success of the case, and also that the amount of money collected at the end of the case will be sufficient to cover the principle of the loan plus all fees and accrued interest (which is often, by design, quite substantial). Because of this very important difference, which involves significant financial risk to the loan company, “lawsuit loans” are structured differently, and are subject to a very different set of laws and rules, than traditional loans like mortgages or home equity loans.
Among the most obvious differences between a “lawsuit loan” and a traditional loan is the astronomical amount of interest charged against “lawsuit loans”. These loans always involve sky-high interest rates (often as high as 3% per month on a compound basis) that are, believe it or not, far higher than even the notorious credit card interest rates. It is not uncommon for these loans to double in value over the course of approximately two years (if, for example, a personal injury plaintiff borrows $2,500.00, they will commonly be obligated to repay up to $5,000.00 or more when their case concludes). While such high interest rates are actually illegal in the context of traditional loans (by virtue of the application of a set of laws known as “Usury” laws, which set caps on the amount of interest that can be charged on traditional loans), because “lawsuit loans” are essentially investments in a personal injury case, the “Usury” laws do not generally apply and the loan companies can charge as much interest as a plaintiff, as advised by their attorney, is willing to pay. In the example stated above involving the $2,500.00 loan turning into a $5,000.00 obligation within two years, the annualized simple interest rate is approximately 50% running over two years. In New York State, the “Usury” statute prohibits charging interest rates equal to 25% or more on the vast majority of loans. As you can see from this example, loan companies can charge double the otherwise-legal limit of interest because of the unique structure of “lawsuit loans” and the significant repayment risk incurred by the loan companies.
Because of the potential for “lawsuit loan” providers to charge predatorily high interest rates and fees, and because the injured clients who need the loans are often in desperate situations (such as being unable to feed and clothe their children, or pay their rent) and thus can feel enormous pressure to submit to predatory contract terms to get much-needed cash, “lawsuit loans” were not always permitted in New York State. In fact, before 1994, the question of whether or not these loans were ethically permissible at all under the rules that apply to lawyers was not a settled one in the State of New York. Many New York lawyers believed it inimical to ethical law practice to allow clients to surrender usurious interest payments to third-party loan companies who, it was argued, were taking advantage of an injured person’s desperation and dire straits in offering them loans that would be illegal in almost every other context. It should be noted that, if a practice is considered to be “unethical” by the New York State Bar Association, this is tantamount to it being illegal as lawyers who engage in “unethical” practices can, in some cases, lose their licenses to practice law (equal to the “professional death penalty” for lawyers). The issue of lawsuit loans was debated within the profession and, in 1994, the New York State Bar Association issued an ethics opinion which found that lawyers can facilitate their clients’ obtaining “lawsuit loans” under certain conditions (which have now become industry standards with which reputable companies comply), the details of which are not discussed here. Over the years, as the “lawsuit loan” phenomenon has grown and developed, more rules have been established about how lawyers must conduct themselves in referring clients to loan companies (for example, it has been determined that lawyers can charge additional fees for facilitating these loans – our firm does not charge these fees, but many do), but those details are not discussed in this article.
If you would like to read more about lawsuit loans, we will be posting our second installment on this topic shortly. Our firm has extensive experience helping victims of personal injury and medical malpractice in the Bronx and all over New York City obtain “lawsuit loans” to help them maintain their standard of living while their case is pending. We have relationships with several high-quality lenders who can help you get the money you deserve while your case is pending. We will make sure that you understand the risks and benefits of these arrangements, and will tell you if such a loan agreement is the right thing for you to do in your Bronx personal injury lawsuit. If you would like to discuss “lawsuit loans” against your personal injury or medical malpractice case, please do not hesitate to contact us at (718) 354-8000 for more information.