Mountain Law: Litigation financing comes before state’s high court (column)
December 22, 2015
Litigation financing is a growing industry. However, it has benefits and drawbacks for borrowers and was recently the subject of an important decision by the Colorado Supreme Court.
Let's begin by taking an imaginary person named Joe who is hurt in an industrial accident and has severe injuries for which his employer may be liable. Joe will likely be able to find an attorney to take his case on a contingency fee basis (where the attorney is paid a percentage of the eventual recovery), but the case might take a long time, and Joe needs money now.
Without litigation financing, Joe's basic options would be to turn to personal loans and credit cards to cover expenses while waiting for his case to be resolved. This could be a significant financial distress, and the money would have to be repaid with interest regardless of how the case turned out. The fact that Joe may eventually receive a recovery for his legal claim would not be considered an asset for purposes of traditional financing. Because Joe is financially distressed and facing an adversary with deep pockets, he might be pressured to settle his case early and for a lesser amount. A healthy fear of losing the case and getting nothing would also weigh on Joe's peace of mind.
With litigation financing (which is alternatively known as legal funding, third-party litigation or something similar), a company would pay Joe money now — perhaps 10 to 15 percent of the expected settlement in his case — in exchange for his agreement to give some or all of the case proceeds to the company at the end. If, for some reason, the case were unsuccessful, Joe would not have to repay the money.
The obvious drawback of litigation financing from Joe's perspective is that he would be giving up a significant portion of his potential recovery. For example, if Joe settled his case without litigation financing for $100,000, he might net $66,666 after paying a 1/3 contingency fee to is attorney. However, with litigation financing, Joe might receive 10% up-front, or $6,666, and forego the balance of $60,000 that would go to the lender from the settlement. That would be expensive financing, indeed.
Of course, there are also benefits from Joe's perspective. The main benefits would be getting the money up-front to use for whatever he wants, avoiding the need to obtain traditional financing and repay debt, not having any downside risk of losing the case and confidently being able to take the case to trial. While traditional lenders would not lend on the basis of Joe's claim, the litigation financing company likely would.
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Under pressure from the U.S. Chamber of Commerce (which is opposed to litigation financing companies because it believes they are bad for business), the state of Colorado informed litigation financing companies that they would need to comply with consumer lending laws. In response, some of the companies filed lawsuits against the state, arguing that litigation financing arrangements are not loans but rather a form of asset purchase because the money does not have to be repaid if the lawsuit is unsuccessful. In a closely watched decision called Oasis Legal Fin. Grp., LLC v. Coffman, the Colorado Supreme Court determined in November 2015 that litigation financing arrangements create a "debt" in the form of the obligation to pay the proceeds from the case to the company and are, therefore, "loans" within the meaning of Colorado laws. This decision means that litigation financing companies in Colorado are now regulated the same as payday loan companies.
Litigation financing has it benefits and drawbacks for the borrower. In the end, the Joes of the world will have to make their own decisions about whether to enter into litigation financing arrangements. In light of the Colorado Supreme Court's decision, the industry is now more regulated.
Noah Klug is the owner of The Klug Law Firm, LLC, in Summit County, Colorado. He may be reached at 970-468-4953 or firstname.lastname@example.org.
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