Spring Newsletter 2006

The Ultimate Irony: Banks and Venture Capitalists Investing In Litigation By Way of Lawsuit Financing Companies.

Perhaps you've seen the ads on television or better yet, you've received a call from a client about an advance on money in their case from an outside company who specializes in lawsuit financing. I've seen advertisements for these firms claiming "We do what banks won't."

As any attorney knows, it takes money to litigate. Well-financed plaintiffs firms tend to stay away from litigation finance companies because of the high interest rates and strings attached to contingency fee agreements. Law firms that can afford to usually prefer to invest their own capital in experts, case screening, discovery and trial expenses. But what about the thousands of small or solo firms that are attempting to litigate expensive cases too? From an attorney's perspective, a company who can help fund cases may be a blessing. But at what cost?

Smaller or less-established firms may have no choice but to resort to outside sources for money. An interesting story reported on a finance company website is that of Patricia Bellasalma. Ever since she finished law school 10 years ago, Los Angeles solo practitioner Patricia Bellasalma has represented a class of 600 minority police officers that is suing the county of Los Angeles for disparate pay. Along with co-counsel, she sank everything she had into the litigation, falling a half-million dollars into debt to do it. In 2002 Bellasalma's clients won a $152 million jury verdict -- but then the county appealed. "They were hoping I'd just leave," says Bellasalma, who works out of an office in her parents' home, where she lives. "If I didn't have the capacity to rely on my family, I couldn't have withstood it." Bellasalma knew the appeals process would be expensive, but she couldn't get a bank loan, even with the jury verdict in hand. She turned to a company called a lawsuit finance company, which has lent her a total of $1 million. "They gave me the funds fully to defend and prosecute my case," she says. "I can fight another day."

In exchange for funding, Bellasalma will owe the finance company about 37 percent annual interest (capped at three years) on her $1 million principal -- total interest payments, in other words, of more than $1 million. The company she borrowed from makes "nonrecourse" loans, which means that Bellasalma won't have to pay back anything if she loses her appeal. These loans are riskier for litigation finance companies but the return is potentially higher. Not all of the loans available to clients are "nonrecourse", some companies offer more traditional loans, meaning that the borrowing firms are liable for repayment of what they borrow, regardless of the success of their cases. These companies are licensed lenders bound by lending regulations.

In today's fast paced society of home equity lines and second mortgages, these companies make loans against a law firm's caseload or against a trial verdict on appeal -- and they typically charge double-digit interest rates (or double-digit percentages of the attorney's contingency fees). Financing law firms, an industry that's only about five years old, grew out of the longer-established business of lending money to plaintiffs engaged in personal injury litigation. In essence, by using borrowed money instead of their own capital on which they've already paid taxes, law firms can rationalize borrowing the money, even at high interest rates. Moreover, depending on their retainer agreements, law firms may be able to pass interest payments on to clients as expenses.

It has been reported that some litigation financing companies have made loans or extended lines of credit of up to $15 million or $20 million to single law firms. Several companies claim they've invested more than $100 million in litigation. Obviously, mass tort litigation can encompass years and take millions of dollars to litigate. These more complex cases, including mass torts, asbestos, fen-phen and Vioxx, can have unseen layers of investors: litigation finance companies, which, in turn, are themselves sometimes backed by banks, venture capital and hedge funds.

The next logical question regarding lawsuit financing is ethics. A quick internet search of litigation finance company web sites shows various states' ethical opinions and restrictions on lending to law firms. At first glance, lawsuit lending does not appear to be creating litigation, because loans are usually made on the basis of existing cases. Nor is there a conflict of interest between the lawyer and client, as long as the client understands and agrees to whatever loan-related expense the lawyer passes on. Also, if the client chooses to enter into an agreement with a finance company about a pending lawsuit, the contract is between the client and the company, which means the lawyer is not involved in any way. In this instance, the client is responsible for satisfying the loan out of the proceeds received by the client.

Indeed, there seems to be something ironic about free-market forces including banks, venture capitalists and corporations, which tort reformers claim are impeded by personal injury litigation, actually investing in litigation.

J. Stuart McAtee