“What’s the hardest thing about your practice?”
A fellow attorney asked me that a couple weeks ago over lunch. I had to think about it for a few minutes, and the answer that I finally settled on really surprised me. You might think that a civil litigator’s biggest struggle might involve the philosophy of the law, client communication, ethics, negotiating skills, or some other nebulous and over-arching concept. But consistently, the hardest thing about my practice is much more mundane than that; it’s money.
As a litigator practicing mostly personal injury, cash is an ongoing thorn in my side for two reasons. First, litigation is spectacularly expensive. You’re paying filing fees, court reporters, document review staff, expert witnesses, couriers, postage, copying costs, and a host of other costs. It’s not at all uncommon to see litigation expenses for a single trial climb into the tens of thousands of dollars.
The second, and more troubling, reason is that many clients come to me in a financially difficult position. Think about it; the person in my office, having just been involved in an accident, is some combination of the following: (i) without a car, (ii) injured, (iii) in urgent need of expensive medical care, (iv) unable to work, (v) unable to care for his or her family, and (vi) helplessly watching the medical bills pile up. When this happens, the client is in serious financial trouble; expenses are significantly higher than normal, and cash flow is substantially lower.
So what can we do about the need for money in situations like these? One option is what we refer to as “pre-settlement financing.”
What’s pre-settlement financing?
The idea here is that you have two involved parties; a debtor (either the client borrowing living expenses or the attorney borrowing litigation expenses) and a creditor. The creditor looks at the facts of the case and makes an underwriting determination as to the odds of success under the circumstances. If the odds of success are high, the creditor agrees to loan money to the debtor and claim what amounts to a lien against the plaintiff’s recovery down the road (basically, the plaintiff’s recovery is the collateral). When the plaintiff gets his or her settlement or judgment, he or she pays the loan back to the creditor along with any interest that may apply. Let’s tease this out by looking at a couple of examples.
Example 1: The Attorney
Dexter is a plaintiff’s attorney running a one-man shop. His resources are limited and his operating account doesn’t have enough funds to front the expenses for a major lawsuit. Dexter is approached by Minerva, who has suffered devastating injuries after being struck by a tractor-trailer. Since the truck driver’s insurance is denying liability, Dexter is forced to file a lawsuit in order to recover. In order to prove liability, Dexter’s going to have to conduct depositions of all parties involved, as well as obtaining expert testimony from accident reconstructionists, mechanical engineers, and all of Minerva’s treating physicians. Dexter’s conservative cost estimate is $25,000.
Because Dexter’s operating account is lighter than that, he seeks out a lender offering pre-settlement financing and inquires about the possibility of borrowing the money against his contingent fee in Minerva’s recovery. The lender vets the claim, determines it to be meritorious, and loans Dexter the money. At trial, Dexter secures a nice judgment for Minerva, plus costs and expenses. He pays the lender back and everyone’s happy.
Example 2: The Client
Same example as before, except from Minerva’s perspective this time. Minerva’s badly hurt and has to miss six months of work, during which time she racks up $250,000 in medical bills. Her medical providers are hounding her and threatening to send her accounts to collections, and Minerva can’t pay anything down because she can’t work. On top of that, she still has her regular living expenses to worry about.
With Dexter’s help, Minerva seeks out a reputable lender and applies for pre-settlement funding. Like before, the lender vets the claim, determines the odds of recovery to be high, and agrees to loan Minerva $15,000 for living expenses and to keep the debt collectors at bay until the trial is over. At trial, the jury awards Minerva $500,000. She pays back the $15,000 plus interest, and walks away with a nice win.
Is pre-settlement financing legal in North Carolina?
The short answer is yes, but the analysis gets pretty hairy and differs depending on what type of financing you’re talking about. So let’s talk about it!
Since the bigger policy interest is the protection of injured consumers, attorney financing really isn’t regulated as heavily here in North Carolina. As long as the agreement is legal (see more about this below), lawyers are permitted to enter into litigation financing agreements. Keep in mind that the debtor is the attorney or law firm, not the client, in these situations.
Most of the guidance in this type of financing comes from the North Carolina State Bar, which applies and enforces the Rules of Professional Conduct for attorneys in our state. 2006 Formal Ethics Opinion (FEO) 12 does a great job of breaking out what attorneys can and can’t do with regard to securing pre-settlement financing:
1. Lawyers can enter into pre-settlement financing agreements under the appropriate conditions;
2. Lawyers cannot put up a client’s contingent recovery as collateral, though it’s okay to put up the lawyer’s share of said recovery;
3. Lawyers can put up law firm assets as collateral, but they cannot share protected confidential information about clients in the process of doing so, unless any affected clients give informed consent beforehand;
4. Lawyers can pass on the expense of obtaining financing to the client, but only if (i) the client gives informed written consent beforehand, (ii) the expenses are not clearly excessive under the circumstances, and (iii) the financed funds are only used to pay for that particular client’s case.
Fairly straightforward. The more complicated scenario arises when the client wants to borrow money.
There are two distinct sources of law that govern a person’s ability to borrow against a civil recovery, a lender’s ability to loan against said recovery, and a lawyer’s ability to refer clients to said lenders. Those sources are (i) the State Bar’s Rules of Professional Conduct, and (ii) North Carolina law. We’ll cover each of these in turn.
The North Carolina State Bar
It’s important to remember that the State Bar doesn’t offer opinions on the legality of any given topic. The only guidance the Bar gives is in relation to whether the conduct is ethical. With that in mind, the State Bar has published two Formal Ethics Opinion pertaining to injured clients borrowing money against their future recovery.
2000 FEO 4 pertains to lawyers acknowledging a finance company’s interest in a client’s recovery. This means that the client enters into a financing agreement, and the lender sends a copy of its claimed lien to the lawyer for the lawyer to acknowledge by signing. The effect of the lawyer’s signature is that he or she recognizes the lien as valid and agrees to reimburse the lender when the settlement or judgment check comes in. The State Bar allows lawyers to do this, provided that the lawyer determine the agreement to be legal in his or her best judgment, and subject to the lawyer’s pre-existing ethical duties to the client. Moreover, if the attorney determines the lien to be valid and enforceable, and if the client acknowledges the debt, the lawyer is obligated to disburse settlement funds to the lender even if the client instructs him or her not to do so. There are some specific rules about what the lawyer’s acknowledgement has to include, but I don’t see the need to bore you with the minutia here.
2006 FEO 2 permits lawyers to actually refer clients to specific lenders, provided that (i) the lawyer is satisfied that the agreement is legal, (ii) the lawyer receives no compensation or other consideration as the result of the agreement, and (iii) the lawyer believes the referral to be in the client’s best interests. Since the State Bar won’t settle the first element – that of legality – we have to turn to our own analysis of North Carolina law in order to figure out what the standard is.
North Carolina Law
Legal precedent pertaining to pre-settlement financing in North Carolina is actually pretty scant at this point. From a statutory perspective, we’ve got standard consumer protection legislation on the books; Unfair and Deceptive Trade Practices, the Consumer Finance Act, et cetera. In terms of case law, the landmark case is Charlotte-Mecklenburg Hosp. v. First Georgia Insurance Co., 340 N.C. 88, 455 S.E.2d 655 (1995), wherein the North Carolina Supreme Court basically green-lit these agreements provided that the client assign the lender his or her interest in the proceeds of the claim and not the claim itself.
But the plot didn’t really thicken until thirteen years later, when the North Carolina Court of Appeals handed down its opinion in Odell v. Legal Bucks, LLC, 665 S.E.2d 767 (N.C.App., 2008). Legal Bucks is the most thorough, thoughtful, and comprehensive judicial view of pre-settlement funding that we have to date, and it’s more than worth spending some time on.
In Legal Bucks, Nancy Odell took out a high-interest pre-settlement loan of $3,000 from Legal Bucks to cover living expenses during the pendency of her claim. After recovering $18,000 through settlement, Odell discovered that the terms of her financing agreement required her to pay back $9,582; more than triple the loaned amount and more than half of her recovery. Odell then sued Legal Bucks, alleging that the financing agreement was illegal and unenforceable because it violated North Carolina’s laws against (i) illegal gaming contracts, (ii) champerty and maintenance, (iii) usury, (iv) illegal consumer finance practices, and (v) unfair and deceptive trade practices.
Illegal gaming contracts. Odell first claimed that the agreement was null because it constituted a “bet” and a “wager” in violation of N.C.G.S. § 16-1, which declares gaming and betting contracts to be unenforceable. The Court of Appeals determined that the contract wasn’t a “bet” because a bet has to have a winner and a loser; since the contract contemplated that both parties would benefit, the “bet” argument was out. The Court then held that a “wager” requires that neither party have an independent, vested interest in the “contingent event at issue.” Because Odell obviously had a very direct interest in the outcome, the agreement couldn’t be wager, either. Because the contract wasn’t a bet or a wager, the Court said “no” on illegal gaming contracts under § 16-1.
Champerty and maintenance. Odell then turned to the argument that the agreement was void because it promoted champerty and maintenance. Without getting into the guts of what these two ancient legal doctrines are, suffice it to say that champerty exists (i) when an otherwise uninterested party inserts itself into ongoing litigation by paying the up-front expenses in exchange for control over the manner in which the litigation is handled, and (ii) where the interference is “clearly officious” and for the purpose of “stirring up strife and continuing litigation.”
The issue of champerty ended up being the fulcrum on which Charlotte-Mecklenburg was decided. What the Supreme Court landed on in that case was that it’s permissible for a party to assign away the proceeds of his or her claim, provided that the claim itself remain undisturbed. In other words, lenders may loan money against the funds that the plaintiff anticipates receiving upon settlement or judgment, but the lender may not loan said money on the condition that it be allowed to assert control over the plaintiff’s claim.
The agreement between Odell and Legal Bucks stated that Odell “unconditionally and irrevocably transfers and conveys to Legal Bucks all of [Odell’s] control, title and interest in the first monies paid … [emphasis added].” Because the agreement clearly attached to the proceeds of the claim, and not the claim itself, the Court of Appeals also nixed Plaintiff’s champerty argument.
It should be noted, however, that the Court issued a stern warning to lenders and made its concerns clear that lender involvement could encourage litigation, which would (i) violate North Carolina’s strong public policy in favor of claim settlement and (ii) indirectly allow lenders to assert a degree of control over whether or not a claim goes to trial. If that were to happen, a pre-settlement financing agreement would be champertous and unenforceable; however, the agreement at issue in Legal Bucks didn’t quite reach that threshold. That was because Odell offered no evidence that Legal Bucks’s involvement was for the purpose of stirring up “strife and continuing litigation.” In addition, the agreement clearly stated that Legal Bucks was to have “no control, input, influence, right or involvement of any kind” in the prosecution of Odell’s claim. This more than anything seems to have influenced the Court’s decision that the agreement didn’t constitute champerty.
Usury. Odell’s next argument was that the agreement illegally constituted usury. Usury basically exists where one party intentionally makes a loan or forbearance to another party, said loan or forbearance being subject to illegally high interest rates. Under Chapter 24 of the North Carolina General Statutes, pre-settlement agreements constitute “advances,” which are explicitly subject to our State’s usury laws. Legal Bucks never contested that the interest rate was significantly in excess of what was allowed under Chapter 24, so the analysis turned to whether the advance was made “intentionally.”
The Court found that “intent,” for usury purposes, doesn’t necessarily mean a malicious, criminal intent to overcharge unsuspecting consumers; Odell just had to show that Legal Bucks entered into the agreement intentionally, and that the agreement required the debtor to pay unlawfully high interest. Since both of these elements were met, the Court agreed with Odell that the agreement was illegally usurious and therefore unenforceable.
Consumer Finance Act. North Carolina’s Consumer Finance Act is pretty straightforward; it requires that lenders can’t loan under Chapter 24 without getting a license first from the Commissioner of Banks. Since Legal Bucks was irrefutably unlicensed and it was already established that it was in violation of Chapter 24, the Court held that it was also in violation of the Consumer Finance Act. Easy-peasy.
Unfair and Deceptive Trade Practices. Odell’s final argument was that the agreement constituted an Unfair and Deceptive Trade Practice (or “UDTP”), in violation of North Carolina General Statutes Chapter 75. A UDTP exists where a defendant (i) commits an unfair and deceptive act or practice, (ii) the action in question was in or affecting commerce, and (iii) the act proximately caused injury to the plaintiff. It’s certainly worth mentioning that under § 75-1.1, a violation of Chapter 75 entitles the plaintiff to treble (triple) damages. Not really applicable here since Odell was using Chapter 75 as a shield (protecting her from having to pay Legal Bucks) rather than a sword (trying to get money out of a defendant), but the specter of treble damages can be a huge stick to use on a flippant prospective defendant.
The Court disagreed with Odell’s initial contention that a violation of Chapter 24 constitutes a per se (automatic) violation of Chapter 75. It’s worth noting that violations of many statutes do constitute UDTPs, but in this particular case the Court didn’t agree that the agreement was a UDTP solely by virtue of the Chapter 24 violation. Chapter 24 does get close enough that the statute itself dictates high-interest home loans to be UDTPs, but it never says anything about illegally high-interest pre-settlement financing agreements. That would have made the analysis a lot easier, but there you go.
Legal Bucks argued that the agreement couldn’t be deceptive because it thoroughly set forth all of its terms, in writing, within the body of the contract. The Court disagreed, as prior North Carolina case law dictates that (i) the act in question doesn’t have to actually be deceptive if it has the capacity to deceive, and (ii) the act in question does have the capacity to deceive in situations where an agreement that violates the Consumer Finance Act fails to state that it does so. As a result, the agreement was held to be unfair and deceptive, and Legal Bucks was therefore held to be in violation of Chapter 75.
In summary, the Court of Appeals held that the Legal Bucks agreement wasn’t an illegal gaming contract and that it wasn’t champertous (though it was very, very close), but that it was usurious and a violation of Chapters 24 (Consumer Finance) and 75 (Unfair and Deceptive Trade Practice). Since the contract was unenforceable, Odell didn't have to pay anything back to Legal Bucks.
Now, does this mean that all pre-settlement financing agreements are illegal in North Carolina? No. It means that lenders need to learn from Legal Bucks’s mistakes. They need to stay abreast of permissible interest rates, get licensed to loan money, and make sure that all of their terms are very clearly laid out in their agreements. North Carolina courts haven’t come right out and said that these agreements won’t fly, but they sure don’t seem to be big fans of them, either. You can probably bet that a presiding judge will take advantage of any opportunity to void one of these contracts.
What are the pros and cons of pre-settlement financing?
Pre-settlement financing can have some very strong, and very obvious, benefits. The biggest one is that the client can get some much-needed relief, allowing him or her to pay living expenses and medical bills while waiting for the check to come in. Another biggie is that the client can often use the financed funds to pay for medical care that might otherwise have been prohibitively expensive. This helps the client get healthier faster, but it also does wonders for the client’s case for recovery. Finally, from the lawyer’s perspective, cash in hand can enable the attorney to hire the best possible experts, explore opportunities for recovery as thoroughly as possible, and otherwise prosecute the case with maximum effectiveness.
Clients should also be cautioned, however, about the potential drawbacks to accepting a pre-settlement loan. Even under the best terms, the loan repayment is going to cut into the client’s recovery. It’s all too common that these settlement amounts are treated as a windfall (statistics show that recipients of settlements tend to fritter their money away with the same speed and recklessness as lottery winners), and if the money isn’t budgeted properly, it’s very easy for the client to end up netting a loss. For the same reason, the client should keep a very close eye on the interest rates contemplated by the agreement; as should lenders, by the way, since loaning at a usurious interest rate to a shrewd plaintiff is likely to end up meaning free money for the debtor. Finally, the client should read the agreement carefully and have his or her attorney do the same. This is the case with any contract, but particularly so in the case of pre-settlement financing agreements.
Pre-settlement financing can be a serious benefit to injured claimants under the right set of circumstances. It’s legal and ethical in North Carolina, provided that all of the conditions discussed above are met, it has the potential to help both attorneys and their clients, and in extreme cases, it could even save lives. As long as you’re making sure to use your common sense, read the fine print, and have your attorney do the same, pre-settlement financing could make a huge and positive difference in your case, your health, and your financial well-being.