Settlement Loans in Canada 10 Years On: Cautions and Considerations
May 8, 2012 | Bridgepoint Financial |Posted in Viewpoint
Troubling issues currently facing the litigation finance market in Canada
I have been actively involved in the litigation finance business since its inception in Canada over a decade ago. During that time I have witnessed a number of developments in this still evolving market: many of them positive – the use of financing for treatment where an insurer has unreasonably denied med/rehab benefits, for example – and some negative.
As with any form of borrowing, litigation "settlement loans" can be effective tools where used responsibly and to date have assisted thousands of claimants across Canada manage the financial pressures of the litigation process. When used irresponsibly, they can have damaging consequences on claimants' recoveries and in certain cases impede the very settlements they are intended to protect.
The following are a few of the more troubling issues currently facing the litigation finance market in Canada as it reaches is adolescence:
Many litigation lenders have little sense of the value of a claim. Imagine a real estate mortgage market where lenders relied exclusively on the borrowers and their agents to advise them on how much a given property was worth and could therefore support in debt. Google "US subprime mortgage market" for a case study of the nasty repercussions of such a scenario for all participants. Litigation represents an infinitely more complex and risky form of security than real estate yet many lenders in this space – blinded by the allure of charging inordinately high interest rates - rely entirely upon the views of claimants and/or their counsel as the basis for their lending decisions. The inability of some lenders to independently assess a claim's prospective value and monitor their lending decisions accordingly portends a similar fate for them as their US subprime counterparts. As a case in point, one of the original and more active litigation lenders in Canada recently exited the market as the results of its overly aggressive lending practices came to pass.
Too many claimants view their lawsuits as ATMs. The original premise (and promise) of litigation funding was to ensure that claimants could sustain themselves through the final, critical stages of their litigation without succumbing to opportunistic insurer settlement offers. Such "emergency" funds were intended to stave off evictions, keep utilities turned on and put food on tables while counsel negotiated a reasonable resolution of the underlying claims. The advent of an increasing number of litigation lenders promoting "fast" and "easy" money has fostered the perception amongst claimants that their litigation can be repeatedly tapped for discretionary cash like an ATM machine, with little consideration for the costs and consequences until it is too late.
Lawyers are often 'out of the loop' of their client's borrowing decisions. Five years ago, most decisions to borrow against a future legal settlement were made only after a serious dialogue between claimant and counsel about the implications of doing so. In fact, it was typically counsel who made the decision to introduce a litigation lender into the equation once more traditional (and less expensive) avenues of funding were exhausted. Today's claimants are much more aware of their litigation borrowing options through lenders' active online marketing and promotions in venues such as payday loan outlets resulting in an increasing number of settlement loans being executed without counsels' knowledge. By the time a client presents his/her lawyer with an assignment notice for signature, it is too late to reverse the damage and discuss alternatives.
Many lawyers refuse to get involved with clients' personal financial issues. A claimant's financial distress can be as attributable to their cause of action as their physical or psychological impairments - and may require similar monitoring and treatment. And yet, most lawyers are far less enthusiastic to get involved in addressing any issues of a financial nature.
Consider the following: a recent Canadian Payroll Association study revealed that 57% of working Canadians could not sustain even a one week delay in their paychecks without experiencing financial difficulty1. Now compare this to the ordeal of the average personal injury claimant whose income replacement benefits (if available) take weeks to commence, often fall well short of the actual income needing replacement and are subject to exhaustion or termination by an insurer with minimal notice at any time - typically years before the litigation is resolved. Beyond the brief window where their savings and/or assistance from family and friends can sustain them looms the serious prospect of eviction or similar economic crisis.
Is not assisting a client in coping with the many trials of the litigation process – including those of a financial nature – simply part of a responsible plaintiff personal injury practice? A qualified litigation lender's ability to make the most informed, responsible financing decision is predicated on counsel's co-operation in providing access to certain factual (non-privileged) information about a prospective borrower's claim. Note this does not include providing representations about the value of a claim and any lender requesting this or similar opinions in writing from counsel should raise a serious red flag. Ignoring such basic information requests and/or separately billing for the time spent doing so is a disservice to the client and serves only to steer them towards less diligent lenders - invariably at a higher cost.
In summary, while it is easy to blame claimants who have borrowed excessively and/or on egregious terms as the authors of their own misfortunes, the truth is that both litigation lenders and borrowers' counsel share responsibility in these situations. The population of prospective litigation borrowers is by definition a desperate and vulnerable one. Lenders who offer their services in this specialized area should adopt and abide by responsible lending practices, offer reasonable and clear terms of funding subject to open review by the market and should be held to account by the legal community to demonstrate such practices on a continued basis. Lawyers have the responsibility to educate themselves on all means of financial support available to assist their clients in various circumstances – including litigation financing alternatives. This would prepare them for an open dialogue with their clients where the need arises and reduce the chances of their clients making uninformed decisions with potentially negative implications on the outcome of the litigation for both parties.
The following is a list of questions and considerations for anyone contemplating a settlement loan:
- Have other financing options been explored? Loans against future settlements should only be considered as a last resort once other less expensive alternatives have been exhausted (including family, friends and more traditional lenders such as banks if the required monthly payments can be maintained).
- Discuss your situation with your lawyer. Your lawyer is the best source of information about the status of your claim and any financial benefits you may be entitled to. While ultimately the decision to borrow funds against a future settlement is yours to make, it is important for your lawyer to understand your financial situation and for you and your lawyer to discuss the pros and cons of your available options.
- Determine your true financial needs before applying. Settlement loans are not intended for discretionary purchases and should only be considered to pay for:
- Necessary basic living expenses (rent, mortgage, utilities, food, etc.);
- Reasonable and necessary med/rehab, attendant care or other treatment services where insurance coverage is not available;
- Refinancing higher interest debt or to cover minimum monthly payments on bank or credit card debt that may be in default;
- Reasonable disbursements for your legal claim if these are not covered under the retainer agreement with your lawyer.
- If a settlement loan is required, consider a "staged" loan. If the loan is to be used to cover ongoing living expenses, a "staged" loan where pre-determined amounts are advanced to you each month may be a good option. Staged loans offer borrowers the peace of mind of a regular source of funds while reducing interest costs compared to lump sum loans (interest only accrues once funds are advanced). Depending on a borrower's needs, a combination lump sum/staged loan can be arranged.
- Once a decision to pursue a settlement loan has been made – comparison shop for the best terms. Many borrowers mistakenly assume that the terms offered between different litigation lenders are similar. In fact, the total financing costs between the main litigation lenders in Canada can vary between 20% up to 60% per year. Many litigation lenders do not disclose their loan terms up front and several add an array of fees, charges and interest rate fluctuations over time which can be very confusing to borrowers. The following are suggested questions that borrowers should ask any litigation lender in order to properly compare the terms offered:
- What interest rate will apply to the loan and will it fluctuate over time?
- How often will interest be compounded? Loans with more frequent compounding - monthly vs semi-annually or annually - will accrue much greater interest over time.
- What admin fees or charges aside from interest will I incur? Will such fees be deducted from the loan proceeds or added to the principal (and hence accrue additional interest over time). A lender charging a 20% admin fee to be deducted from the loan proceeds means a borrower of $5,000 only actually receives $4,000 (put pays interest on the full $5,000).
- Is the litigation lender collecting fees or charges on behalf of any other service provider such as a payday loan company?
- Is there a minimum interest period? This is particularly important for borrowers who expect their settlement quickly.
- To compare charges between lenders, ask how much in total would be owed on a loan at various repayment dates (i.e. 6 months, 1 year, 2 years, 3 years).
- Do not deal with any lender who is unwilling to provide in writing the information requested above.
- Be sure to also have your lawyer review any loan documentation before you sign!