It’s An Investment
Part One of Two
While many perceive legal funding as a loan, it needs to be said that such a claim, while seemingly logical, is inaccurate . Legal funding is actually an investment in a legal case. When one asks the question of what the difference between a loan and an investment is, it can be said that the answer to that question is – risk. It is the existence of substantial, actual risk that distinguishes a loan from an investment. On that note, many agree that legal funding is an investment precisely because it involves a substantial amount of actual risk.
When it comes to lawsuits, it can be said that it’s strange to think of them as something that can be assigned, sold or bought; the fact to the matter is that they can be, much like stocks or even real estate. Regardless of the circumstances, loans must be paid back with interest, because they are regarded by the law as financial obligations. For example, only if the litigant settles or wins their case are legal funding investments paid. Much like company owners, who take on the risk of losing their investment if their company fails, legal funders are also at risk of a lawsuit failing.
Because of the fact that consumer loans are subject to very strict regulation in the great majority of states, dramatic consequences can occur if legal funding becomes misclassified as a loan. For instance, companies who deal in loans to consumers are required to comply with strict state usury laws; these laws are responsible for capping the rate of return, which is charged on the consumers. Now, compared to some other types of investments, loans are considered relatively less risky ; this means that the rates of return (that are required in order to make a profit) are somewhat lower than for legal funding, for example, as well as other types of finance that carry more risk. In order to ensure a profit, legal funding companies are required to charge higher rates because they are at risk of the lawsuit failing. Therefore, if one was to subject legal funding as an activity to usury laws, the model simply wouldn’t work.
In the great majority of states, the definition of a usurious loan has 4 main elements:
- An agreement that features lending money
- The existence of an absolute obligation of the borrower to repay (the loan), with the addition that such an obligation is not contingent on any other event
- A rate of repayment that exceeds the statutory maximum
- An intention to receive a greater payment than allowed by the usury law
Out of these four, it can be said that the most important and critical element, in terms of this debate, is the second element; its focus in on the way in which a loan is specifically defined.
When you look at the surface of things, it seems as though the critical second element is not triggered by legal funding transactions at all. After all, they are, in essence, non-recourse cash advances that are made contingent after a court award or settlement. In other words, until or unless a lawsuit has succeeded, the consumers are under no legal obligation to pay anything. That being said, legal funding agreements tend to spell this out in very precise, obvious and easily understandable terms.
Here’s how you should look at it – an attorney contingency fee is also not contingent on the outcome of the case, if legal funding isn’t, as well. In other words, attorneys and legal funders who are working on contingency are pretty much the same in this sense: until you get paid, they don’t get paid either.
*Part Two To Follow