Legal financing, also known as litigation financing, professional funding, settlement funding, or third party funding is a generic term used to describe the mechanism or process through which litigants (and even law firms) can finance their litigation or other legal costs through a third party funding company. These third party funding companies provide cash advance to litigants in exchange for a percentage share of the judgment or settlement. However, if the case proceeds to trial and the litigant loses, the third party funding company receives nothing and loses the money they have invested in the case.[1] In other words, if the litigant loses, he does not have to repay the money. Accordingly, to qualify for funding with a legal financing company, a litigant's case must have sufficient merits.
Litigation funding is available in most common law jurisdictions in the United States. The process is mostly commonly used in personal injury cases, but may also apply to commercial disputes, civil rights cases, workers' compensation, and structured settlement.[2] The amount of money that plaintiffs receive through legal financing varies widely, but often is around 10%-15% of the expected value of judgment or settlement of their personal injury lawsuit. Some companies allow individuals to request more or less money (as needed) and have varying payout rates depending on the characteristics of the case at hand.
Similar to legal defense funds, legal financing companies provide money for lawsuits but is more often used by those without strong financial resources. Legal financing companies also provide the cash advance in a lump sum fashion and generally no specific "account" is provided for the litigant. Furthermore, legal financing is more likely to be used by plaintiffs, whereas legal defense funds are more likely to be used by defendants. Money obtained from legal financing companies can be used for any purpose, whether for litigation or for personal matters. On the other hand, money obtained through legal defense funds are solely used to fund litigation and legal costs.
People often confuse legal funding with loans. On the surface, legal funding appears to possess the same characteristics as an unsecured loan with a traditional lender. In actuality, litigation funding is generally not considered a loan, but rather as a form of nonrecourse debt. The debt does not have to be repaid if the plaintiff's law suit is unsuccessful. In addition, litigants generally do not have to pay monthly fees in obtaining legal financing. Instead, there are no payments of any kind until the case settles or judgment is obtained, which could be months or years away. Because such legal funding advances are not debt and not reported to the credit bureaus, the litigant's credit ratings cannot be adversely affected if a litigant obtains a legal funding advance.
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In the past, plaintiffs who were not aware of legal funding often turned to credit cards and personal loans to cover litigation fees, attorneys' fees, court filings, personal finances, and living expense shortfalls while they waited for litigation to be resolved. Regardless of whether the lawsuit was successful or not, the plaintiff was still required to repay the debt, dealing with the heavy burden of monthly payments on principle and interest. Before the emergence of the Legal Funding Industry, little financial assistance was available to help injured plaintiffs survive financially while waiting years for their cases to be resolved. Some ethical rules preclude an attorney from advancing money in the form of loans to their clients.[3]
Legal financing is a fairly recent phenomenon, beginning on or around 1997.[4] In fact, it is new enough that many people do not realize that legal financing exists. The American Legal Financing Association (ALFA) was established in New York as a non-profit corporation in July 2004 and represents about 20 legal funding companies nationwide for personal injury victims.[5] The organization's main goals are to establish standards for the legal funding industry and to serve as the liaison with the public, government officials, and the media.[6] The legal funding industry has risen from relative obscurity in the last few decades to the forefront of marketplace solutions for financially troubled attorneys and their clients. ALFA claims that industry leaders currently review more than 40,000 funding applications per month.[7] ALFA members are believed to have originated approximately 90% of currently outstanding legal fundings.[8] While the ALFA itself is a non-profit organization, most legal funding companies are for-profit organizations.
Lawsuits are expensive. Legal financing can help avoid financial disaster during the pending of a lawsuit, which can take months or years. The money is used not just to pay for litigation, but also for personal matters such as to avoid foreclosure, eviction, bankruptcy, and ruined credit. The funding may be used to benefit others, such has to keep a child in college or to pay child support. In addition, the funding can be used for surgical procedures for plaintiffs that would otherwise be unable to pay, thereby getting the needed medical procedures to improve his health and quality of life. Statistics provided from one of the larger firms within the industry demonstrate that over 62% of funds provided to plaintiffs are used to stop a foreclosure or an eviction action.[9] Legal financing, which allows plaintiffs to avoid financial ruin, gives them the peace of mind needed to continue litigating their lawsuit.
People who normally do not have access to loans due to bad credit or other reasons will have access to legal financing. In contrast to banks, the underwriting of legal funding advances is based on the merits of the lawsuit. Banks do not recognize lawsuits as assets when determining an individual's qualification for a traditional loan. As such, many plaintiffs that may not qualify for traditional credit can qualify for legal funding.
Prior to legal financing, many litigants had to settle their legal case early or for a lesser amount just to get some cash to avoid financial troubles. Many plaintiffs would face large companies who have deep pockets and may be in no hurry to settle the case early with a fair settlement. With the rise of the legal funding industry, plaintiffs can level the playing field so the case is not simply won because one side has more money. In essence, legal funding relieves financial pressures to better obtain a fair settlement. Plaintiffs have greater access to the courts and are given greater bargaining power when facing large corporations or other wealthy defendants.
Legal funding companies generally do not provide legal advice, nor can they refer people to or provide an attorney. As such, qualifying for legal financing generally requires one to have already hired an attorney on a contingency fee.[10] This means that the attorney agrees to work for the injured party and is paid out of the proceeds of the case. If the injured party does not obtain an award from the case, then the attorney does not get paid. Qualification for some legal financing companies also require that one suffer an injury of a specific type, such as a personal injury from an automobile accident or a civil rights violation at work.
The merits of the case must also be fairly strong, such that the litigant or plaintiff himself must not be at fault. Furthermore, The defendant in the case (the person or company being sued) must also have the ability to pay, and this usually is satisfied if the defendant is a large corporation. The injured party's attorney must also agree to the legal financing and generally has to sign an additional agreement allowing for the legal financing. This is often a benefit to the injured party, as this means that the attorney has likely reviewed the agreement himself and has advised the injured party accordingly.
Other qualifications vary depending on the company and the case at hand. Other qualification or approval factors include the total amount of damages sought, the defendant's liability, the sufficient margin for investment, the background of the applicant, and the state of residence.[11] The litigant, in applying for legal financing, may have to fill out an application form and provide supporting documents.
A major criticism of litigation funding is that it encourages frivolous claims. This argument is weakened by the fact that it is in the best interests of a litigation finance company to advance money only to those plaintiffs who, in the company’s determination, have a strong chance of succeeding. The industry has come under fire from critics for potential ethical violations. In June, 2011, the New York City Bar Association addressed such ethical issues by publishing an opinion about third-party non-recourse legal funding. It stated that legal finance is “a valuable means for paying the costs of pursuing a legal claim, or even sustaining basic living expenses until a settlement or judgment is obtained.”[12] In response to industry critics, the American Legal Finance Association (ALFA) was established in 2004 and set out to establish industry standards in the legal funding industry. Of preeminent concern is addressing issues of transparency in transactions and providing full disclosure to plaintiffs.
Another problem with litigation funding is that it may take a large chunk out of plaintiff's settlement. The amount of interest may often be high and build up over the years of litigation. After paying attorney contingency fees and the amount owed to the legal financing company, the plaintiff may recovery very little of the original claim. There is also no guarantee that the parties will settle for a greater amount when litigation is prolonged.
Industry opponents argue that litigation finance has led to a proliferation of settlement activity in the court system. In one study of civil lawsuits published in the Journal of Empirical Legal Studies, data concluded that between 80% and 92% of cases do settle. The findings, which are based on a study of 2,054 cases that went to trial from 2002 to 2005, also noted that most of the plaintiffs who decided to pass up a settlement offer and went to trial ended up getting less money than if they had taken the offer.
Some critics have argued that attorneys do not like lawsuit funding because it takes away from their fee. This is generally not true, but may depend on the policies of the legal financing company and the agreement with the attorney. The reality is that attorneys do like legal funding, because it gives them additional time to fight the case and obtain a higher settlement, which in turn allows the attorneys to receive a larger contingency fee. This extra time takes pressure off the attorneys and is generally welcomed by them.
Litigation funding is generally unregulated in South Africa.[13] Yet, it appears that litigation funding has quietly become part of the South African legal landscape, getting little to no resistance in the face of what used to be portrayed as contra bonos mores champertous agreements. A pactum de quota litis is defined as “an agreement to share the proceeds of one or more lawsuits” and it is the duty of the Court to ascertain, of its own motion, the lawfulness of such agreement as it cannot lend its assistance to the execution of agreements and transactions which are contrary to law. An initial distinction between an acceptable and an objectionable pactum de quota litis was formulated in Hugo & Möller N.O. v Transvaal Loan, Finance and Mortgage Co, 1894 (1) OR 336. The Court held that a fair agreement to provide the necessary funds to enable an action to be proceeded with, in consideration for which the person lending the money is to receive an interest in the property sought to be recovered, must not be considered per se to be contra bonos mores. The court was concerned about potential abuses for such agreements, such using them for purposes of gambling with litigation cases.
Several cases have provided further guidelines for such litigation financing agreements. In Headleigh Private Hospital (Pty) Ltd t/a Rand Clinic v Soller & Manning Attorneys and Others 2001 (4) SA 360 (W), the Court affirmed that an agreement to share the proceeds of one or more lawsuits is not necessarily unlawful and must indeed be considered acceptable when a litigant is not in a financial position to fund his litigation completely. In another case, the South Africa Supreme Court of Appeal held, in PriceWaterHouse Coopers Inc and Others v National Potato Co-operative Ltd 2004 (6) SA 66 (SCA), that the "[a]lthough the number of reported cases concerned with champertous agreements diminished, courts have still adhered to the view that generally they are unlawful and that litigation pursuant to such agreements should not be entertained." However, the Supreme Court sought to clarify any disagreements and took a different route. The Court ruled that (1) an agreement in terms of which a stranger to a lawsuit advances funds to a litigant on condition that his remuneration, in case the litigant wins the action, is to be part of the proceeds of the suit is not contrary to public policy or void, and (2) the existence of such an assistance agreement cannot be the base of a defense in the action. In June 2010, in an interlocutory ruling rendered in the same case, the High Court found that the funder is, after all, a co-owner of the claim and should therefore be joined as a party to the trial. Therefore, an order for costs may be made directly against him to the extent that the funded party cannot support them even after the termination of the funding agreement.[14]