Yes, lawsuit loans are legal in most states and jurisdictions. It is however important to understand though that the term “loan” is a word used primarily for marketing purposes. Legally speaking, these financial products are not loans in the traditional sense, but rather cash advances structured as non-recourse purchases of an equitable lien in a settlement claim.
These cash advances, which we’ve seen often marketed as “lawsuit loans,” “pre-settlement funding,” or “litigation financing,” are legal and prominent because they don’t fit the traditional definition of a loan. Instead, they represent a unique financial arrangement where a funding company purchases a portion of the potential future settlement or judgment in a pending lawsuit.
This is not a “shady” or under-the-table arrangement, it’s just a legal workaround to ensure that money can be lent, and which ensures the borrower doesn’t take on undue risk, and same for the lender, that the lender can be sure of payment from the respective future settlement.
Note: lawsuit loans are a legitimate industry, and legal funding services are useful and commonly utilized by plaintiffs in the U.S. who have been injured, such as in car accidents or other personal injury accidents, where they as the victim need immediate access to a portion of their future settlement monies while awaiting the litigation or trial of their case.
In the lawsuit funding industry, companies may use different methods to calculate the cost of their advances. Some (the nicer) funding companies advertise very clearly that they only use simple interest—such as this company offering lawsuit loans (Provident Lawsuit Loans)—where the fee is calculated only on the principal amount. While many other lenders use compound interest, where fees are calculated on both the principal and previously accumulated fees. This can significantly increase the amount owed when the loan is due and be quite the surprise for the borrower!!
How these lawsuit loans/ legal cash advances work is key to their legality:
- Non-recourse nature: This is a big deal.. The recipient (borrower) is not personally liable for repayment if they lose their case or if the settlement is insufficient to cover the advance. This is similar to how most personal injury attorneys and other plaintiff firms work which you may be familar with.
- Purchase of an equitable lien: The funding company is buying a contingent right to a portion of the future settlement, not actually lending money with an expectation of repayment regardless of the case outcome.
- Risk-based pricing: The cost of the advance is typically higher than traditional loans due to the risk assumed by the funding company. So this is something to keep in mind.
- No periodic payments: Unlike traditional loans, these advances don’t require monthly payments. Repayment only occurs if and when the case settles favorably. This is important, and no debts can “be called” arbitrarily.
It’s important to note that terms like “loan,” “lending,” “interest,” and other lending-related language are used in marketing these products to make them more understandable to everyday consumers… However, from a legal standpoint, these terms aren’t accurate descriptors of the financial arrangement.
Also, the legality of these cash advances is further supported by their structure as a purchase of a contingent asset rather than a loan… this distinction has been crucial in legal challenges, as it often exempts these products from usury laws and other regulations that typically apply to loans.
However, while the basic structure of these cash advances is legal in most jurisdictions, the specifics of their regulation vary significantly from state to state. Some states have enacted specific legislation to govern these products, while others rely on existing laws and court decisions to determine their legality and permissible practices.
Legal Status of Lawsuit Loans at the Federal Level
Ok let’s take a look at the federal level: there are no specific regulations governing lawsuit loans. BUT, the lack of federal oversight has led to various state-level regulations. Also, the Consumer Financial Protection Bureau (CFPB) has shown interest in the industry, particularly regarding consumer protection issues.
State-by-State
The legality of these lawsuit loans varies significantly from state to state. Generally, states fall into four categories regarding their approach to lawsuit loans:
- Fully legal and regulated
- Legal with restrictions
- Prohibited
- Gray areas with unclear regulations
States Where Lawsuit Loans Are Legal
Many states have embraced lawsuit loans as a legitimate financial product. For example:
- New York: Lawsuit loans are legal and regulated under the state’s Banking Law.
- Illinois: The state has enacted specific legislation governing lawsuit lending practices.
- Ohio: Lawsuit loans are permitted and subject to state usury laws.
In these states, regulations often focus on interest rate caps, disclosure requirements, and licensing of lawsuit lending companies.
States with Restrictions
Some states allow lawsuit loans but have imposed significant restrictions. For instance:
- Maine: Lawsuit loans are legal but subject to a 3% monthly interest rate cap.
- Nebraska: The state requires lawsuit lenders to register with the Department of Banking and Finance.
These restrictions aim to protect consumers while still allowing access to pre-settlement funding.
States Where Lawsuit Loans Are Prohibited
A few states have taken a strong stance against lawsuit loans:
- Arkansas: The state Supreme Court has ruled that lawsuit loans violate state usury laws.
- Tennessee: Lawsuit loans are effectively banned due to strict interest rate caps.
In these states, the prohibition is often based on concerns about excessive interest rates and the potential for lawsuit loans to prolong litigation.
States with Unclear Regulations
Several states have ambiguous laws regarding lawsuit loans:
- California: The legal status of lawsuit loans is currently being debated in the courts.
- Texas: There is ongoing discussion about how to classify and regulate lawsuit lending.
In these states, the legality of lawsuit loans may depend on how they are structured and marketed.
Interest Calculation Methods in Lawsuit Funding
Did you know: in the lawsuit funding industry, companies may use different methods to calculate the cost of their advances. There is simple interest-where the fee is calculated only on the principal amount, and there is compound interest, where fees are calculated on both the principal and previously accumulated fees.
For example, with a $10,000 advance and a 3% monthly fee:
- Simple interest: After 12 months, the amount owed would be $13,600 ($10,000 + [3% * 12 * $10,000]).
- Compound interest: After 12 months, the amount owed would be $14,257.61 ($10,000 * 1.03^12).
So,,, these different calculation methods can significantly impact the total amount a plaintiff owes, especially in cases that take longer to resolve! It’s crucial for plaintiffs to understand which method a funding company uses before agreeing to an advance.
Lawsuit Loans Origin – a Legal Alternative
Lawsuit loans first started up in the 1990s as a response to the financial pressures faced by plaintiffs involved in lengthy legal battles. The concept was favorable to all parties as a way to “level the playing field” between individual plaintiffs and well-funded defendants, particularly in personal injury cases.
There weren’t many companies selling lawsuit loans in the early days, and most were underwriters and lenders, whereas now there are many websites who are brokers and “middlemen” that simply take a cut from the loan as part of their services in connecting the customer with the lender.
Early legal challenges to lawsuit loans focused on whether they violated usury laws or constituted champerty and maintenance – ancient legal doctrines that prohibit third parties from profiting from lawsuits. However, many courts ruled that the non-recourse nature of lawsuit loans exempted them from these restrictions…
Changes in Regulations
As the lawsuit lending industry grew, so did concerns about potential abuses. This led to a gradual evolution of regulations:
- 2004: The American Legal Finance Association (ALFA) was formed to promote self-regulation within the industry.
- 2010: Colorado became one of the first states to enact specific legislation regulating lawsuit loans.
- 2015: The Arkansas Supreme Court’s decision in Oasis Legal Finance v. Coffman effectively banned lawsuit loans in the state.
These milestones reflect the ongoing tension between providing access to legal funding and protecting consumers from potentially predatory practices.
Consumer Protection Measures
FYI: many states have implemented consumer protection measures specific to lawsuit loans:
- Disclosure Requirements: Lenders must provide clear, written explanations of all fees and terms.
- Interest Rate Caps: Some states limit the annual percentage rate (APR) that can be charged on lawsuit loans.
- Cooling-off Periods: Several states require a period during which borrowers can cancel the agreement without penalty.
These measures aim to ensure that plaintiffs make informed decisions about lawsuit loans and are protected from excessive fees.
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