Oregon State Bar Bulletin — MAY 2002
|Settle Now, Pay Later|
By Richard H. Braun
Those of us who peruse the classified ads have noticed a bloom in recent times of ads offering 'Get cash now/Settle later!' or 'Injured? In a Lawsuit? Need $$ until you settle'? Similar ads run on television. These enticements to clients come from a relatively new industry: the 'legal funding' or 'personal injury loan' industry.
The Oct. 13, 2001 New York Times ran a story about how legal funders approached victims of the Sept. 11 terrorist attacks with blandishments of $100 bills, recommended certain lawyers and offered advance cash for the victims’ cases against future tort recoveries. It is not uncommon that an injured or wronged person is in debt for medical bills, unemployed or otherwise financially strapped. That situation can cause or force a client to accept an early 'low ball' settlement. In theory, the legal funding industry provides a mechanism for the client to survive economically during litigation and therefore obtain a fair result. Essentially, the legal funding industry accomplishes what our rules of professional responsibility prohibit us from doing, i.e., assisting injured persons financially during the pendency of litigation. See DR 5-103 (B).
Research reveals that despite the theoretical benefits of these loans they are fraught with peril for both clients and attorneys. Economically, they are bad deals. Lawyers should be extremely thoughtful and careful before involving themselves and their clients in these funding schemes. The lawyer who assists a client in a legal funding transaction risks substantial exposure to subsequent ethical and malpractice problems. This article is not intended to exhaustively cover the subject of legal funding; instead it identifies major issues and suggests deeper research when the issues arise.
THE MECHANISM OF 'LEGAL FUNDING'
A person with a claim or lawsuit pending can obtain an advance of cash against future recovery when the claim is resolved. Repayment of the cash advance is contingent on recovery. However, the amount of repayment is independent of the amount of recovery, i.e., the client is obligated to pay the cash advance plus interest no matter how much is ultimately recovered by way of settlement or satisfied judgment. The interest rates are stupendous, generally 50-250 percent of the amount advanced, and the industry justifies this by the high of risk of non-payment. In fact, the funder’s risk is small. As a condition precedent to making the advance, the funder requires the client to instruct the lawyer to make the file available for the funder’s inspection. Funders form their own opinions about the merits and value of the client’s claim and make their funding decisions accordingly.
Legally, these transactions take one of two forms: 1) a loan to be repaid only if the client collects a recovery; or 2) a partial assignment of the client’s right to recovery for which the cash advance is consideration, with the understanding that the cash advance plus interest will be repaid when the client makes a recovery. One universal requirement is that the injured party’s lawyer sign the agreement with the funder.1 Generally, the funding agreements expressly state that the funder will not control or direct the conduct of the litigation or settlement. However, as discussed below, the funder in fact exerts substantial control by virtue of its economic interest in the client’s case and financial circumstances.
INTEREST RATES AND'FEES'
Depending on the value of the case and amount of cash advanced, it is entirely possible for the case to proceed to resolution with the client getting little or nothing at the end. It is also possible for the client to end up indebted to the funder after settlement. One funding contract we examined charged simple interest at the rate of 10 percent per month. On a $5,000 cash advance, repaid 12 months later, the borrower will repay $11,000, including $6,000 interest. The solicitation from another funder quoted rates of 50-250 percent. At these rates, time to resolution rapidly diminishes the injured party’s net recovery.
TERMS OF THE LEGAL FUNDING AGREEMENT
The funding agreements contain several provisions of critical importance to the lawyer. First, the attorney and client must agree that the funder may inspect the attorney’s file and client’s medical records. Second, some agreements require the client to waive all defenses to re-payment and agree not to avoid or attempt to avoid repayment. Third, some agreements require the client to warrant that repayment will be superior to certain liens. Fourth, the client agrees to pay a multiple of the amount then due as liquidated damages if the client terminates or breaches the agreement. Fifth, if the client changes counsel repayment is immediately due in full. Each of these provisions has the potential for creating substantial trouble for any lawyer who signs or recommends the agreement.
IS IT A LOAN OR AN ASSIGNMENT?
Are legal funding assignments enforceable? To avoid usury laws some funders style their agreements as 'high risk purchase[s].' The client is called the 'transferor' and the funder is called the 'transferee.' These agreements cast the interest assigned or transferred in terms of a right to the first paid dollars from the client’s tort recovery. That is a peculiar interest, and its nature raises substantial questions about whether Oregon courts will enforce such an agreement. Could a court consider the interest to be a partial assignment of a personal injury claim? Would the court recognize such an assignment? Our courts have generally considered the assignability of personal injury claims in the context of insurance subrogation and bad faith. It remains unclear whether the courts will enforce partial or complete assignment of personal injury claims to disinterested third parties. See Gregory v. Lovlien, 174 Or. App. 483, 487 (2001) (declining to decide if personal injury claims are assignable).
Is the assignment champertous and unenforceable? The last Oregon case to even contain the word 'champerty' was decided in 1971. Three years earlier the court defined the word: 'Champerty is the intermeddling of a stranger in litigation of another, for profit, and maintenance is the financing of such intermeddling.' Groce v. Fidelity General Insurance Company, 252 Or. 296, 304 (1968). This is precisely what the legal funding contract accomplishes. A court could refuse to recognize an assignment it deems champertous.
Are legal funding contracts usurious loans? In economic fact, the 'high risk purchase' is a high-interest loan transaction. The funder obtains nothing more than a contingent right to repayment of money advanced to the client. The consideration for the cash advance is a percentage of the recovery based on such factors as perceived risk and time to repayment, precisely the factors traditionally used to calculate loan cost. Will Oregon courts consider legal funding a loan transaction no matter how it is styled in an agreement? Are these transactions usurious under ORS 82.010(3)? If a loan is usurious and not exempt from the statute, the lender forfeits the right to collect any interest. ORS 82.010(4).
Oregon’s usury statute, ORS 82.010 et seq., limits the interest a lender can collect on certain loans. However, the statute contains an express exemption from coverage for 'any consumer finance licensee under ORS chapter 725 …' ORS 82.025(1). It is easy to become a 'consumer finance licensee;' the substantive requirements are minimal under ORS 725.140. A license may be denied if the applicant is insolvent, has engaged in dishonest or fraudulent conduct, has violated certain statutes or has been convicted of crime an essential element of which is fraud. ORS 725.145. A duly licensed person or entity can charge any amount of interest on which the parties 'agree.' Thus, the legal funders can obtain consumer finance licensing and obtain exemption from the usury law. The careful practitioner will contact the Oregon Department of Consumer and Business Services to check the license status of any legal funder before advising or assisting a client in a legal funding transaction.
MAJOR PITFALLS AND TRAPS FOR ATTORNEYS
Contractual waiver of defenses
As set forth above, there are a number of reasons a court might find the legal funding contract wholly or partially unenforceable. However, the funding contracts typically contain provisions waiving all defenses to collection and warranting that the client will not seek to avoid payment. A lawyer who signs the agreement, or knowingly permits a client to sign, will be waiving important defenses. No client will know the arcane law of champerty, prohibited assignments and usury. The contracts typically recite that the client has had the advice of counsel before entering the agreement. It is critically important that the lawyer explain this waiver to the client in writing. At a minimum the explanation should clearly set out that: 1) the agreement may not be enforceable and why; 2) the client is waiving all defenses against the lawyer’s express recommendation; 3) a recommendation that the client get a second opinion from an independent lawyer; 4) the client may not get any money when the case is concluded and why; 5) if there is a dispute with the legal funder, the lawyer will likely become a witness whose testimony is likely to be adverse to the client’s interests2 and 6) the lawyer cannot represent the client in any dispute with the funder and why.
As a practical matter the explanation set out above will be lengthy and complex. To avoid a malpractice claim, the lawyer needs to be able to prove that the client understood the funding contract and the rights that were waived. The lawyer should ensure that the explanation is written and organized clearly and that the client has had meaningful opportunity to ask questions and express concerns and consult with the lawyer face to face. Because of the complex issues involved — and the adverse financial effect these agreements can have on a client’s ultimate recovery — it is entirely foreseeable that some clients may later claim that they did not understand the agreement.
Waiver of attorney/client privilege
Legal funders only take informed risks. That is why their contracts require the client to instruct the attorney to give the funder access to the client’s file. Typical contract language provides, 'Transferor hereby authorizes his attorney[s] to release to [funder] any information, files, records, documents regarding the litigation requested by [funder] who agrees to treat such information as privileged ….'.(emphasis supplied) This is a minefield for the participating attorney.
The funder will rely on the attorney to provide information about the case sufficient for the funder to make a reasonable business decision about advancing funds to the client. Does the lawyer breach the funding agreement and expose his client to a claim from the funder by refusing to disclose documents and 'information' protected by the attorney/client privilege? It appears virtually certain that disclosure of privileged information will waive the entire privilege.
OEC 511 provides that waiver occurs 'if the person. . . .while the holder of the privilege voluntarily discloses or consents to disclosure of any significant part of the matter or communication' (emphasis added). The funder is not a 'client' or the representative of a client. The funder has not sought your legal services. ORE 503(1)(a). By signing the funding agreement you are accepting an instruction from your client to waive the privilege. The consequences can be devastating.
Thorough defense attorneys will ask and discover that a client obtained a cash advance on the claim and the identity of the funder. The defense attorney will obtain discovery from the funder and learn that the funder has received privileged information. Lawyer and client may be confronted with previously privileged information that lessens both settlement and trial value of the case. The lawyer should explain this possibility to the client in writing.
It may be possible to refuse to provide the funder with any privileged information. But suppose that the lawyer has advised the client in writing or that the file contains privileged work product indicating that the case has substantial problems. If the client loses at trial, would the funder have a fraud claim against the client or attorney? If a funder will agree to forego inspection of privileged communications and attorney work product it would be prudent to include in the agreement a waiver by the funder of claims based on the contents of those materials. Of course, request for a waiver may scare off the funder.
CONFLICTS BETWEEN ATTORNEY AND CLIENT
Legal funding schemes have the potential for causing serious trouble between the attorney and client.
Attorney or client terminates the relationship.
Mature attorneys know that cases sometimes lose their luster with investigation and discovery. Sometimes bad facts turn up or serious differences erupt between attorney and client. Fee agreements commonly have provisions permitting the lawyer to resign if the client fails to cooperate, or the lawyer’s opinion about the case changes substantially. In such cases, the attorney may decide to withdraw or the client may fire the attorney. Legal funding agreements typically provide that the entire balance advanced including interest is immediately due if the attorney/client relationship is terminated. The resulting problems are obvious. The attorney’s withdrawal leaves the client immediately vulnerable to collection suit by the funder. Suddenly the client needs two lawyers — one to pursue the original claim and one to defend against the funder. The potential for ethics and malpractice claims against the attorney are clear.
Conflicts in decisions to settle the case.
It is not possible to imagine and catalog the thicket of problems that might arise in decision-making when a case is subject to a legal funding agreement. But the tip of the iceberg is clearly visible.
The funding contracts universally protect the attorney’s fee. Only the client is at risk. That structural feature builds in a potential conflict between the attorney and client. Because of the high interest rate on legal funding advances, the passage of time rapidly reduces the client’s potential net recovery. A client may pressure the attorney to accept an early low settlement offer to cut off accrual of a huge eventual interest payment to the funder. The attorney may have accepted the case originally believing that the case had substantially higher value. The attorney clearly has an interest in obtaining the higher value. Thus, the funding agreement places a wedge between lawyer and client which could develop into a situation where the lawyer’s self interest in obtaining a full and fair fee conflicts with the client’s interest in obtaining a quick settlement that cuts off liability to the funder.
The client can waive the conflict after full disclosure, but it is unclear whether such a waiver is meaningful given the client’s probable inability to afford or obtain 'independent legal advice to determine if consent should be given.' DR 10-101(B)(2). The attorney who recommends rejecting a settlement offer that would net the client a positive, but low, result is placing the client in an extremely risky position. If the attorney’s judgment is wrong about the ultimate recovery, the client could end up in debt and worse off than before the case was started. The potential for a malpractice or breach of fiduciary duty claim is obvious.
Special Problems for Guardians Ad Litem.
Minors must appear in court through legal guardians or court appointed guardians ad litem. See generally, Oregon State Bar, Civil Pleading and Practice §6.10 (2001 Supplement). Legal funding is sometimes offered to guardians ad litem in cases involving minors. In particular, when parents are the representative parties for their minor children they may wish to have cash in advance of settlement for general household expenses including care, feeding and housing the injured minor. A legal funding arrangement presents numerous problems and complexities.
First, the guardian ad litem must identify what portion of an ultimate recovery belongs to the minor or the minor’s estate. Parents can combine their claim for medical expenses with the minor’s claim. ORS 30.810. Thus, a recovery by way of settlement or satisfied judgment has two owners. Does the guardian ad litem have any authority to pledge or assign any part of the minor’s case? If so, is court approval of the funding agreement required prior to its execution?
Second, if a cash advance is obtained on the minor’s potential recovery, that advance must be used exclusively for the benefit of the minor. When a case produces money a conservator must be appointed for a minor. A conservator is a fiduciary and is subject to strict conflict of interest rules. ORS 125.221. Parents cannot obtain a cash advance on a minor’s claim and use the funds for general household expenses. Failure to adhere to that restriction could result in a claim against the guardian ad litem, parents and the attorney handling the claim.
Third, in some counties settlements for minors must be approved by the court. See, e.g., Multnomah County Supplementary Local Rule 9.055. Some jurisdictions require that the proceeds of settlement go into a conservatorship. Often, defense counsel will not provide the settlement funds unless a conservatorship is opened to receive the funds. In each of these cases the court will eventually review disbursal of the funds, either through a statutory accounting or petition for approval of settlement and disbursal. The minor’s attorney will have a difficult time justifying payment of an extremely high interest loan out of the minor’s settlement. If the court finds the funding agreement unenforceable, the settlement funder may sue the guardian ad litem and the attorney.
Superficially, legal funding appears to serve a need and help injured people survive. In fact and practice, however, legal funding is dangerous and harmful to injured parties. Attorneys should avoid participating in these arrangements and should recommend that their clients avoid them. They are bad deals economically. They adversely prejudice the client’s case, interfere with the attorney client relationship, put the client in economic peril and expose participating attorneys to ethics and malpractice problems. The only winner is the 'funder.'
Rick Braun is a sole practitioner in Portland with a trial practice emphasizing attorney malpractice, business and financial disputes. He is secretary of the OSB Legal Ethics Committee and a member of the Local Professional Responsibility Committee.
1. As of June 2001 the Florida State Bar ethics committee was drafting an opinion that would prohibit lawyers from signing the agreements. See, Litigation Funding Road May in Works for Florida, Law.com, June 19, 2001.
2. The lawyer will likely be asked testify that the client was competent to contract. This puts the lawyer in a very difficult position. If in fact the client was not competent to contract the lawyer will have a difficult time explaining why the client was allowed to sign the contract. If the funder prevails, the client may sue the attorney thereby waiving the attorney/client privilege and putting directly at issue the efficacy of the lawyer’s explanation of the funding contract’s terms. In either case, the attorney client relationship becomes adversarial.
© 2002 Rick Braun