The True Cost of Consumer Litigation Funding: Payday Loans Versus Nonrecourse Funding
“When you need money, you don’t care how much it will cost” is a sentiment shared by many plaintiffs in their search for pre-settlement funding.
Knowing they will have incoming settlement funds that are not yet accessible can be particularly stressful– especially if they are in an emergency and need immediate support. For those in the most desperate situations, their funding options are limited to unregulated payday loans or nonrecourse funding. Oftentimes times plaintiffs end up agreeing to disadvantageous funding terms for the sake of affording groceries, preventing eviction, or having reliable transportation.
A notorious solution in the consumer litigation funding space is the “payday loan”. Financing of this nature implies that plaintiffs in need of immediate and/or high-interest funding often end up losing out on their “payday”. To consumers, payday loans may seem like the only relief from financial stress. With quick cash available, it’s easy for plaintiffs in distress to have their financial woes temporarily alleviated. Despite the transparency required by the Truth in Lending Act, and in the wake of hastily signed agreements, consumers may be under the impression they are receiving a fair deal when seeing a timeline for repayment and a set amount owed.
However, with compounding interest and the ability for repeat borrowing, this financing can have the opposite effect, even to the extent of causing someone to lose the entirety of their lawsuit earnings. It has been suggested through behavioral economics that plaintiffs are more frivolous when receiving a payday loan, with the likelihood of ending up in Chapter 7 bankruptcy. This may be credited to the unpredictable nature of litigation, as well as difficulties with patience and spending. Often, when utilizing a payday loan, plaintiffs will depend upon these services and continue to take out money, misunderstanding how much they owe. We’ve come across plaintiffs who received a payday loan of $8,000 in funding and over six years now owe more than $100,000.
An alternative to the payday loan is nonrecourse funding, meaning that the monies lent to a plaintiff are an investment in their case; if and only if their case settles, the plaintiff must repay their advance plus interest to the company that provided the funding. Since repayment is tied to the success of a case, this type of financing is incredibly risky – if the case doesn’t resolve, then the plaintiff does not have to repay, and the company loses its investment. Payback is not on a set schedule, so it can be difficult for plaintiffs to comprehend how much they’ll owe once their case settles. Due to the high-risk nature of non-recourse litigation funding, some companies have complex agreements and charge excessive interest rates and fees. Yet, an advance of this nature is often the preferable option for plaintiffs, as repayment comes directly from their settlement funds, preventing them from going into debt.
It may seem as if the only viable choices for a plaintiff in need of consumer litigation funding are payday loans or non-recourse funding. Without consistency within and between payday loans and non-recourse funding, a debate exists as to whether implementing restrictions would be more harmful or helpful to plaintiffs. While payday loans can exacerbate financial disarray, their banishment could cause more harm by completely restricting credit available to low-income borrowers who are unable to access traditional forms of credit. And since payday loans typically do not require credit checks and don’t report to national credit bureaus, this type of funding might be the sole lifeline for individuals who are financially struggling. Likewise, for those in states where the high interest of payday loans is restricted, the removal of non-recourse litigation funding could be detrimental, as there would be no options remaining for those in desperate need.
Ultimately, attorneys or the state may end up preventing plaintiffs from pursuing any such transactions, as they deem them too disadvantageous. Since consumer litigation funding is a relatively new industry, there is not yet enough empirical information as to which type of funding is best or how to effectively govern this type of financial assistance. While interest is capped per annum, there are restrictions on the amount a person can borrow, and there are limitations on how long an advance can be outstanding, these regulations are not consistent among companies or states.
A proposed solution is for the consumer litigation industry to include disclosure statements regarding the rates and fees associated with payments, and to make contracts clearer for plaintiffs to comprehend. Another potential approach is to put forth a clear repayment structure on agreements so that plaintiffs know how much will be owed at an approximate date.
Yet another possible answer is for companies to explore ethical alternative funding models like the one we have at The Milestone Foundation. Our procedures are compliant with existing regulations, and our non-compounding 10% simple interest rate, minimal fees, and easy-to-read agreement put the plaintiffs first. By providing ethical funding across all 50 states, we hope to inspire other companies and policymakers to make strides in providing ethical funding within the industry.