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The Continuing Struggle Over Litigation Funding

In the case of Rancman v. Interim Settlement Funding Corp., the Ohio Supreme Court invalidated a contract relating to litigation funding. The contract memorialized a woman's sale, to a well-established litigation investment group of a portion of her interest in her personal injury claim, for $7000.

This is the first time in many years that a state supreme court has so sweepingly endorsed the rule against "champerty" - the legal term for the sale of a party's interest in a lawsuit. I will argue that the court's decision was mistaken, and fails to reflect current law and theory relating to champerty.

Historically, English and American common law has prohibited champerty - and officially, that is the still the American rule. In reality, however, many companies now invest in lawsuits, and many state courts allow them to do so - for reasons I explained in an earlier column on the emerging market in litigation funding. However, as more private investment groups invest in litigation support, the issue has begun to get litigated more and more.

In theory, the market for litigation interests could be an efficient one. Suppose a plaintiff has a good claim, but can't afford to pursue it - perhaps because her medical costs from an accident are too high, or because she can't convince a lawyer to take her case on contingency, or because she's so badly injured she can't work, and thus can't pay for necessities? Why can't she sell her interest in her lawsuit for its expected value, and get the money she needs immediately to pay her expenses?

After all, the modern view of litigation is that it is itself a market mechanism designed to put a price on the risks and benefits of various personal and business activities. Thus, consumer advocates see litigation as a way of forcing corporations to bear the 'true' cost of their economic activity.

Similarly, many law and economics scholars argue that the purpose (or, at least, one of the main purposes) of the legal system as a whole is to promote efficiency. And one who believes that tort litigation can insure that accidents are accurately priced should also support a market in litigation interests - for it distorts the pricing of accidents if plaintiffs must drop their lawsuits or settle too cheap because they could not afford to press their claims.

Furthermore, one might think that companies who invest in lawsuits would help the system achieve its goals. A professional "tort investor" would only invest in lawsuits that were credible, based on the available evidence and state of the law of the jurisdiction. Thus, the most meritorious lawsuits would be the ones that progressed forward to settlement or verdict.

Nevertheless, there has been a backlash developing against the emerging market in litigation. Consider, for instance, the Rancman case itself - which involved a typical form of litigation investment.

The Facts of Rancman

There, Roberta Rancman had been injured in a car accident. In March 1999, she sued her estranged husband's insurance company, believing it owed her benefits under the policy's uninsured motorist benefits provision.

Later in 1999, for reasons undisclosed in the Ohio opinions in the case, Rancman decided to enter into deals with two litigation funding companies Interim Settlement Funding Corp. ("ISF"), an Ohio company, and Future Settlement Funding Corporation ("FSF"), a Nevada corporation.

FSF gave Rancman $6000. In exchange, if Rancman won a judgment or settlement in the suit within twelve months, she would give FSF the first $16,800 she received. If she resolved her suit within 18 months, she would owe FSF $22,500. Finally, if she resolved the suit within two years, she would owe FSF $27,600.

Meanwhile, ISF gave Rancman $1000. In exchange, she promised to give ISF $2800 if she won or settled her suit.

In December 1999 Rancman settled her suit for $100,000. Under her contracts, she owed FSF $16,800, and ISF $2800 - a total of $19,600. However, instead of paying them, she filed for a declaratory judgment voiding the contracts.

The Ohio Lower Court Decisions in Rancman

The lower courts in Ohio voided the contracts on the grounds that they were usurious loans. But in fact, the contracts weren't loans in the first place; they were investments on which FSF and ISF hoped to get returns.

To see why the contract was not a loan, note that Rancman never promised to repay the $7,000 she had received. She promised, instead, that if she received a settlement or verdict, she would pay part of it to ISF and FSF (a much larger part than $7000). If she lost or abandoned her case, she owed them nothing. No matter what, she kept the initial $7000.

The Ohio Supreme Court thus correctly held on appeal that the contracts were not usurious loans. The rest of its decision, however, is much more troubling.

The Anti-Champerty Backlash

The Ohio Supreme Court voided the contracts, but on a different ground than the lower courts had invoked. It held that champerty violates Ohio law - and is bad, from a policy perspective, for several reasons. But on closer examination, none of these reasons is persuasive.

This is obviously true, but so what? Rancman's lawyer, who was guaranteed 30% of her recovery if she won was also seeking to profit from her case. What is wrong with third parties helping an injured victim bring a lawsuit against a wrongdoer out of a profit motive? Why should society care why good lawsuits are brought, as long as the lawsuit that is brought is good?

Second, it worried that the considerations in Rancman's decision regarding when to settle, and how much to settle for, had been altered by her contracts. It pointed out that, in the deals' first year, Rancman had no incentive to settle her suit for less than $28,000. If she did, she would get nothing - her lawyer would get 30 percent off the top, or $8,400, and FSF and ISF would get the rest, $19,600.

But again, so what? Without the $7,000, Rancman might not have been able to pursue her suit - and might have been under irresistible pressure to settle her case for much less than $100,000, or even to abandon the case entirely. Indeed, perhaps it was only because ISF and FSF loaned $7000 to Rancman that her suit's true value went above $28,000.

On this view, what ISF and FSF did is hardly as sinister as the Ohio Supreme Court suggested it. Indeed, all they did was to insure was that a wrongdoer--the defendant insurance company that wrongfully withheld Rancman's money--faced a well-funded, powerful opponent in Rancman.

An Unpersuasive Objection to Champerty: "Junk" Lawsuits

While the Ohio Supreme Court did not mention it, there is another reason that is sometimes cited to explain why the law should retain its traditional hostility to champerty. But I believe this rationale, too, is unpersuasive.

On this view, the tort system already suffers from many "junk" lawsuits. And the sort of aid provided by firms like ISF and FSF thus only adds more fuel to the "torts crisis" fire by pumping more lawsuits (and among them, more junk lawsuits) into the system.

The problem, however, is that banning champerty throws out the good lawsuits with the bad - and thus the baby with the bath water. Plaintiffs' ability to afford to try their cases has little, if anything, to do with the merits of those cases. Thus, at best, champerty kills off good and "junk" lawsuits alike.

Indeed, it is even possible that the stronger the tort lawsuit is, the harder it will be for the plaintiff to make it to the finish line. A grievously injured plaintiff - especially one who cannot work, or requires 24-hour care - may be forced to settle early in order to pay high medical expenses, or simply to enjoy living the last few years of life. Only champerty may be able to allow that plaintiffs in such situations get an amount close to that to which the law entitles them.

Anthony J. Sebok is a Professor of Law at Brooklyn Law School, where he teaches Torts, among other subjects. Professor Sebok has written several other columns on tort litigation for FindLaw; they can be located in the archive of his columns on the site.

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