Settlement Loans and the Doctrine of Champerty

Settlement loans are sometimes called “lawsuit loans” by the public.  Unlike a real “loan”, settlement loans are typically structured as an assignment of the future proceeds of a successful lawsuit, if any.  Over the years, transactions which involve third parties’ entitlement to the lawsuits of others have been treated in various ways in a wide range of jurisdictions.  This  post will briefly discuss the doctrine of Champerty and its relationship to the modern settlement loan industry.

According to Black’s Law Dictionary, the doctrine of Champerty is:

A bargain made by a stranger with one of the parties to a suit, by which such third person undertakes to carry on the litigation at his own cost and risk, in consideration of receiving, if he wins the suit, a part of the land or other subject sought to be recovered by the action.

The Emergence of Champerty

There has always been and always will be people who are willing to take advantage of others.  Attorneys, unfortunately are no different.  Not surprisingly then, many attorneys historically utilized their leverage to take larger and larger stakes in the outcomes of legal proceedings.  Maximizing compensation was the goal but this practice did not sit well with others resulting in the legal doctrine of Champerty.

The concept of Champerty eventually evolved as a “term of art” describing the situation where an entity would purchase an interest in a litigated claim.  The transaction was that the purchaser paid the “pre-settlement” expenses but was also entitled to share the benefits if the lawsuit was successful.

settlement loans and champerty

Settlement Loans and Champerty

Historically, the most important litigation in the era of Champerty involved land.  Entities which purchased a lawsuit involving real estate could acquire a partial interest in land.  At the time this was deemed a windfall because the lawsuit’s purchase price usually fell far below the market price of the land at issue.  In response, and since almost all of these arrangements involved attorneys, jurisdictions prohibited the practice altogether.

Champerty Evolution

The environment in which we live changed dramatically in the last hundred and fifty years in terms of population growth and technological innovation.  And while negligence actions were available to plaintiffs under common law, a rapid increase in the amount of personal injury accidents saw a rise in actionable claims in the court system.  Because many potential litigants could not afford costly legal fees, local bar associations allowed for the “ethical” charging of contingency fees for personal injury plaintiffs.

However, local ethics rules usually set forth a maximum for these types of fee arrangements.  Undoubtedly, the ability of plaintiff attorneys to turn a profit for their services (as they should) was a primary concern.  The maximum must therefore take into consideration the attorney’s ability to effectively pursue the case, the client’s interests, and the effect of unsuccessful outcomes.

Over time, legal landscape involved more diverse actions than just lawsuits involving land.  Presently, there are legal actions in literally dozens of areas, each with their own nuances and procedures.  The complexity of contingency fee arrangements has also evolved.

Settlement Loan and Champerty

Eventually, ancillary businesses began to fill litigants’ other needs.  One example is the need for liquidity for plaintiffs involved in personal injury actions while they wait for their lawsuit to be resolved.  Up until the emergence of the settlement loan business, most attempts to collect on the future proceeds of lawsuits involved attorneys.  When private parties began offering advances on lawsuits, the doctrine of Champerty showed its presence once again.

In a landmark case in Ohio, (Rancman v. Interim Settlement Funding Corp., 789 N.E.2d 217,219 (Ohio 2003)  the court declared settlement loan transactions void citing the doctrine of champerty.  Since that time, settlement loan outfits made significant steps to differentiate their contractual terms from traditional champerty provisions.

One such step is the wording used in settlement loan contracts.  Although lawsuit advances are sometimes termed “lawsuit loans”, the transaction is really NOT a loan at all.  “Loaning” money to another implies repayment at a future date.  Settlement “loan” contracts however, are usually deemed an assignment or sale of the future proceeds of the lawsuit, if any.  In other words, if the case does not resolve favorably for the plaintiff, there is no repayment.

The transactions are thus “non-recourse” and means that only if a condition is met (the successful lawsuit), repayment is necessary.  The design was originally intended for these types of transactions to fall outside of state usury laws.  However, differentiating settlement loan contracts from champerty was not persuasive to the Court in 2003, possibly because the repayment terms exceeded 180% per year.

Lawsuit “lending” has since been dealt with Ohio Lawsuit Funding Regulations setting forth certain provisions designed to protect the public.

The purpose of this article is to provide background regarding the legal doctrine of champerty as it pertains to settlement loans.  It also illustrates the reality facing pre-settlement funding firms – that is, their contracts may be voided at any given time by courts with varying interpretations of legal doctrine.

Thank you for your interest in the settlement loans business.