Beware the False Equivalence Between Litigation Funding and Cash Advances

A recent article worries that regulatory enforcement actions in Minnesota and New York indicate that state and federal regulators may soon turn their focus to litigation finance companies, especially with respect to rules prohibiting usury and mandating full disclosure.  A careful consideration of those enforcement actions demonstrates that non-recourse litigation financing transactions should not run afoul of state or federal regulations, especially when investors are careful about making complete and accurate disclosures in such transactions.

The New York enforcement action was brought by the state’s Attorney General and the Consumer Financial Protection Bureau (CFPB) against RD Legal Funding, which had offered advances to the beneficiaries of class action settlements.  Specifically, the advances were paid to persons who were entitled to receive benefits from settlement funds established for victims of the 9/11 terrorist attacks and for former professional football players who had suffered long-term brain injuries caused by playing football.  In the Minnesota action, the CFPB again teamed with the state’s Attorney General to challenge the legality of cash advances that were secured by future pension payments.  In both cases, the regulators alleged that the companies providing advances violated state usury laws and state and federal rules governing the disclosure of terms of the transaction.

The crucial fact about the New York and Minnesota cases is that they involved transactions that were properly characterized as loans because the recipients of the advances were guaranteed to receive the future payments that were offered as security for the advance.  In Minnesota, the advances were made against guaranteed pension payments.  In New York, advances were made against payments from a settlement fund that had been established by a judicial order but was not yet making payments.  Thus, in both cases, the parties receiving the advances had a duty to repay the advances at the time of the transaction.  Under most states’ usury laws, a transaction is characterized as a loan and subject to usury regulations, when the borrower has a definite duty to repay at the time of the transaction.

Of course, the typical litigation finance transaction is different.  The key distinction between litigation financing and the kind of lending at issue in the New York and Minnesota cases is that litigation financing involves a non-recourse transaction.  That is, the recipient of the advance does not have a definite duty to repay when the transaction is made.  To the contrary, the recipient’s duty to pay depends upon a contingent event – a judgment or settlement in an amount that exceeds the recipient’s attorneys’ fees and litigation costs.  In the overwhelming majority of jurisdictions, courts have held that usury laws do not apply when the duty to repay is truly contingent.

Notwithstanding the fact that the New York and Minnesota cases are distinguishable, they still create a cautionary note for litigation finance companies.  To avoid the application of usury laws, it is essential that the litigation finance transaction truly be non-recourse.  As long as the transaction creates a contingent duty to repay, it should be exempt from usury laws.  In addition, even in non-recourse transactions, litigation finance companies should be sure to make full disclosure of all costs and fees.  Of course, this kind of full disclosure is often required by state or federal law.  But even where it is not, it is just good business.

Topics:  litigation finance, legal reform, third-party funding, litigation costs, alternative litigation finance, pension advance, structured settlement advance, non-recourse

 Works Cited:  Minnesota AG Files Lawsuit Against Pension Advance Companies, JD Supra (August 18, 2017) available at http://www.jdsupra.com/legalnews/minnesota-ag-files-lawsuit-against-78800/

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