Everything You’ve Ever Wanted or Needed to Know About Consumer Legal Funding!
Legal funding was developed by legal experts as a cash flow solution for contingency fee attorneys and plaintiffs. Though the industry has grown tremendously in the past few decades, it’s still a relatively new field, so most people don’t know much about how it works and who would benefit from it.
In short, legal funding companies offer financing to attorneys and plaintiffs based on the value of future receivables. Legal funding is intended to be used by plaintiffs who are short on capital after experiencing physical or emotional trauma, or by attorneys who are lacking the financial capital necessary to adequately push business forward.
Quick Note: This guide is an educational resource that provides an overview of the legal finance space, including how it applies to both plaintiffs and attorneys.
- If you’re a plaintiff interested in learning about whether or not lawsuit funding is right for you, please read The Essential Guide to Plaintiff Lawsuit Funding.
- If you are an attorney looking to learn how legal funding can improve your law firm’s cash flow, please read The Essential Guide to Attorney Funding.
Hopefully, you don’t find yourself in either of the situations mentioned above — but if you do, it’s important for you to understand your options.
After you finish reading this guide, you’ll be able to answer the following questions:
- What is legal funding?
- How is legal funding different than a bank loan?
- What other types of financial options exist?
- When should I use legal funding?
- How does legal funding work?
- What does a legal funding application look like?
- What are the different types of legal funding?
- What are some real-world examples of legal funding?
- Without further ado, let’s look into the world of legal funding!
Let’s Start With A Definition
Stated simply, legal funding is an advance available to contingency fee attorneys and plaintiffs, which is calculated based on the anticipated legal fee or settlement reward of the party being funded.
Here’s the definition of legal funding provided by Wikipedia:
…the mechanism or process through which litigants (and even law firms) can finance their litigation or other legal costs through a third party funding company. These third party funding companies provide cash advance to litigants in exchange for a percentage share of the judgment or settlement.
When the definition mentions “third party funding company”, it is simply referring to the legal financing firm that advances funds to plaintiffs, attorneys, or both.
The definition above goes on to touch upon an important aspect of legal funding:
However, if the case proceeds to trial and the litigant loses, the third party funding company receives nothing and loses the money they have invested in the case.
When a legal funding company advances capital to someone whose lawsuit does not settle favorably, the funding company does not accept repayment of the advance. This type of advance is called “non-recourse”.
How Does Legal Funding Work?
Generally, legal funding works something like this:
A plaintiff’s legal funding advance is based on their award, or expected award, from a successful settlement, judgement, or verdict.
An attorney’s legal funding advance is based on their projected legal fee, which is typically 30% to 40% of the award that their plaintiff will receive, pending a favorable settlement, judgement, or verdict.
You can read a much more detailed description of the legal funding process below.
Different Names For The Same Thing
You may have also heard the terms “litigation financing”, “lawsuit lending”, “lawsuit loans”, and “settlement loans”. These are all different ways about talking about legal funding.
In this guidebook, we will mainly be talking about the two most common types of legal funding: pre settlement funding and post settlement funding. These types of funding are available to both attorneys and plaintiffs. In addition, at the end of this book, we will discuss two other funding options: voucher funding and attorney lines of credit. We’ll get to all of that a bit later, though.
Legal Funding Is NOT A LOAN!
Let me say it one more time because it’s that important:
Legal funding is an advance, NOT A LOAN!
Unlike a loan, legal funding doesn’t come with monthly payments, points, or upfront fees. Yes, there are fees associated with the advance (usually to cover the costs of underwriting), but you will never be asked to pay those fees upfront; typically, all costs will be paid when the advance is due for repayment.
Also, as we talked about above, legal funding is a non-recourse process. So plaintiffs and attorneys will not be asked to repay their advances if a case doesn’t settle favorably or if an obligor cannot pay the full award or fee amount.
Why not just go to the bank?
Though bank loans and lines of credit (LOCs) are the more common (and less expensive) options for those struggling with cash flow, attorneys and plaintiffs may find that dealing with the bank is not the easiest or most practical choice.
Banks usually require loan and LOC applicants to present non-liquid assets, such as bonds, stocks, and real estate. These assets, used as collateral, are used to guarantee that the applicant will have something of significant value with which to pay back the loan.
Some plaintiffs and attorneys may have no problem coming up with the necessary collateral to secure a loan, but others may find this difficult, or might not have the right type of collateral. For example, many attorneys rent offices or invest much of their capital into future cases. Banks do not accept rental spaces or future receivables as collateral.
Credit checks are another potential problem that plaintiffs and attorneys might face when applying for a bank loan or line of credit. Plaintiffs who recently lost jobs, had to leave work due to injury, or are covering other case-related expenses may have unbalanced credit scores that would be unacceptable on a loan application. Similarly, attorneys, who often finance their own business expenditures, may low credit scores because of work-related expenses.
While it is of course possible for a bank to approve an attorney’s or plaintiff’s loan application, and though banks typically have lower interest rates than alternative financing options, the difficult application process and monthly repayment requirement may deter some plaintiffs and attorneys from pursuing a bank loan or line of credit.
Consider These Financing Options First
Though legal funding can give you or your business a much needed boost, it shouldn’t be your first option. Before committing to the idea of a legal funding advance, try these options first.
If you’re a plaintiff:
- Apply for bank loans or lines of credit
- Ask friends and family for help
- Use savings account
- Borrow against your 401K
- Open credit cards
If you’re an attorney:
- Try to increase referral fees and referral traffic
- Expand local network
- Apply for small business loans
- Use credit cards and savings accounts
Legal funding companies risk losing their principal investments when they advance capital against cases that have not yet settled. Because there is no guarantee that they will make any money on these investments, legal funding companies charge a higher discount than other financial institutions.
However, if you have had trouble securing other means of financing and are in need of capital to support your law firm or solo practice, or to live your life more freely and comfortably while pursuing a lawsuit as a plaintiff, legal funding may be a good option for you.
When To Use Legal Funding
Litigation is an uncertain and notoriously lengthy process. A typical personal injury case, from filing to settlement distribution, has a two year life span; MDLs, class actions, and malpractice cases take even longer. Factor in processing paperwork for minors, governments, and international entities and a case’s lifespan may extend past ten years.
Waiting over two years for a case to reach a decision is not just an inconvenience; for a plaintiff who was injured on the job or for a solo practitioner, time without access to a settlement award or an attorney’s fee could be crippling.
Legal funding provides plaintiffs and attorneys a means of supporting themselves while lawsuits are in session or settlements are pending. For many, funding advances can make the difference between getting by and thriving.
Legal Funding Helps Attorneys Keep Their Businesses Alive
Plaintiff’s attorneys are not just legal professionals: they are also businesspeople who need capital to manage their practices. The act of running a business is an extra challenge for contingency fee attorneys, who sacrifice their time, expertise, and money to build solid cases for their clients without any guarantee of payment.
The different types of litigation financing were created to fit the needs of all contingency fee attorneys, solo practitioners and larger firms alike. With the help of a funding advance, attorneys can hire expert witnesses, cover discovery costs, pay for advertising and administrative costs, and maintain office space without worrying about running low on capital.
Lawsuit Funding Lets Plaintiffs Live Their Full Lives
Plaintiffs turn to the legal system to seek compensation after suffering an injury due to negligence, losing a loved one in an accident, experiencing medical complications after a surgery, or enduring any number of injustices.
But even though litigation often does provide plaintiffs with financial compensation, plaintiffs must still wait years for a decision or settlement to be made and then distributed.
Legal funding can be used to make up for lost wages, pay medical bills or for necessary surgeries, or cover daily expenses. Gaining immediate access to capital with a funding advance can help reduce some of the stress associated with expensive litigation and allow plaintiffs to focus on other important issues in their lives.
Don’t Settle For Less
With a funding advance, attorneys can work harder to make sure that their clients see justice. Often, plaintiffs attorneys are forced to accept lowball settlements because they simply don’t have the funds to pursue a case any further.
Insurance companies and defense attorneys, often aware that their opponents are in dire need of cash, have been known to delay hearings and employ other tricky tactics to convince plaintiffs attorneys to take the first available settlement offer.
With the assistance of legal funding, attorneys can spend more money and time on their cases. Plaintiffs who opt for legal funding can afford to hold out and wait for a better settlement.
OK, so how does legal funding work?
Lawsuit lending is unique in two ways: first, from application from distribution, it was specifically designed for attorneys and plaintiffs. Second, as we talked about earlier, most forms of legal funding are advances, not loans.
In a loan agreement, a financial institution like a bank lends a portion of its own money to the client. In an advance agreement, a third party lender (in this case, the legal funding company) purchases a portion of the client’s own future receivable (a settlement award or legal fee) and then advances the money to the client.
Lawyer-Friendly Legal Funding
Unlike banks, which ask for non-liquid assets as collateral to secure a loan or line of credit, legal funding companies accept case inventories as collateral. Legal funding firms understand the potential value of pending settlements and verdicts, so they can accept case inventories as proof that solo practitioners or larger law firms will be able to repay advances.
Litigation finance firms do not perform personal credit checks as part of an application. Funding advances are business expenses, not personal expenses, making personal credit checks unnecessary. Moreover, in most legal funding arrangements, attorneys are not directly responsible for repayments; rather, payments are directly taken from attorney escrow accounts, administrative accounts, or obligor accounts.
Pain-Free Funding For Plaintiffs
As mentioned above, legal funding companies will accept future receivables as collateral. For plaintiffs, future receivables come in the form of a pending settlement award.
As with attorney funding, personal credit checks are unnecessary for plaintiff funding. Legal funding companies are directly reimbursed from a plaintiff’s obligor (often, the obligor is an insurance company or corporation on the defendant’s side), so they do not need to evaluate whether or not the plaintiff has enough money in their personal account to make a payment.
Underwriting The Deal
Among the talented people who work at legal funding companies are the underwriters, who are intricately familiar with the legal process and use their specialized knowledge to review applicant case files, determine eligibility, and customize funding packages.
Underwriters need to understand how strong a client’s lawsuit is in order to figure out whether or not the firm can provide an advance — and if so, how much. To be able to determine the strength of a client’s lawsuit, underwriters are intricately familiar with the most common types of cases presented for legal funding: personal injury, medical malpractice, and product liability.
As we mentioned earlier, credit checks are not necessary in determining whether or not someone is eligible for a legal funding advance. This is because of the underwriting process: underwriters almost exclusively use a plaintiff’s or attorney’s case information to determine eligibility.
Underwriters Determine the Following:
- How strong a case is and how likely it will yield a favorable outcome.
- The approximate value of the case based on numerous variables, including the outcomes of similar past lawsuits.
- The projected timeframe for the litigation to resolve.
- How much the funding company can safely advance so that they make a profit and the plaintiff still has settlement proceeds upon completion of the lawsuit.
- The discount rate (this is different from interest rate, as we are dealing with an advance, not a loan) that should be applied to the advance based on the overall risk assessment of the case.
After You’ve Been Approved
Once an application has been approved, the funding company will purchase a portion of the client’s future receivables from the obligor. Typically, attorneys or plaintiffs can receive their funding within 48 hours of their application’s approval.
The funder will never purchase the entire settlement amount or legal fee from the obligor as a way to minimize risk and to guarantee that the client will have access to some of their funds in the future. Typically, a legal funding firm will purchase between 10% and 50% of a settlement award or attorney’s fee from an obligor.
What types of legal funding are available?
Two types of funding are available to both plaintiffs and attorneys: pre settlement funding and post settlement funding. As their names suggest, one is available only before a settlement amount has been determined, while the other is available only after a settlement amount has been determined.
The other two types of funding, voucher funding and attorney line of credit, are only available to attorneys. Attorney Lines of Credit work differently than the other types of funding that will be described below; it is more similar to a traditional bank loan.
Pre Settlement Funding
As mentioned earlier, even the most routine personal injury cases can have a two year life-span. During this time, attorneys and plaintiffs need a source of capital to get through day-to-day life and cover any expenses related to their lawsuits.
Pre settlement funding has a higher interest rate than other types of legal funding because there is a greater risk involved. When plaintiffs or attorneys apply for pre settlement lawsuit funding, there is not yet a guarantee that a settlement will be reached, so funding companies usually charge a higher premium.
Pre settlement attorney funding is the best financing decision for attorneys who are short on capital and need to finance a pending case.
With the money from a pre settlement funding advance, attorneys can pay for travel, discovery, witnesses, and administrative costs, and reach the desired settlement or verdict. With the money from a pre settlement advance, attorneys can build a better case and avoid settling on low-ball settlement offers.
Pre settlement lawsuit funding is the best funding option for plaintiffs who need immediate access to capital and cannot wait until a settlement has been declared. To qualify for pre settlement funding, plaintiffs must have already secured an attorney and filed a legal claim. Typically, pre settlement legal funding applications for plaintiffs can be approved within forty-eight hours.
Post Settlement Funding
Settlement awards are usually delayed by months or years even after a case has been settled. Post settlement funding is the best option for clients who need advanced access to their capital but do not want to pay for the risk associated with pre settlement funding.
Post settlement funding is a great option for contingency fee attorneys struggling to pursue new cases, secure new clients, and maintain a functioning practice due to delayed legal fees. With this advance, attorneys will have the funds necessary to develop new cases and expand their practices.
Attorney post settlement litigation funding is non-recourse, meaning that if for any reason the obligor were unable to pay the agreed upon settlement amount, which would prevent the payment of attorney fees, the attorney would still keep any portion of the fee that was advanced under a legal funding agreement.
For plaintiffs who need access to capital to pay for daily expenses and costs associated with their lawsuits but do not want to pay for the premium associated with pre settlement funding, post settlement lawsuit funding is the best option.
As with attorney post settlement funding, plaintiff post settlement funding is non-recourse. This means that if the obligor were unable to pay the agreed upon settlement amount, the plaintiff would still keep any portion of the settlement that was advanced under a legal funding agreement.
Voucher Funding For Public Defenders
Many attorneys are government-appointed public defenders, also known as indigent defense attorneys. These attorneys are public servants, so they are supposed to receive their legal fees directly from the state, rather than from a defendant. The state provides these attorneys with vouchers that can be exchanged for payment.
State appointed attorneys typically have to wait only one or two weeks before receiving their attorney fees; however, due to recent economic downturns that have taken a toll on many state governments, public defenders have been forced to wait months for their pay.
Voucher funding works much like post settlement funding does. A legal funding firm will purchase a portion of the public defender’s expected fee and provide the attorney with a capital advance. When the full portion of the fee becomes available, the legal funding firm will be repaid directly from the obligor, which in this case would be the state that hired the attorney.
Line Of Credit For Attorneys
Unlike the other forms of legal funding discussed in this guide, attorney lines of credit are not advances. Rather, they function much like bank lines of credit. The primary difference between bank LOCs and attorney LOCs is that law firm funding companies accept case inventories as collateral, as they do with all other types of legal funding advances.
The amount of capital that can be extended in a line of credit depends on the future receivables in a law firm’s case inventory. An LOC can be increased as a case inventory grows.
Lines of credit are the best options for law firms that are seeking to advance their practices. Whether they are looking to expand their marketing efforts, attract new clients, bring on new staff, or increase their caseloads, a line of credit offers a continuous source of capital that can be accessed on a monthly basis. Repayment plans are flexible and can be arranged to fit the specific needs of an individual law firm.
So there you have it. In sum: legal funding is a solution for plaintiffs and attorneys who are in need of capital but cannot get by on traditional funding methods. Legal funding companies provide their clients with advances, which are calculated based on the strengths of client’s cases. With the money from legal funding, attorneys have the ability to put together great cases or build up their practices, and plaintiffs have the ability to rebuild their lives.
Any questions or comments? Looking to apply for legal funding? Please get in touch! You can call us at 267-457-4540.