Lawsuit lending is a relatively new industry. Right now, lawsuit lenders are, for the most part, unregulated under state and federal law. However, state legislatures have recently begun considering whether the lawsuit loan industry should be regulated.
Because there is little regulation of lawsuit lenders, you should be extra careful if you are looking to take out a lawsuit loan in order to get money during your legal case.
What Is a Lawsuit Loan?
You might be considering a lawsuit loan if you are a plaintiff in a personal injury (or other type of) lawsuit and are short on cash. With a lawsuit loan, you can get money right away. Lawsuit lenders advance money to plaintiffs with the expectation that the money, plus interest, will be paid back out of a future settlement or judgment award. (Learn more about how lawsuit loans work.)
This largely unregulated industry has been criticized for its large fees and lack of transparency in its business practices. The lack of transparency makes it difficult for borrowers to make an informed decision about whether a lawsuit loan is a good choice.
How Does Government Regulation Protect Borrowers?
State and federal governments try to protect you from unscrupulous lenders in other areas of consumer credit, such as when you sign a student loan, a promissory note to buy a house, a credit card application, an automobile installment loan, or even a rent-to-own contract. Laws generally regulate consumer credit by:
- limiting the amount of interest that a lender can charge, and
- controlling the way in which the lender discloses the terms of the loan.
Interest rate limits. Generally, state legislatures pass laws governing how much interest a lender can charge to residents of the state. The state will also put into place penalties for those lenders who charge usurious -- unreasonably high -- interest rates.
Loan term disclosure. The federal government, along with some states, regulate how a lender discloses the terms of the loan, including how the interest rate is calculated, how much interest the borrower will pay over the life of the loan, the penalties for failing to pay the loan back, and what other fees are included in the loan. Federal disclosure regulations even dictate how large the font should be and where the pertinent interest rate should be located on the loan documents.
These regulations protect consumers in two ways:
- They make it less likely that lenders will take unfair advantage of cash-strapped consumers.
- They allow consumers to make informed decisions about these loans and allow them to compare terms between different lenders.
Lawsuit Lending Is Generally Unregulated
Unlike other types of lending, lawsuit loans are not yet regulated by the federal government, and few states have put into place consumer safeguards. This is in part because the lawsuit lending industry argues that lawsuit funding is not a loan, and therefore the usual laws and regulations applying to loans should not apply to them.
According to the lawsuit funding industry, lawsuit loans are not actually "loans" because they are non-recourse, meaning plaintiffs don't have to repay the money if they lose the case. Instead, they characterize the transactions as "non-recourse purchases of a portion of the proceeds of a potential future case judgment or settlement."
Using this argument, lawsuit lenders have convinced some state legislatures not to regulate their products as if they were traditional loans.
Opposition to Lawsuit Loans
Consumer advocacy groups have strongly opposed lawsuit lending or have actively proposed regulating it on behalf of consumers. In their push for more regulation, these consumer groups have found themselves aligned with entities not necessarily known for their consumer advocacy, including insurance companies and business groups like chambers of commerce. These pro-business groups oppose lawsuit loans because of their concern that this kind of lending encourages litigation by making it easier for plaintiffs to hold out for higher settlements.
Because of the opposition to lawsuit loans, there have been attempts to pass laws that would regulate the lawsuit lending industry. Some of these recent attempts, however, have failed. For example, one such bill in Texas died in committee.
On the other hand, the lawsuit lending industry has had some success in introducing its own legislation to lawmakers in some states, like New York. Not surprisingly, these bills fail to impose interest rate limits. Furthermore, they specifically provide that the transactions are not loans and that state lending laws do not apply to them.
Courts May Be Changing the Landscape
Not all courts agree with the lawsuit lenders' characterization of their products. For example, in a recent Colorado case, an appeals court ruled that lawsuit loans were indeed loans, and that lawsuit lenders must comply with Colorado consumer protection laws.
As a result of this case, many lenders have chosen to stop doing business within the state of Colorado and within other states, like Maryland and North Carolina, after receiving unfavorable court rulings.
What This Means for You
Because there are little formal consumer protections regarding lawsuit loans, if you are considering this type of funding, you need to be extra vigilant. Understand what the loans are, carefully consider whether such a loan is a wise financial decision in your situation, and if you decide to look for a loan, shop carefully. (Learn how to shop for a lawsuit loan.)