Pre-settlement funding is a auto accident loan, the collateral for which is a lawsuit settlement or verdict award. Almost any personal injury plaintiff can apply to a pre-settlement funding company and, if approved, they can receive money up into the hundreds of thousands of dollars, all secured by a lien on their ultimate settlement or court judgment.
These days, the internet is filled with hundreds of companies participating in pre-settlement funding. Pre-settlement funding goes by many different names. Depending on the company you contact, they might call it a “lawsuit loan”, “legal funding”, “litigation advance”, “auto accident loan” or any other number of terms. In application they are all the same thing and there is no conceptual or legal difference between any of them.
The advertising tactics used by these companies are surprisingly uniform. Almost without exception, pre-settlement funding companies will insist that their service is not a auto accident loan. Instead, they say, it is an “advance” on their settlement or jury award. Furthermore, they market their service as a necessary lifeline to offset the costs of litigation and living with injuries. Pre-settlement funding companies more often than not label their funding as safe and risk free because, after all, they only get paid if you win your case.
However, the reality is not nearly as rosy as pre-settlement funding companies would have their consumers believe. Punishing interest rates, underhanded fees, and convoluted contracts often mean that successful plaintiffs end up signing away a lot more of their settlement than they thought they were agreeing to. These practices have been likened to those of pay-day lenders, leading to the widespread belief that these companies fit the profile of predatory lending.
Furthermore, these businesses are largely unregulated, with very little in the way of legal limitations. In many states, like Arizona, the legality of these loans is altogether unclear. This article explores the harms and questionable legality of pre-settlement funding, including the financial pitfalls for plaintiffs and the ethical considerations for attorneys.
II. The purpose and dangers of pre-settlement funding
Perhaps unfortunately, pre-settlement funding fills an acute need for personal injury plaintiffs. Litigation, now more than ever, is a long and tedious process. People who have been seriously injured may have outstanding medical bills, limited ability to work, and permanent debilitating injuries that require ongoing care. The distressing reality is that many plaintiffs, through no fault of their own, begin falling behind on their financial obligations while waiting for settlement or trial.
Attorneys are generally unable to give their clients financial assistance in a form other than fronting the cost of litigation because doing so might create an improper conflict of interest. (American Bar Association, Model Rules of Professional Conduct 1.8(e)) This means that for all other bills, clients are unfortunately on their own. The result is that many plaintiffs are forced to make ends meet another way. Sometimes this means loans, other times a mortgage or selling a vehicle, other times still, plaintiffs opt for a lawsuit “advance” in the form of pre-settlement funding.
Pre-settlement lending appeals most heavily to the most desperate of plaintiffs. Predictably, that desperation is exploitable by pre-settlement lenders. Plaintiffs seeking pre-settlement funding often find themselves stuck in lending contracts with high compounding interest rates and expensive fees. The result is that, by settlement, a plaintiff may find that their recovery is substantially less than they expected. In some situations, there may hardly be any recovery left at all after the lender takes their piece.
Pre-settlement lenders, aware of their reputations, often vigorously defend their lending practices by labeling them as an economic reality of the industry. After all, there is always a possibility that a plaintiff may lose their case and get no recovery. Since pre-settlement loans are “non-recourse”, lenders cannot come after the personal assets of the plaintiff, and that may leave the lenders with empty pockets if a plaintiff ‘s case unexpectedly falls apart. As lenders see it, these loans are high risk. Therefore, pre-settlement funding companies see their high interest rates and fees as justified in the face of risky and potentially unrecoverable loans.
However, lenders do not take on just any case. Because there is always a risk that a plaintiff’s case might fail, pre-settlement funding companies are very selective of the cases they will issue loans for. Typically, lenders request case materials and documents early in the application process so that they can assess the strength and value of a case. If the case is still early in development, weak, or not worth much money, lenders can and will refuse to lend to prospective clients.
Furthermore, given that the vast majority (Most estimates are upwards of 90%) of civil trials in the U.S. settle rather than go to trial, there are legitimate questions to be asked about just how risky these loans actually are.
Regardless of whether the fees and interest rates charged by pre-settlement lending companies are actually justified by the risk involved in the loans, the unfortunate reality is that many plaintiffs find themselves between a rock and a hard place. When the alternative is having no money at all, most plaintiffs will opt for the loan regardless of interest and fees.
III. Are they legal?
In Arizona, personal injury claims cannot be assigned. Furthermore, proceeds from a personal injury case are likewise unassignable. (Karp v. Speizer, 132 Ariz. 599 (1982)) An assignment is the transfer of a legal right or benefit held by one person to another. In substance, Arizona’s prohibition on the assignment of personal injury claims and proceeds prevents a plaintiff from transferring their right to be paid in their case. Contract provisions that transfer the claim or the right to collect personal injury proceeds to another person or entity are illegal and void.
When determining whether an agreement is an assignment at all, courts look past the language of the agreement, analyzing instead its practical effect. Whatever the form, label, or theory, when the effect of an agreement is to create an interest in a 3rd party for the plaintiff’s recovery, it is the equivalent of an assignment and is therefore unenforceable. (Allstate v. Druke, 118 Ariz. 301 (1978))
Arguments about personal injury assignment arise most often in cases involving insurance companies, where medical insurance might demand payment out of the proceeds of a personal injury award. However, there are parallels between those situations and pre-settlement funding cases that are worth examining.
1. Harleysville Mutual Insurance Company v. Lea
Harleysville is one of the earliest Arizona cases concerning assignment of personal injury proceeds. In 1963, defendant Lea was injured in an automobile accident. (Harleysville Mutual Insurance Company v. Lea, 2 Ariz. App. 538 (1966)) Harleysville, Lea’s insurance company, paid a sum of $620.98 for Lea’s medical care. Id. The terms of Lea’s policy with Harleysville and his acceptance of the payment demanded that he assign his personal injury claims to Harleysville. Id.
Shortly thereafter, Lea entered into a settlement with the other party to the accident and refused to reimburse Harleysville. Id. Harleysville then sued Lea to recover their payments. Id. The Arizona Court of Appelas held that an action for personal injury was not assignable in whole or in part, and that although Lea had agreed to assign his interest in the case, he did not have the legal power to do so. Id. Therefore, Harleysville had acquired no interest in Lea’s settlement, and could not be reimbursed from it.
2. Allstate Insurance Company v. Druke
Allstate Insurance Company v. Druke arose out of different circumstances than those in Harleysville but concerned a similar practice. In 1976, a class action complaint was filed against Allstate Insurance, alleging that Allstate’s policy provision requiring an insured to repay medical expense benefits out of proceeds from a lawsuit was illegal under Arizona law. (Allstate v. Druke, 118 Ariz. 301 (1978))
Allstate contended that because their interest in the personal injury claim did not mature until it had been reduced to judgment or settlement, it was not an assignment for a cause of action. Id. The Arizona Supreme Court did not find the distinction meaningful, noting that any policy that created an interest in personal injury recoveries was, in substance, an illegal assignment. Id. The Court reasoned, citing Harleysville, that:
“Whatever the form, whatever the label, whatever the theory, the result is the same. The policies create an interest in any recovery against a third party for bodily injury. Such an arrangement, if made or contracted for prior to settlement or judgment, is the legal equivalent of an assignment and therefore unenforceable.” Id.
3. Karp v. Speizer
Karp v. Speizer involved an entirely different scenario then those contemplated by either Harleysville or Allstate v. Druke in that neither party was an insurance company. (Karp v. Speizer, 132 Ariz. 599 (1982)) Seymore and Shirley Karp obtained a judgement against Donald and Virginia Speizer. In satisfaction of the judgment, the Speizers assigned the proceeds of his pending personal injury case to the Karps. The Speizers’ case was settled, but they failed to deliver the proceeds to the Karps. The Karps filed suit to recover under the agreement.
The Karps attempted to distinguish the assignment of lawsuit proceeds from the assignment of a cause of action. Citing Allstate, the Arizona Court of Appeals reiterated that the assignment of proceeds was indistinguishable from assignment of the claim.
The Karps argued that because there was no insurance company involved in the agreement, the public policy justifications for the general bar on assignment of claims should not apply. The Court explained that the public policy considerations for the rule applied equally to the context of insurance companies and private parties. The agreement was ultimately found to be unenforceable.
4. Application to Pre-settlement funding
In examining Arizona case law on the assignment of personal injury claims, 3 things become apparent.
- Validity of an agreement hinges on whether it is an assignment in effect rather than on the face of the agreement.
- The prohibition on personal injury claim assignment goes beyond the legal claim itself, extending also to its proceeds.
- The rule against assignment applies equally to all parties. Whether the parties are an insurance company, private party, or otherwise, is irrelevant for these purposes.
In applying these rules to pre-settlement funding, it quickly becomes apparent that these loans are in direct conflict with settled law. First, although the terms of pre-settlement loans do not call for an assignment of claims on their face, they undeniably transfer an interest in the outcome of the plaintiff’s lawsuit to the lending company.
Second, pre-settlement financing seldom, if ever, assigns a personal injury cause of action to the financing company. However, these loans are, by definition, secured by an interest in the proceeds of personal injury settlements or awards. As we know from Allstate, the fact that the pre-settlement financing company has no interest in the case it is reduced to a dollar amount does not meaningfully distinguish the agreement from an illegal assignment.
Finally, Karp made it clear that the public policy reasons for the prohibition against assignments apply to both business and private parties. It does not seem to matter who is doing the assignment, only that it is being done. Pre-settlement financing companies would seemingly be treated the same as an insurance company or individual. Given the established law in Arizona, it seems there is no legitimate argument to distinguish pre-settlement loans from any other kind of personal injury assignment.
Though Arizona courts have not yet addressed the issue with specific regard to pre-settlement financing, liens over personal injury proceeds in exchange for advance payment are likely not legal.
IV. Ethical considerations
1. With the client
For attorneys, a client’s interest in pre-settlement funding should be approached with caution. First, Ethical Rule 1.3 mandates that lawyers act with reasonable diligence in representing their clients. (MRPC 1.3) If a client asks their attorney about a pre-settlement funding agreement, the attorney must carefully examine the agreement between the client and the pre-settlement funding company before advising the client on a course of action.
Furthermore, the attorney must not advise their client to engage in conduct that the lawyer knows is fraudulent. (MRPC 1.2d) If the lawyer knows the pre-settlement financing agreement is invalid and advises the client to sign it anyway, the lawyer may be assisting the client with bad faith, if not outright fraudulent conduct. This could open up the attorney to unnecessary liability.
2. With the pre-settlement finance company
While liability arising from interactions with the client should be foreseeable and obvious, less apparent are the hazards that come from working with pre-settlement funding companies. In order to vet the cases they take, pre-settlement financing companies do a detailed examination of case materials before they issue any money on a case. Sometimes the documents come directly from the client.
More often, the pre-settlement companies will reach out to the attorney handling the case to ensure that they receive all the relevant documents and information. Obviously, releasing documents and materials should only be done with the client’s consent. But note that releasing any information about the case requires a client to give informed consent. (MRPC 1.6a) Attorneys should discuss all possible implications of releasing case specifics to the pre-settlement financing company.
Should the client give informed consent, attorney’s must use additional caution in their interactions with the company. A deeper level of involvement with the pre-settlement financer will result in more exposure to liability. Although the company is not the attorney’s client, the attorney still has ethical obligations to them.
First, the lawyer cannot knowingly make a false statement of material fact or law to a third person. (MRPC 4.1a) This means that if the pre-settlement company asks for information about the case, the lawyer may not conceal or misrepresent facts relevant to the financer’s assessment of the case.
Furthermore, if the attorney has a good faith belief that the provisions of the clients’ contract with the company are an illegal assignment, cooperation with the financing company without discussing the legal defects of the agreement may amount to a misrepresentation of law. At the very least, the financing company could make a compelling argument that both lawyer and client entered into the agreement in bad faith.
Second, attorneys should be careful not to say anything to the company or the company’s agents that could be construed as legal advice. Attorneys are prohibited from giving legal advice to an unrepresented person if the lawyer knows that there is a reasonable possibility that the person’s interest conflict with the client’s interests. (MRPC 4.3.)
Because the client has an interest in keeping as much of their personal injury recovery as possible, the interests of a company that has a lien on the recovery clearly conflict with the client’s interests. When possible, attorneys should advise the company to seek independent counsel and communicate only with that counsel from then on.
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