In this post, we will be looking at the practice of hedging as it pertains to pre-settlement funding.
Let’s say you’re in Las Vegas this summer and you place a bet on the New York Giants to win the Super Bowl at odds of 15 – 1. That is, you bet $1,000 to win $15,000. But some stroke of luck, the Giants rip through the playoffs and find themselves pitted against Tom Brady and the Patriots for the big game. If the Giants win, you win $15,000. If they lose, you lose the $1,000 bet.
A hedging play in this scenario would be to bet against the Giants in the Super Bowl. This way, you are a guaranteed winner. If the Giants win, you still win the $15,000 minus the game day bet on the Colts. If the Colts win, you win the game day bet minus your initial $1,000 bet on the Giants. This “hedging” of your bet guarantees you profit from your position. This is just one example of hedging.
In fact, risk takers use hedging as a way to manage risk every day. Hedging can be defined, in markets, as a position taken attempting to offset exposure to price fluctuations with the intent to minimize the exposure to risk. One example might be buying options against a long position in a stock so that if the price of the share drops, the options become more valuable. But hedging against risk can be a much broader concept than its application to the financial or commodities markets.
Let us take an example using a cash advance against a pending lawsuit. These types of transactions are often known as “Lawsuit Funding”, “Case Loans” or “Pre-Settlement Financing”. Essentially a plaintiff takes money against the future proceeds of his case. In exchange for the cash now, he assigns his right to a certain amount in the future if he wins. On the surface, this resembles a hedge in that it guarantees a recovery regardless of the lawsuit’s final resolution. Because the plaintiff does not have to pay if the case is unsuccessful, he is locking in a guaranteed return. So we know it can be used to mitigate against the risk of loss, but let’s explore even further.
Traditional hedging involves the management of risk. And there is a cost associated with this management. In the markets, the cost is buying that option or shorting a portion of the position. The same can be true for lawsuit funding contracts – the cost is the amount that has to be paid back less the amount the plaintiff receives. So now we see the comparison is a valid one. The funding agreement can achieve similar aims for plaintiffs.
The question then becomes: Is lawsuit cash advance funding as a hedge a good deal and if so, for whom?
In the real world of litigation finance, very few plaintiffs intentionally hedge their position. The purpose of lawsuit loans are to help plaintiffs pay their expenses while they pursue their cases in court. By easing the financial burdens, the theory is that plaintiffs can endure the long, drawn out litigation process. The vast majority of pre-settlement funding clients need the money to pay bills, medical expenses, home improvements, cars, or other daily expenditures. Hedging against losing the case usually is the last thing on their mind when they apply for a case loan.
Further, such a technique is very expensive. When you consider the costs associated with most legal funding, you will realize this type of financing is usually the last resort for plaintiffs who are strapped for cash. Although some funding companies offer very reasonable rates, most charge well in excess of 50% per year when fees are included. For this reason, hedging in this regard is an expensive proposition.
Nevertheless, there is money for plaintiffs at a “fair rate” if their case qualifies. In this circumstance, the benefits may very likely outweigh the costs. However, only preferred cases qualify for these low rates and the traditional reasons for obtaining case loans still apply.
Also, because these cases are less “risky” there may really no reason to intentionally hedge the position. The purpose of hedging is to limit the risk of loss and to lock in a gain if possible. But at what cost? Placing a costly bet against a case that already has a 95% chance of recovery may not really be prudent. Ultimately, the client must decide.
In final analysis, utilizing lawsuit loans to hedge against the potential loss of a legal proceeding comes down to weighing costs. This type of determination is not an exact science and is best evaluated by the person in the best position to understand the risk/reward – the plaintiff himself.
Thank you for your interest in legal funding.