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Litigation Funding And Contingency Fees Are Not Inherently Unethical

Banks Law Office

Litigation Funding Is Criticized Because Of Predatory Practices

CBS News aired a 60-minutes segment titled “Litigation Funding: a multibillion-dollar industry for investments in lawsuits with little oversight.” As the segment explained, “litigation funding” is the practice of funding someone’s lawsuit in return for the right to collect a portion of the money that person recovers in the litigation.

The 60-minutes segment first features an individual, Craig Underwood, who was the victim of unfair litigation funding. Underwood is a jalapeno pepper farmer. He won a $23 million verdict in a case against his corporate customer. But the corporation appealed the verdict, and Underwood could not afford to hire an attorney for the appeal. So, he turned to Buford Capital—the world’s largest litigation funder—which gave him $4 million in litigation funding.

In the end, the appellate court sustained the $23 million verdict, and Buford received $8 million as its cut. So, Buford received a mighty 100 percent return on its initial $4 million funding.

Lesley Stahl, the host of the 60-minutes segment, noted that Buford “argues that the reason they demand so much [return on investment] is because of the big risks they take. But actually, they pick their cases very carefully.” The segment then cut to a clip in which Buford’s CEO says “[w]e’re right about 90 percent of the time,” implying that they only lose principal on their litigation-funding investments about ten percent of the time. Buford’s CEO also stated that the 100 percent return on investment is typical for its litigation funding.

Predatory Practices Are Not Unique To Litigation Funding

Let me be clear: like Stahl, I think it is grossly unfair for Buford to consistently take a 100 percent return on its investments in individuals’ lawsuits, particularly when Buford is only losing money on about 10 percent of these litigation-funding arrangements. But charging unfairly high rates to individuals for financing is not a problem unique to litigation funding. Unfairly high interest rates occur in auto loans, student loans, home mortgage loans, credit cards, and just about any other source of financing for individuals.

Stahl seems to argue that predatory litigation funding is more egregious than predatory financing from more traditional sources because litigation financing is less regulated. “If you take out – say, a car loan,” she says, “usury laws that prevent predatory lending cap the interest rate, in New York at 16%. But remember, [litigation financing agreements] aren’t loans per se.”

But Stahl is overstating the difference between regulations over litigation funding and regulations over other financing for individuals in two ways. First, and most importantly, she is exaggerating the extent to which traditional sources of financing are regulated. Her example of New York’s 16 percent interest cap only applies to non-licensed lenders. Anyone who obtains a license can charge higher rates. And New York’s law is not representative; other states make it even easier to circumvent their usury laws. In South Dakota and New Mexico, for example, you can escape the usury regulations simply by putting the lending agreement in writing. And in Mississippi and Georgia, the usury regulations do not apply to any loans over $2,000 and $3,000, respectively.

Second, contrary to what Stahl was implying, states do in fact regulate litigation funding, including by limiting the fees that funders can charge. I think the regulations are inadequate, but so are the regulations for other funding sources.

Lobbyists For Tortious Corporations Demonize Litigation Funding

To its credit, the 60-minutes segment makes the following point very well: “One entity that’s been very vocal [about litigation funding] is the U.S. Chamber of Commerce that represents big businesses because the sector that’s most concerned about this is big corporations. Now there’s money to sue them, and there’s money to preserve, and not to settle early at a discount.” I absolutely agree, and I suspect that’s part of the reason that litigation funding is treated so differently from other financing practices that are equally prone to abuse.

But the irony is that the 60-minutes segment itself is mostly devoted to perpetrating the nefarious corporate influence it articulately describes. Aside from the segment’s misleading comparisons between regulations of traditional loans and regulations of litigation funding (discussed above), the segment is otherwise filled with anecdotes that seem intended to demonize litigation funding.

For example, the segment’s longest story is about a 9/11 responder named Donald Sefcik, who suffered significant medical issues because of the dust he inhaled at ground zero. Stahl says that there was no question that he was entitled to eventually receive $90,000 from the 9/11 Victim Compensation Fund. But he needed the money immediately, and an evil corporation convinced him to sign a vague contract that gave him just $25,000 while the company gained rights to $64,800 of the compensation fund. 

The problem with using Sefcik’s story as a criticism of litigation financing is that he was not the victim of any litigation financing. He was the victim of an evil and unconscionable loan, but that loan had nothing to do with any litigation. In fact, Sefcik’s story supports my main point: unreasonably expensive funding to individuals is pervasive in all funding to consumers; it is not a problem specific to litigation funding.

Nonetheless, featuring a 9/11 hero victimized by scam artists was probably effective propaganda, however non-sensical it may be. That is the sort of messaging that may lead the public to believe, wrongly, that litigation funding presents a predatory-financing problem fundamentally more dangerous than the threat of predation presented by other sources of financing.

Contingency Fees Are Similar To Litigation Funding

Litigation-funding discussions are important issues to me as a contingency-fee lawyer because contingency fees are similar to litigation funding. A contingency fee lawyer agrees to work without being paid any fee unless and until he or she recovers money for the client. It’s as though a contingency fee lawyer is making a loan to his or her client to fund the litigation and then immediately getting back the loaned money as payment for the attorney’s time. For that reason, it’s fair to think of the contingency-fee lawyer as funding the litigation, and I’ll do that for the rest of this blog post.

Given their similarities, it shouldn’t be surprising that people make criticisms about contingency fees that are very similar to the criticisms CBS makes about litigation funding. That is, people criticize contingency fees because some contingency-fee attorneys charge unreasonably high fees for their “funding.” And just as I wholeheartedly agree that some litigation funders charge too much, I also agree that some contingency fee lawyers charge too much.

But—maybe you can see where this is going—that’s not fundamentally a criticism specific to contingency-fees. It is instead part of the much more general problem that it is far too easy in this country for the greedy to overcharge for providing financing to individuals. The solution is not to ban contingency fees—which tortious corporations sometimes advocate for because of the devastating impact the ban would have on individuals’ access to justice—but to have better regulations (such as caps on contingency fees) and enforcement.

Plaintiffs May Be Wise To Use Both Litigation Funding And Contingency Fee Lawyers

Let me finish by discussing how litigation funding and contingency fee lawyering are different from each other and, relatedly, how they may be able to complement each other. The difference is that in contingency fees arrangements, but not in litigation funding, the funder is the lawyer, and the recipient of the funding is the lawyer’s client. That difference has at least two implications.

First, only in contingency fee arrangements will the funder (that is, the lawyer) be bound by attorney ethics rules, including the rule against charging unreasonable fees and acting in its client’s best interests (to be sure, those ethics rules are often not obeyed and are underenforced).

Second—and more importantly—contingency fee lawyers often have perverse incentives to settle cases prematurely. As a simplified illustration, suppose a contingency-fee lawyer has two choices: (1) settle a case for $50,000 after spending fifty hours of time on it, or (2) settle the case for $75,000 after spending 150 hours of time on it. It is in the client’s interest, of course, for the contingency-fee lawyer to spend more time and get the larger settlement. But the contingency fee lawyer might be tempted to take the first option because that outcome will result in an effective fee of $1,000 per hour, whereas the lawyer would make $500 per hour if he or she takes the second option. Litigation funders, of course, do not have the same issue because the litigation funders aren’t spending much more time on the case as it progresses. They, like the client, would prefer that the attorney spend as much time as necessary to get the highest settlement possible.

So, a possible strategy for an individual who needs litigation funding is to obtain funding from a litigation financer but, instead of spending that money on a pay-by-the-hour attorney, hire a contingency-fee lawyer. The litigation funder and the contingency-fee lawyer might keep each other in check. Specifically, the attorney can help the client negotiate the litigation funding to make sure the funding arrangement is fair. In doing so, the attorney will be bound by his or her ethical duties to act in their client’s best interest. Then, the litigation funder can consult with the client to make sure that the attorney does not accept a premature low-ball settlement. As discussed above, the litigation consultant’s incentives would be aligned with the client’s (and possibly opposed to the attorney’s).

Ethical contingency-fee lawyers may be able to offer that strategy to clients or potential clients to ease anxiety the client may have about contingency fee lawyers acting opportunistically.

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