Litigation Lotto And Hedge Funds

Not enough gets written about the matter of legal fees, and what gets written generally scares me. Fictional lawyers practice law in a cocoon; readers rarely if ever get a glimpse of what it takes to keep the lights on and the copying machine operable. The press catches a whiff only of the most dramatic developments. Most lawyers practice law amid something like quiet desparation. This is especially so in a bad economy, where easy credit and the collapse in the housing market has left many folks in need of a lawyer high and dry for spare cash. The bar is hungry just now.

Enter hedge funds.

I suppose I ought not to have been shocked by this morning's frontpage story in The New York Times, but I was. Burned by the collapse of the subprime real estate mortgage market, capital is wandering around looking for a return. What better place than funding lawsuits? "Lawsuit lending is a child of the subprime revolution, the mainstream embrace of high-risk lending at high interest rates than began in the early 1990s," the Time reports. I suppose I would have realized this if I had bothered to read all the emails I receive pitching me on the practice. My firm represents plaintiffs in civil rights suits, some of the riskiest litigation going. But I've been unwilling to sign on with a lender; the practice strikes me as dubious. But is it, really?

We get many calls each week from folks wanting to sue police officers, public employers or other large entities. I spend hours a week sifting through these calls. Paralegals first screen them and write a summary of what the caller wants. I read the summaries, and return those calls that present claims I think have some merit. Many of the callers are angry; they want a defendant to be held accountable for an act of misconduct. Invariably, these calls come down to a question of fees and expenses. According to the Federal Judicial Center, the average civil suit in federal court costs $15,000 to advance; that's due in large measure to a court system that has come to regard the pursuit of justice as little more than widgetry. There are reports, mandatory conferences, motions and all manner of costly mumbo-jumbo associated with the simplest of claims. I turn many folks away not as a matter of justice, but as a matter of cost. They just don't have even a comparatively modest sum to advance their claims. Governmental and corporate defendants, by contrast, don't count the money at their disposal; they weigh it. Sure, David can beat Goliath, but the court's require David to toss gold bars these days; mere rocks won't do.

So the big capital boys at firms such as Plaintiff Support Services or GE Capital can serve a role by levelling the financial playing field between plaintiffs and defendants. In the late 1990s, GE Capital turned a $4.2 million profit when it invested $5.8 million in a lawsuit brought by a discount retailer against Chase Manhattan. Big money can help translate into big damages in the personal injury world, too, where the expense of hiring experts is often beyond the reach of small law firms and ordinary people.

But there is a dark side. Interest rates are often high, sometimes as high as forty percent. And lawyers are not always required to notify their clients in any but a meaningless boilerplate sort of way about who pays the interest on these loans. In the ground zero litigation brought on behalf of 9,000 workers in New York, a total of $6.1 million of the $11 million the lawyers seek to recover in costs from the $712.5 million settlement is interest on loans taken to advance the litigation. It is not at all clear to me that lawyers should be permitted to pass these interest costs on to clients. Aren't the lawyers fees generated in significant measure by the loans they take on behlf of their clients?

Contingency fees were controversial a century ago. Courts and ethics committees looked askance at the practice as it seemed to encourage litigation. Only clients with a stake in the game were regarded as capable of playing justice's game. But the law gave way to reality: Ordinary people don't have the funds necessary to head to court in many cases. Permitting lawyers to take cases on contingency enabled folks who would not otherwise have access to the courts to seek a jury's justice. Implicit in this system was a sense that lawyers would be shrewd in how they invested their time, thus leading to a form of implicit regulation: What lawyer throws good time after bad?

Of course, those assumptions more easily goverened in an era in which there was no glut of lawyers. Law schools belch out legions of new litigation wannabes each year. Hungry lawyers chase marginal claims as a means of surviving. If there are investors willing to gamble on these claims, so be it. But it seems foolhardy to permit lawyers to transfer these risks to their clients in the form of interest payments on the loans a lawyer takes.

Many firms have credit lines with banks. These firms pay the interest on loans taken to keep the firms afloat in lean times. The cost of the interest payments are then folded into the firms' fee structures. It is not at all obvious to me why investment in discrete claims should be treated any differently than is a firm credit line.

Although I am wary of the practice, I see no reason to bar investors from backing litigation. It will help to level the playing field between well-heeled defendants and shoeless plaintiffs. But before we permit speculative capital to do to courtrooms what it did to the real estate market, we ought to pay close attention to what incentives access to easy money creates for lawyers. The market it legal services remains largely self-regulating; we saw what pouring vast sums of money into a poorly regulated banking industry did for us. Let's not let a similar disaster befall the law.

Also listed under: Legal Fees

Comments: (1)

  • Law Finance
    Norm -
    The problem for those of us in the Plaintiffs' bar is the intersection of tax law and increasing scrutiny on expert opinions. Because courts are looking for more and more reasons to strike expert opinions, we have to spend ever greater amounts of money on multiple experts, expensive testing, etc. On a major case, we can spend several hundred thousand dollars. Yet the IRS considers all of these expenditures as non-tax-deductible loans to clients. If we don't borrow money to finance these expenses, the "phantom income" created by the non-deductible case expenses will put us out of business.
    While 40% interest would be insane, I am looking at some options other than my bank to best fund my cases. I don't think I'm doing anything unethical as long as I fully disclose everything to my clients and don't end up with usurious interest rates.
    Michael Cowen
    Posted on November 15, 2010 at 9:13 pm by Michael Cowen

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