The Difference Between Traditional Loans and Lawsuit Loans
Lawsuit loans are specialty finance transactions where money is advanced to plaintiffs in anticipation of a favorable settlement in civil court. Also known as settlement loans or case loans, lawsuit funding transactions are not actually loans. In this post we examine loans vs. lawsuit loans by comparing lawsuit funding with other types of traditional “loans”.
Defining Loans vs. Lawsuit Loans
Merriam-Webster defines “loan” as “money lent at interest”. But this does little to explain the differences between lawsuit loans and traditional loans. This is true because the definition fails to assess the repayment terms.
If we search the online encyclopedia for the phrase “credit”, we come up with the following interesting definition:
Credit, transaction between two parties in which one (the creditor or lender) supplies money, goods, services, or securities in return for a promised future payment by the other (the debtor or borrower). Such transactions normally include the payment of interest to the lender.
So according to this definition, a credit transaction must meet the following criteria.
- Creditor supplies money, etc.
- Debtor promises a future repayment, often at interest.
If we use this definition, we can clearly see why lawsuit loans are not “loans” in the traditional sense of the term. But first, let us define some traditional loans and see how they compare.
Traditional Loans
Traditional loans generally fall within two types – secured and unsecured. The differences between the two are the available remedies in the event of default (non payment according to the loan terms).
Secured Loans
Secured loans are “secured” by some type of collateral. In any “secured transaction”, the debtor pledges a specific collateral through the execution of a “security instrument” and the creditor files notice of that interest in the public record. We find this situation every day in mortgage arrangements or the financing of automobile purchases.
In these transactions, the debtor/borrower signs a note, which outlines the loan terms, including the rate of interest, time and amount of the repayments. The debtor also signs a security instrument (e.g. mortgage) which is recorded in the public record, usually in the county where the property is located. This instrument gives the creditor the legal right to obtain the property (repossession, foreclosure, etc.) if the loan terms are not fulfilled by the debtor.
Unsecured Loans
Examples of unsecured loans include credit cards, certain lines of credit for businesses, and others. With unsecured debt, there is no collateral pledged from which the creditors’ advance is “secured”. Instead, in the event of a default, the creditor simply sues the debtor for the loan balance plus whatever penalties, fees or costs as are outlined in the debt instrument (note). The creditor retains the right to sue but does not have any right in any specific collateral. It should be noted that debtors usually pay more interest for unsecured obligations than secured loans.
Loans vs. Lawsuit Loans
As stated above, a loan refers to a transaction where the creditor gives money and the debtor promises to repay. Lawsuit funding contracts differ from traditional loans because the lawsuit loan is only repaid IF there is a settlement or other recovery.
In other words, while traditional loans imply repayment under all circumstances, a lawsuit “loan” is repaid only if a condition is satisfied. That condition is the plaintiff recovering on the claim/lawsuit. Thus, because payment is contingent on recovery, a lawsuit “loan” fails to satisfy our definition of a loan.
The contractual language of a lawsuit loan agreement can also shed some light on the differences between normal loans and lawsuit funding. Lawsuit loans are designed as a sale of property rights in the future proceeds of a lawsuit/claim. Most contracts are labelled “asset purchase agreements” or something similar. The idea is to leave no doubt as to what the parties intend by entering into the transaction.
The purchaser (lawsuit loan company) desires to purchase a portion of the case. The seller (plaintiff) desires to sell a portion of the settlement. If what was purchased (settlement) should expire worthless (case is unsuccessful), then what was purchased is without value (advance is not repaid). That is the unique nature of lawsuit loan contracts and the major difference between loans vs. lawsuit loans.
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Similar Terms, Major Differences
So far we made a distinction between traditional loans vs. lawsuit loans. At first blush, the difference may seem little more than a legal technicality. Yet the practical effect of this distinction is pretty significant.
Established Laws and Regulation
Secured and unsecured loans are usually regulated by the jurisdiction in which the loan was originated. Many states have a “Department of Banking” or other similar bureaucratic office charged with protecting the public from unscrupulous lenders otherwise known as “loan sharks”. One method of control is mandating maximum amounts of interest allowable for traditional loan transactions. These decrees are normally called “usury laws” and often make it a criminal offense to charge interest in excess of the statutory maximum.
Legal funding is sometimes referred to as “legal loansharking” but ironically, lawsuit loan contracts are not governed by usury laws in most states. Essentially, there is no limit to what a lawsuit funding company can charge for their services – other than the common sense of plaintiffs themselves.
Free Market Principles Rule the Industry
If plaintiffs do a little homework, they’ll discover there are dozens of companies that want their business and the free market actually determines the best lawsuit loan rates. Unfortunately, some lawsuit funding companies charge oppressive rates simply because they can get away with it. That is bad news for some.
The good news is that lawsuit loans offer plaintiffs the ability to sell a portion of their settlement for immediate cash. For decades, plaintiffs were forced to ask their attorneys for advances on cases. But most state ethical laws prohibited this practice and still do. And while often more expensive than traditional financing, lawsuit funding offers clients an opportunity to ease their financial burdens where no other opportunity might exist.
Even better news is that as the business matured, companies were forced to offer better terms to compete in the marketplace. That means many companies offer a “fair rate” for cash advances on pending litigation. Often, the pre-settlement loans carry less interest than a credit card. This is a godsend for clients strapped for cash and frequently a good financial deal as well.
Loans vs. Lawsuit Loans Takeaways
Traditional loans obviously have their place in the financial world – offering creditworthy individuals to access immediate cash to serve their needs. However traditional loan requirements such as high credit score or collateral sometimes prohibit access to these vehicles.
Lawsuit loans however are a specialty niche in finance. Lawsuit advances are not traditional loans but are instead a sale of the future proceeds of a lawsuit or claim. Repayment is thus dependent upon a successful outcome. That is, lawsuit loans are ONLY repaid if the case is successful and monetary recovery is made. For this reason, lawsuit loans are deemed non-recourse funding. A lawsuit lender cannot pursue a plaintiff for repayment under normal circumstances. The advance must be repaid from the proceeds of the case.
If you have any questions or concerns regarding the distinction between traditional loans and lawsuit loans, give us a call and speak to a live representative. We are here to help and are at your service.
Thank you for your interest in the lawsuit funding business.
