How Usury & Other Consumer Lending Regulations Can Affect Litigation Finance Agreements

Every state has usury laws that limit the amount of interest that a lender can charge a borrower.  Because litigation financing is often misapprehended as a “lawsuit loan,” there has been some suggestion that usury law can apply to limit the return that funders can seek for their investment in a litigation matter.  But when the actual nature of a litigation funding transaction is properly understood, it becomes clear why usury law has no application to litigation finance.

The crucial question in determining whether usury law applies to a transaction is whether the transaction involves a loan.  Although the standard funding contract specifically provides that it is not a loan, most courts do not characterize transactions on the basis of such a purely nominal consideration.  Rather they examine the substance and nature of the transaction.

In most jurisdictions, the test of whether an agreement involves a loan is whether the agreement creates an absolute duty to repay.  If the duty to repay is conditional, depending upon the occurrence of a contingent event, the transaction will not be characterized as a loan.   In the typical litigation funding agreement, the litigant’s duty to repay is contingent upon the litigant obtaining a recovery in the litigation matter.

Some courts have held that practicality matters more than form in determining whether a duty to repay in contingent.  These courts insist that it is necessary to look behind the language of the contract to determine whether, given the circumstances of the transaction, the litigant is virtually certain to win a recovery.  For example, if the litigant wins a judgment at trial and obtains funding to cover the cost of the defendant’s appeal, a court may conclude that the funding transaction was a loan because the plaintiff had a very high probability of preserving its judgment on appeal.

The problem with this approach, however, is that it is contrary to the fundamental principles of contract interpretation, which prescribe that the language of the contract, in itself, is controlling as long as it is unambiguous. It seems likely that the courts who follow this approach are less interested in following the principles governing contract interpretation and more interested in making the regulation of litigation funding conform to uninformed preconceptions.  Where the law establishes that a loan is a transaction involving an absolute duty to repay, litigation funding should not be characterized as a loan.

Topics:  litigation finance, legal reform, third-party funding, usury, non-recourse financing

 Works Cited: Lawsuit Financial, L.L.C. v. Curry, 261 Mich. App. 579; 683 N.W.2d 233 (2004)

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