February 13, 2006
SubPrime Lending & Plaintiff's Attorneys
Posted by Christine Hurt

Calculator While we're talking subprime lending, here is an article from American Lawyer about plaintiff's attorneys who finance contingent fee cases by literally financing them.  Specifically, attorneys are project financing cases with loans that are nonrecourse to the attorney, just as project financing to an SPE is nonrecourse to the parent companies.  If the case is a winner, then the lender takes its money back with a return or may even just take a percentage of the attorney's fee.  If the case is a loser, then the attorney and the lender part ways.  Firms catering to this specific market have sprung up and offer loans at double-digit rates, somewhere between the cost of loans and the cost of venture capital.  Some of the firms profiled are run by attorneys, who evaluate each case or portfolio of cases much as an underwriter of risk would.  Some funds are financed by hedge funds.  (We could all become plaintiff's lawyers just by being investors!)

Established plaintiffs firms have the liquidity to subsidize cases with long time horizons (and their appeals), but other firms cannot, often financing cases out of their own pockets.  In some litigation, part of a defense tactic may be to drag out litigation until the plaintiff's attorney is out of money.  These firms may fulfill a valid purpose.  The creditor seems to share the risk of loss with the attorney, so the attorney won't be forced to declare bankruptcy or go out of business should the case tank.  (Remember Jan Schlichtmann in A Civil Action?)  I know, I know, I am a big skeptic of subprime lending, but this kind of project financing seems to make a lot of sense to me. 

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Comments (9)

1. Posted by Dale Wettlaufer on February 13, 2006 @ 17:54 | Permalink

Is it just me, or does it strike anyone else as self-serving when an attorney who doesn't like higher-risk (I.e. subprime) lending suddenly likes it when it serves to finance the plaintiff's bar? It strikes me so.


2. Posted by William Henderson on February 13, 2006 @ 18:45 | Permalink

Christine,

I too am impressed with these new financing mechanisms for the plaintiffs' bar. As noted in the Am Law article, it appears to be a good way to make sure that meritorious claims are actually paid out at close to their true value.

To my mind, however, it is unclear how these companies deal with the longstanding bar against fee splitting with nonlawyers (unless all principals are licensed lawyers, which I doubt). Sure, the deals are structured, at least superficially, like loans, but appears to be more like investment contracts in which finance companies share in fees.

And no, there is nothing self-serving in Christine's observations.


3. Posted by Christine on February 13, 2006 @ 19:37 | Permalink

Bill, I am also interested in the "splitting profits with a nonlawyer" rule, particularly with the loans that specifically are payable as a percentage of the lawyer's fee.

I believe that I could distinguish between loans between sophisticated and nonsophisticated parties; loans that bear an extremely high risk given the nonrecourse nature and loans that bear almost no risk; and loans with high social utility and loans with negative externalities. I don't see the negative externality with these loans. Lending firms presumably will not finance what they see as frivolous cases, cases with a low probability of payout.


4. Posted by William Henderson on February 14, 2006 @ 7:10 | Permalink

I agree that the loans appear to fill in an important void.

If you are looking into the fee splitting rule, make sure you look at DC Rule of Professional Conduct Rule 5.4, which loosens the fee-splitting with nonlawyer rule so that DC firms can have nonlawyer partner (i.e., lobbyists). The change took place in 2002. See "Inadmissible," National Law Journal, May 20, 2002.


5. Posted by Christine on February 14, 2006 @ 9:19 | Permalink

Bill, I remember when that rule was passed. Back when we were all going toward "multidisciplinary" firms. We were all going to work for Arthur Andersen. I wonder where that idea went?


6. Posted by Mike Collins on February 14, 2006 @ 11:38 | Permalink

Are there any ethical concerns in this type arrangement regarding the attorneys' loyalties? For instance, how do attorneys shield themselves from pressure from the lenders to obtain a return on their investment (winning a dollar amount)? This sort of split loyalty is most dangerous when settlement offers are on the table. A lender could pressure the attorney to take an offer that it views as its best outcome, when, in the absence of the loan, the attorney might hold out for a better deal for his client (especially when non-monetary considerations come into play). Does the attorney cave to the lender (a business decision that might make obtaining similar loans in the future easier) or keep his ethical obligation to his client to seek the client's best outcome?

The ultimate responsibility of a lawyer is to the client, not the lending firms. But when big third-party money is involved, I would imagine that moral dilemmas arise quite often.


7. Posted by Dale Wettlaufer on February 15, 2006 @ 5:52 | Permalink

I believe that I could distinguish between loans between sophisticated and nonsophisticated parties; loans that bear an extremely high risk given the nonrecourse nature and loans that bear almost no risk; and loans with high social utility and loans with negative externalities. I don't see the negative externality with these loans. Lending firms presumably will not finance what they see as frivolous cases, cases with a low probability of payout.

Sophistication of the borrower is the subprime yardstick? Who decides who is and who is not sophisticated? I know a lot of wealthy people who are less sophisticated than tradesmen I know and I would guess the supposedly less sophisticated person is far more likely to take out a subprime loan than the rich person.

As for recourse and non-recourse, there is lots of project debt outstanding trading right against treasuries. Recourse vs. non-recourse doesn't decide the level of risk. The collateral of the project, the certainty of cash flows, and other factors decide the rate in project finance.

By the way, credit card companies have no recourse on that debt. Is credit card issuer Metris suddenly wonderful because they have no security interest in their loans customers?

loans with high social utility and loans with negative externalities.

This cracks me up. This is what I am talking about -- lawyers thinking their interests have such high social utility with no externalities while other subprime finance has exactly the opposite. So it's a terrible outcome for a guy with horrible credit to borrow at an 18% APR to get a car to get to his job and a wonderful outcome when trial attorneys finance phony asbestos litigation? Please.

Lending firms presumably will not finance what they see as frivolous cases, cases with a low probability of payout.

You'd be surprised what high returns will incentivize.

There's no reason to believe high-rate project finance is all downy and socially productive while all other subprime finance is socially destructive and reprehensible. Perhaps attorneys on an attorney's blog would not see that, but if you put that in front of the rest of the country, I would think the contradiction would be clearly seen.


8. Posted by Christine on February 16, 2006 @ 15:06 | Permalink

We seem to be using the same term (non-recourse) to mean different things. These litigation loans are non-recourse to the attorney, meaning if the case tanks, then the lender has no default action against the attorney. The loans have "recourse" or are secured against the asset (the case). Credit cards, as you know, are not secured against specific property, but a credit card company does have a default action against a nonpaying credit card holder. Also, project debt (with recourse only to a project company) is risky at the beginning of a project, but once income streams are established, then that debt will be less risky and will be refininanced to have a lower interest rate, and may be traded on the capital markets.

You make a good point that some subprime lending may be very useful to the borrower.


9. Posted by Hamed Elbarki on April 21, 2008 @ 15:19 | Permalink

Very interesting information. Thanks for the American Lawyer article.

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