Looking at the Profitability of Legal Loansharking
Lawsuit funding (lawsuit loans, case advances, settlement funding loans, etc.), are specialty finance transactions where plaintiffs receive a portion of their future lawsuit proceeds prior to the cases’ final resolution. Legal loansharking is a term some opponents use to portray the industry in a negative light.
Opponents often point to the “oppressive” nature of lawsuit loan contract terms. Indeed, it is common to hear pricing objections in both traditional and digital media outlets. A common objection might be phrased: How the hell do you get away with charging 35%-40% per year for lawsuit advances?
In this post we delve a little deeper into “legal loansharking” and examine likely profits for legal funding enterprises. What we reveal might be surprising to those who deem the business as predatory.
Legal Loansharking Basics
Any analysis begins with the basics and the basics of lawsuit funding are this: A plaintiff requires an immediate influx of cash for whatever reason. He/she has a lawsuit, has an attorney who will be compensated only if the case is successful (think personal injury contingency fee arrangements) and the target defendant has the ability to pay a claim (i.e. insurance coverage is in place).
Lawsuit funding contracts involve the selling of a portion of the potential future proceeds of a lawsuit to a “lawsuit lender”. In return, the plaintiff receives a much needed liquidity boost in the form of cash. There are no restrictions on the use of the cash. In fact, many clients use the lawsuit loan for:
- Medical treatment and surgery loans
- Living expenses
- Housing
- Transportation
- Past debts
- School tuition
- and more . . .
A unique feature of lawsuit loans, aka legal loansharking, is that they are not repaid if the case is not ultimately successful. The deal is structured as a sale of future property rights in the settlement proceeds. If there are no proceeds, what was purchased is worthless. This means unless the plaintiff recovers damages, there is no repayment.
This feature is the primary difference between loans and lawsuit loans. It also means there is the additional risk of loss. This additional risk of loss must be accounted for in pricing.
The Legal Funding Process
Contact and Application
The lawsuit loan process begins when a plaintiff contacts a “legal loan shark” for a lawsuit advance. On the phone, the applicant is screened as the business determines if the lawsuit is a candidate for funding. If so, more information is given and the “paper chase” portion of the business begins.
Paper Chase
The funding company requests certain documentation from the plaintiff’s attorney as proof there is a viable claim. These documents might include a police or incident report, evidence of damages, and the defendant’s insurance information. When this information is received, the case is sent to underwriting.
Legal Loansharking Underwriting
Lawsuit funding underwriters largely consist of legal and/or insurance professionals whose job it is to determine the likelihood and amount of settlement. They review the documents and contact the attorney if they have more questions – as they often do.
Approvals
Once the case is approved for funding, the process is easy. A contract is prepared and forwarded to the client and attorney for signature. Once executed and returned, the funds are sent via overnight courier or electronic bank transfer.
If You Have Any Questions, Call 888-964-2224
WE ARE HERE TO HELP YOU!
The Process Costs Money – Business Expenses
Every business incurs expenses in providing the product or service. Legal “loansharking” is no different. Lawsuit funding operations include:
- rent
- payroll
- advertising
- marketing
- communications systems
- insurance
- accounting
- legal services
- etc.
The above are typical of every business but of particular note to the legal funding space is the cost of capital.
Lawsuit Loan Cost
Lawsuit loan cost is most often pointed to when labeling lawsuit funding enterprises as legal loansharking. Generally, lawsuit loan cost is calculated by a percentage rate as applied to the contract amount. Lawsuit loan rates are generally 36% per year in the competitive marketplace.
Opponents seek to label lawsuit loans as traditional loans such as car loans or mortgages. Yet comparing lawsuit loan rates to traditional loans rates is comparing apples to oranges. As we mentioned earlier, lawsuit funding investments carry higher risk than traditional loans.
Moreover, lenders have some options with non-performing traditional loans. For example, secured creditors (car loans, mortgages, etc.) can repossess the property purchased with the loan proceeds, sell it, and recapture some or all of the repayment in this manner. Lenders can also pursue the borrower personally for repayment.
Lawsuit lenders have no such recourse because the transaction is a sale of property rights. As explained earlier, the sole source of repayment is the lawsuit itself under the contract. If the property purchased is without value, the lawsuit funder takes the loss and cannot pursue the plaintiff personally for repayment.
When you consider the recourse traditional lenders have in the event their “loan” defaults and compare it to the non-recourse nature of lawsuit loans, it is clear that legal loansharking is not an accurate depiction of the business.
Proving the Point with Profitability
To further exemplify the point, we need only to consider the profit margin of a typical lawsuit funding enterprise. Without going into the minute detail of every line item, let’s assume that to originate a piece of business on average costs approximately 10%. That is, for every $100,000 of lawsuit loans, an enterprise must spend $10,000 for origination (advertising and marketing) and processing (staff, underwriting, funding, etc.).
Assume further, the cost of capital is higher than that of traditional loans due to the additional risk. Indeed, it is not uncommon for investors to demand 10-15% return on their capital for these investment vehicles.
A loose calculation reveals that for every $100,000 invested, the lawsuit funding company must risk up to $25,000. In other words, the cost basis is $125,000 for securing $100,000 worth of business. These vehicles typically carry a loss of 5% so the cost is really $125,000 for $95,000 worth of “performing” lawsuit loans.
If all the cases settle and advances returned in the first year (unlikely), the return is $129,000 for a profit of $4,000. This is almost breakeven and not a great indicator of profitability. More likely is that some of the advances (45%) are repaid in the first year, and the rest remain outstanding until their ultimate resolution. Depending when the portfolio of cases are returned and the loss ratio applied, the business only becomes a worthwhile endeavor with heavy volume and after a year has passed.
Taking this example a little further, assume that 45% of the portfolio ($42,750) is repaid at the end of year one ($58,140 total) and the remaining cases (55% or $52,250) are repaid at the end of year two ($89,870 total). The total repayment in this example is $89,870 + $58,140 = $148,010. The cost basis for this investment is $129,000 + $7,837 (additional cost of capital, year two) = $136,837. So in this crude example, the lawsuit loan company earned $148,010 – $136,837 = $11,173. This represents a little over 8% total return on investment.
The point here is not to calculate the ultimate profitability of lawsuit funding operations but only to show that legal loansharking is not an accurate depiction of the business. When you consider what loan sharks typically charge (3-20% per week), you can see the comparison is designed to elicit an emotional response in the reader/listener. Lawsuit funding profitability is nowhere near the criminal enterprise offered for comparison. Instead, the margin is well in line with most other businesses.
What We’ve Learned About Legal Loansharking
Lawsuit loans seek to level the playing field between plaintiffs and financially strong insurance companies who defend against their claims. They allow plaintiffs to refuse low-ball settlement offers so they can wait out the legal system and secure just compensation.
The above discussion hopefully explains how describing lawsuit loans as legal loansharking is inaccurate. Interestingly, most criticism does not arise from those who receive the advances. Rather, calls for regulation come from non-participating parties.
Plaintiffs and attorneys who utilize lawsuit funding for their own benefit see the value it provides. The fact lawsuit funding has solidified its place in the legal landscape is evidence of this value.
Thank you for your interest in lawsuit settlement loans.
