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Loans and Lawsuit Loans – Is There a Difference

Lawsuit funding is the the advancing of money in anticipation of a favorable settlement in civil court. The term lawsuit funding is also known as pre-settlement funding, settlement loans, litigation finance, or case loans. Although the term “loan” is often used to describe these transactions, lawsuit funding arrangements are not loans. This post attempts to make this distinction by comparing lawsuit funding with other types of “loans”.

Definitions

Merriam-Webster defines “loan” as “money lent at interest”. But this does little to explain differences between litigation finance and traditional loans. This is true because the definition fails to assess the repayment terms. If we search the online encyclopedia for the phrase “credit”, we come up with the following definition:

Credit, transaction between two parties in which one (the creditor or lender) supplies money, goods, services, or securities in return for a promised future payment by the other (the debtor or borrower). Such transactions normally include the payment of interest to the lender.
So according to this definition, a credit transaction must meet the following criteria.

Creditor supplies money, etc.
Debtor promises a future repayment, often at interest.
If we use this definition, we can clearly see why lawsuit cash advance funding is not a “loan” in the traditional sense of the term. But first, let us define some traditional types of loans and see how they compare.

Traditional Loans

Loans usually fall within two types – secured and unsecured. The difference between the two is essentially the available remedies in the event of default (non payment according to the loan terms).

Secured – secured loans are “secured” by some type of collateral. In any “secured transaction”, the debtor pledges a specific collateral through the execution of a “security instrument” and the creditor files notice of that interest in the public record. We find this situation everyday in mortgage arrangements or the financing of automobile purchases. The debtor signs the Note, which outlines the terms of the loan, including the rate of interest, time and amount of the repayments, etc. The debtor also signs a security instrument (e.g. mortgage) which is recorded in the public record, usually in the county where the property is located. This instrument gives the creditor the legal right to obtain the property if the loan terms are not fulfilled by the debtor.

Unsecured – examples of unsecured loans include credit cards, certain lines of credit for businesses, and others. With unsecured debt, there is no collateral pledged from which the creditors’ advance is “secured”. Instead, in the event of a default, the creditor can simply sue the debtor for the balance of the loans plus whatever penalties, fees or costs as are outlined in the Note. The creditor retains the right to sue but does not have any right in any specific collateral. It should be noted the debtors usually pay more interest for unsecured obligations than secured loans.

Lawsuit Funding

As stated above, credit (loan) refers to a transaction where the creditor gives money and the debtor promises to repay. Lawsuit funding contracts differ from traditional loan documents because the lawsuit cash advance must only be repaid IF there is a settlement or other recovery. In other words, while a loan implies repayment under all circumstances, a lawsuit cash advance is repaid only if a condition is satisfied. That condition is the plaintiff recovering an award.

Because payment is contingent on recovery, a lawsuit “loan” fails to satisfy our definition.

Implications

So far we made a distinction between regular loans and lawsuit funding. At first blush, the difference may seem little more than a legal technicality. Yet the practical effect of this distinction is actually pretty significant.

Secured and unsecured loans are usually regulated by the jurisdiction in which the loan was originated. Many states have a “Department of Banking” or other similar bureaucratic office charged with protecting the public from unscrupulous lenders otherwise known as “loan sharks”. One method of control is mandating maximum amounts of interest allowable for traditional loan transactions. These decrees are normally called “usury laws” and often make it a criminal offense to charge interest in excess of the statutory maximum.

Legal funding contracts are not governed by usury laws in most states. Accordingly, there is no limit to the amount charged for lawsuit cash advances. That means some lawsuit funding companies charge oppressive rates – simply because they can get away with it. That is the bad news for those wishing to obtain funding.