Litigation Finance Agreements — Champerty, Usury, or OK?

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By Lazar Emanuel
[Originally published in NYPRR June 2005]


In a 2005 opinion, Judge Ira B. Warshawsky, Supreme Court, Nassau County, held that an advance made to a personal injury plaintiff by a litigation finance company called LawCash was not champertous but did violate the usury laws. [Echeverria v. Estate of Lindner, Sup. Ct. Nassau Cty. No. 018666/2002 (NYLJ, April 1, 2005).] The opinion is certain to have a dampening effect on the relatively new business of litigation finance.

The prohibition against champerty by a lawyer is contained in Section 488 of the Judiciary Law.

An attorney or counselor shall not:

1. Directly or indirectly, buy, take an assignment of, or be in any manner interested in buying or taking an assignment of, a bond, promissory note, bill of exchange, book debt or other thing in action with the intent and for the purpose of bringing an action thereon.

Violation of the statute constitutes a misdemeanor. Section 489 of the Judiciary Law extends the prohibition against champerty to corporations and collection agencies.

As defined by Black’s Law Dictionary, champerty is “a bargain between a stranger and a party to a law suit in which the stranger pursues the party’s claim in consideration of receiving part of any judgment proceeds.” Champerty is a form of maintenance, which is defined as any unauthorized monetary assistance in support of a party in litigation.

In recent years, an entire industry has developed to make money available to litigants, especially in personal injury actions. The companies involved in this new industry call themselves litigation finance companies.

In a typical case, the injured client needs money, pending the outcome of the litigation, to pay for hospital and medical services or for personal needs such as mortgage payments and other fixed obligations. The litigation finance company assesses the potential for recovery and advances or “lends” money to the client at an interest rate which is virtually certain to exceed the usury limits. The advance or “loan” is repaid from the proceeds of the judgment, if there is any recovery. If there is no recovery, the company does not collect anything.

A search of the Internet reveals many entries for litigation finance companies. Obviously, the industry is thriving and growing. A review of one website shows that the company actively solicits referrals from lawyers.

We offer our service to your clients as a non-recourse advance with NO upfront fees. We want to help you help your client to stay in the case to get the settlement or judgment you and your client deserve.

The lawyer is asked to complete an application and a questionnaire. The application form is marked “Privileged and Confidential” and says “Please note that this information is for case evaluation purposes only, and will not be shared with your client.”

NYSBA Opinions 666 & 769

Transactions between lawyers and litigation finance companies were the subject of Opinion 769 of the Committee on Professional Ethics of the State Bar (11/4/03). The Committee asked:

May an attorney who represents a client in a personal injury matter on a contingency basis also represent the client in a transaction with a litigation finance company that advances the client cash in return for a portion of the eventual settlement or judgment received by the client? If so, may the attorney charge the client a fee for this separate representation in addition to the contingent fee already agreed for the underlying representation?

In a previous opinion [NYS 666 (1994)], the Committee had advised that a lawyer could properly refer his client to a litigation finance company because he would not be paying or advancing the funds himself. However, the Committee warned of the dangers of compromising client confidentiality by disclosing information to the finance company and pointed out that a lawyer could not own an interest in the lender and could not receive a fee or other compensation from the lender for the referral.

Significantly, the Committee did not express any opinion as to the legality of the transaction between client and finance company, but warned that if it was in fact illegal, it would be unethical for the lawyer to make the referral [citing DR 1-102(A)(3) and DR 7-102(A)(7) and (8)].

In the more recent Opinion 769, the Committee recognized that there has been a continued increase in litigation financing and that it was necessary to revisit the subject of transactions between lawyer and lender. Once again, the Committee wondered whether the transactions were legal:

We start by pointing out that whether such a transaction is legal requires an analysis of various court rules, statutes and cases. In this connection we call the bar’s attention to New York’s longstanding rules prohibiting ‘maintenance’ [citing various statutes, including Judiciary Law §§488 and 489, supra].

In Opinion 769, the Committee advised lawyers as follows:

1. The Code prohibits a lawyer from owning any interest in the company providing the financing.

2. The lawyer may not accept any fee or compensation from the finance company.

3. The lawyer may not permit the finance company to affect the exercise of the lawyer’s independent professional judgment on behalf of the client.

4. The lawyer may not undertake to represent the client in the transaction with the finance company if any circumstance exists which would affect the exercise of his independent professional judgment on behalf of the client, without first satisfying the disclosure and consent requirements of DR 5-101(A).

5. Because the finance company will require information about the underlying claim before deciding to make funds available, “the lawyer must be careful not to compromise confidentiality in disclosing information…without the informed consent of the client. [See, DR 4-101(B), (C)(1).] The lawyer should advise the client that disclosures of confidential information…might compromise the attorney client privilege.”

6. In representing the client in the transaction with the finance company, the lawyer should consider whether this is a new matter requiring the lawyer to file a new or amended letter of engagement.

7. The lawyer should guard against the possibility that an unsophisticated client will conclude that the lawyer is endorsing the transaction with the finance company. “To address this possibility, the lawyer must either disclaim such responsibility…or advise the client of the costs and benefits of the proposed transaction, as well as possible alternative courses of action. We note that such arrangements may carry extremely high rates of interest. Plainly, such lenders might be in a position to take unfair advantage of a client in dire need of cash.”

8. If the original contingent fee arrangement with the client in the underlying litigation did not contemplate the proposed transaction with the finance company, the lawyer may charge a separate fee for the transaction. The fee must not be excessive and must not result in compensation exceeding the maximum fees allowable in personal injury cases by the Appellate Division Rules.

Echeverria Decision

The Echeverria decision by Judge Warshawsky is the first case inquiring extensively into the issues created by the practices of litigation finance companies. Plaintiff Echeverria, an undocumented day laborer, sued several defendants for extensive injuries resulting from a fall from a scaffold. Two of the defendants defaulted. The other defendants settled. Judge Warshawsky was appointed to conduct an inquest into damages against the defaulting defendants.

Judge Warshawsky departed from his assignment to address two different issues sua sponte. The first issue (the only one which concerns us here) involved cash advances to Echeverria from a litigation finance company called LawCash. On Nov. 25, 2003, LawCash “loaned, ‘funded’ or advanced” the sum of $25,000 to Echeverria “at an obviously usurious rate of 3.85 percent, per month, compounded monthly.” By Oct. 31, 2004, the company’s charges amounted to $13,916.45, and were increasing at a daily rate of $48.94.

Judge Warshawsky asked first whether the transaction between Echeverria and LawCash constituted champerty. Characterizing the transaction as the purchase of a chose in action, Judge Warshawsky looked to the purpose of the transaction. “In order to constitute champerty in New York law, the primary purpose of the purchase must be to bring suit or proceed with action upon the claim they received.” [Citing Knobel v. Estate of Hoffman, 432 N.Y.S.2d 66 (N.Y. Sup. Ct., 1980).]

In making the Echeverria loan, the intent by LawCash was not to bring an action to enforce its claim against a judgment by Echeverria, but “simply to profit from its loan or investment.” The agreement between Echeverria and LawCash provided that LawCash would recover its principal and interest only from a judgment in favor of Echeverria. If there were no judgment, LawCash would recover nothing. LawCash was not acquiring Echeverria’s right to sue. Echeverria had commenced the lawsuit before the advance from LawCash and remained in full control of the lawsuit.

“If LawCash purchased Mr. Echeverria’s recovery from this lawsuit with the intent of bringing a new lawsuit in order to collect that money from Mr. Echeverria, or the present defendants…then we would have a champertous agreement, but this does not seem to be the intent of LawCash.”

Judge Warshawsky recognized that other courts had reached a different decision on the issue of champerty. In Rancman v. Interim Settlement Funding Corp., 99 Ohio St. 3d 121 (Ohio 2003), the Supreme Court of Ohio was faced with facts very similar to those in Echeverria. Plaintiff Rancman was injured in an auto accident and received an advance of $6,000 from defendant finance company. She agreed to repay the company a total of $16,800 if she recovered a judgment within twelve months; if she failed to recover, the finance company would receive nothing. The lower Ohio courts declared the Rancman transaction void as a loan which the finance company did not have a valid license to make. On appeal to the Supreme Court, Rancman argued that the transaction was a loan without risk and therefore usurious; the finance company argued that the transaction was not a loan but an investment. The Ohio Supreme Court avoided that issue and decided instead that the transaction was void as champertous.

Judge Warshawsky acknowledged that the Ohio court had correctly interpreted the law of Ohio, which had consistently held that the assignment of rights in a lawsuit can be void as champerty, but he argued that under New York law “these assignments are allowed as long as the primary purpose and intent of the assignment was for some other reason than bringing suit on that assignment…The Court is comfortable finding that the instant agreement is not Champerty.”

However, Judge Warshawsky recognized that the development of litigation finance companies required the courts and the legislature to take a new look at the old law of Champerty:

…The scope of Champerty law has been expanded primarily due to public policy against champertous agreements. It is important to discuss these policy arguments…and while some of these policy arguments may favor the continued functioning of these funding institutions, others do not, and this Court would like to think that the legislature will look further into these counter balancing policy considerations in an effort to decide if the agreement before this Court is one that should be considered Champertous, as it was under the Ohio law. This Court does not disagree with the policy reasoning behind the Rancman decision, rather the Court tends to agree with the policy considerations adopted by that Court; however New York law prohibits voiding the agreement here as champerty.

Judge Warshawsky pointed out that one of the reasons for voiding these agreements is to prevent non-interested third parties from taking part in litigation. As noted by the Ohio court in Rancman, the doctrine of Champerty was developed to prevent third parties from “stirring up strife and contention by vexations and speculative litigation which would disturb the peace of society, lead to corrupt practices, and prevent remedial processes of law.” [Citing 14 Corpus Juris Secundum (1991), §3.]

Another reason is the effect these agreements have on the settlement of cases. They may lead to premature agreements, or prevent an agreement from occurring at all. The plaintiff will always be mindful of the rapidly increasing interest burden; this will inevitably affect his response to settlement negotiations.

On the other hand, the agreements do have an upside. They allow clients with meritorious claims to pursue lawsuits they would not have the resources to bring. They provide litigants with coverage for hospital and medical expenses and for living expenses. At the same time, as people become more aware that these companies exist, more law suits may be filed. People will view these agreements as “playing with the house’s money.”

In assessing the pros and cons of these transactions, Judge Warshawsky referred to an agreement which had been reached by a litigation finance company and New York’s Attorney General in June 2004. The agreement provided for a five-day right to cancel; a notarized statement from the client’s lawyer that the contract had been explained to the client; and full disclosure of all the facts, including: the total amount of the advance, all associated fees, the rate of interest; and whether and at what intervals the interest was compounded. Judge Warshawsky’s comments on the AG’s agreement reflect his regret that the agreement did not go further:

While the Attorney General seems to have given these types of funding institutions his blessing through signing an agreement with them, the Court feels that the effects of these types of institutions on the legal system and the judiciary need to be examined in further detail in order to determine whether this type of business practice is more of a benefit or detriment to society as a whole. …

If the Attorney General was to formally legalize these arrangements by an “opinion letter” rather than merely allow them to operate pursuant to an “agreement” which makes their operation safer to the consumer that would be appreciated by the Court.

Transaction Is Usurious Loan

Judge Warshawsky proceeded to ask two questions:

1. Was the transaction between Echeverria and LawCash a loan or an investment?

2. Was the transaction usurious?

The answer to the first question was clear. Echeverria’s claim was based upon his fall from a scaffold and the failure of the defendants to provide worker’s compensation coverage. Judge Warshawsky characterized the claim as “a strict labor law case where the plaintiff is almost guaranteed to recover.”

Under these circumstances, he found the enormous profits that would be made by LawCash from “the rapidly accruing, extremely high interest rates” it was charging to be troubling. This led him to characterize the transaction not as an investment but a simple loan.

…it is ludicrous to consider this transaction anything else but a loan…Is it a gamble to loan/invest money to a plaintiff in a Labor Law action where there is strict liability? I think not…it is not a gamble, but a “sure thing,” therefore, it is a loan, not an investment with great risk….

The answer to the second question followed with equal clarity:

The Court finds that LawCash is lending money at usurious rates….the Court awards pre­judgment interest at 16 percent per annum…The clerk shall calculate the interest on $25,000 at 16 percent per annum from the date of the loan.

Judge Warshawsky’s instruction to the clerk was a direction to cap the interest at New York’s legal limit. The judge ended his discussion with an invitation to the legislature:

I have pontificated enough on a case that was merely sent to me for quick “inquest.” The judiciary cannot nor should it legislate. That is up to another branch of our government, and one can only hope they will address the multi-faceted issues I have raised in the near future.

Lazar Emanuel is the Publisher of NYPRR.

DISCLAIMER: This article provides general coverage of its subject area and is presented to the reader for informational purposes only with the understanding that the laws governing legal ethics and professional responsibility are always changing. The information in this article is not a substitute for legal advice and may not be suitable in a particular situation. Consult your attorney for legal advice. New York Legal Ethics Reporter provides this article with the understanding that neither New York Legal Ethics Reporter LLC, nor Frankfurt Kurnit Klein & Selz, nor Hofstra University, nor their representatives, nor any of the authors are engaged herein in rendering legal advice. New York Legal Ethics Reporter LLC, Frankfurt Kurnit Klein & Selz, Hofstra University, their representatives, and the authors shall not be liable for any damages resulting from any error, inaccuracy, or omission.

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