PROFESSIONAL LIABILITY CLIENT ALERT: Third-Party Litigation Financing Can Drive Up Case Settlement Value

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A recent data study by researcher, Jean Xiao, JD/Ph. D, at Vanderbilt University Law School revealed the effects of the growing Consumer Litigation Finance industry on medical negligence cases. According to the study, the direct availability of litigation funding from investors to plaintiffs resulted in higher malpractice payments and extended the amount of time it took cases to settle.

Traditionally, litigation has been financed through three primary sources: law firms, insurance companies, or the litigants themselves. However, in the past twenty years, consumer litigation finance companies have emerged as a new source of funding to litigants. Under this relatively new funding model, a tort plaintiff – such as someone injured through medical negligence – can apply for a cash advance from a financier in exchange for the plaintiff repaying the advance, plus interest and fees, out of the proceeds of their case. The financiers typically receive their payment after attorneys’ fees and other debts are satisfied. However, should the remaining portion of a plaintiff’s settlement be less than the total amount owed to the financier, the plaintiff is not required to pay the difference, similar to a non-recourse loan.

Backdrop of Dr. Xiao’s Study

Dr. Xiao’s study examined the impact of consumer litigation funding on medical malpractice claims filed in Ohio after two important policy changes toward these loans: the Ohio Supreme Court’s 2003 ban of funding in Rancman v. Interim Settlement Funding Corporation which held that consumer legal funding was void under the common law prohibitions against champerty and maintenance; and the subsequent legalization of the practice in 2008 by the Ohio General Assembly.

In Rancman, a plaintiff received a $6,000 advance from Future Settlement Funding Corporation and $1,000 from Interim Settlement Funding Corporation in exchange for an agreement to repay the advances, with interest, out of the proceeds of her lawsuit against State Farm. The court struck down the agreements, finding them in violation of the common law ban on maintenance (where a third-party with no bona fide interest in the case assists a litigant in bringing an action) and champtery (a type of maintenance where a third-party seeks to profit from litigation proceeds). Specifically, the court stated that such cash advances served to “prolong litigation and reduce settlement incentives.”

Following the Rancman decision, the Ohio legislature adopted a statute in 2008 legalizing the use of non-recourse loans to fund litigation. The statute set forth certain contractual requirements for the loans, such as mandatory disclosures and the itemization of fees.

Impact of Consumer Litigation Finance

Dr. Xiao examined the resolution history of medical negligence cases filed in Ohio since 1991 to determine how Ohio’s ban and subsequent legalization of third-party finance impacted settlement values. According to the study, medical malpractice plaintiffs in Ohio saw a 13.3 percent increase in their overall payout after the 2008 legalization of consumer litigation finance by the Ohio General Assembly. In contrast, settlement payments had dropped by 38 percent and cases resolved 2.4 times faster in the period after the Rancman decision and before the passage of the 2008 statute. As is evident from the study, litigation financing can have a distinct impact on settlement values and the length of litigation.

Dr. Xiao’s study compared the Ohio results with other states in a “synthetic control group” that accounted for various tort reform measures taken by other states. In total, 17 states have addressed consumer litigation funding either through court ruling or legislative action. In Texas, for example, the courts have issued rulings that treat consumer litigation finance not as a loan but rather as an investment, and have upheld the practice’s legality. Similar to the Ohio bill, New York and New Jersey have introduced similar pieces of legislation that seek to legalize and regulate the practice. Additionally, Michigan has already legalized litigation financing via statute. By contrast, the Pennsylvania Superior Court held in WFIC, LCC v. Labarre that consumer litigation finance agreements are void and therefore unenforceable as violations of the common law doctrines of champtery and maintenance.

As more and more states confront the growing consumer litigation finance industry, the trend suggests that if the issue is first addressed by the courts, the practice will be determined to be illegal and interpreted as an attempt by non-interested parties to profit from someone else’s injury. However, if the issue is first addressed legislatively, there is a higher likelihood that consumer litigation finance will be legalized and regulated. The data indicates that once legalized, health care providers involved in the tort system can expect higher settlement values and lengthier phases of litigation in jurisdictions that allow consumer litigation financing. Risk managers and insurers should take this trend into account when evaluating cases and preparing for trial or settlement. Additionally, attorneys should investigate whether a plaintiff has applied for or received a cash advance on their claim during the discovery process. Obtaining this information early in the life of a case can help health care providers and insurers appropriately tailor their resolution strategy in the face of settlement or trial.

Disclaimer: This update is intended to educate generally on certain issues and is not intended to provide legal or professional advice. The information and opinions expressed in this document are solely those of the authors and do not necessarily represent the views or opinions of any current or former clients of Segal McCambridge Singer & Mahoney, Ltd.

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