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Litigation Financing: A Trap For The Unwary?

April 11, 2012

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Ever wonder how some plaintiff’s attorneys fund their cases or smooth out their cash flow?  In a recent case, it seems that one method is to obtain funding from outside sources secured on the estimated value of the firm’s cases, that is, on the settlement or verdict value of each case.  According to<a href=""> <em>Kelly, Grossman &amp; Flanagan, LLP v. Quick Cash, Inc</em>.</a>, the prevailing rate of interest in these transactions is substantial ranging from 3.5% to 3.99% compounded monthly or an annual rate of nearly 40%!
Like many states, New York makes it a criminal offense to charge rates of interest on a loan beyond certain stated percentages.  In <em>Kelly</em>, the plaintiffs argued that the arrangement that resulted in funding of over $1,200,000 was, in fact, a loan subject to New York’s usury laws.  In contrast, the defendants argued that the usury laws only apply to “loans,” and not to transactions that involve interest to be paid based on a contingency not in the control of the debtor. In this case, the finance company contended that the contingency of whether a case settled or a jury returned a favorable verdict was not the  law firm’s control and therefore was not a “loan.”
In <em>Kelly</em>, it was bad news for the lawyers: the court held that the transaction was not a loan but an agreement that created an ownership interest in the proceeds of the lawsuits being prosecuted by the plaintiffs on behalf of their clients.
The <em>Kelly</em> case is a fascinating insider’s view of the recent trend of third party litigation financing where either law firms or their clients are advanced funds in exchange for a piece of the action on the tail end when the case settles or a favorable plaintiff’s verdict is obtained. Unfortunately, the price of admission is steep, with interest rates of near 40%.  These arrangements have ramifications for the defendants in these financed cases because the plaintiff’s settlement demands now must include not only the amount of outstanding medical bills or lost wages, but any sums owed to the third party financing companies.
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