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September|October 2004
The Scalias Court By Stephen B. Presser
Kerry's Even Keel By David Strauss
Dull and Duller By Mark Tushnet
The Passion Of Father Paul Shanley By JoAnn Wypijewski
Litigation By Loan Shark By Daniel Brook

Litigation By Loan Shark

Litigation finance companies loan money to plaintiffs too poor to press their cases against big, well-heeled insurance companies. Is this new industry leveling the playing field or exploiting the system?

By Daniel Brook

I MET SAM DISALVO AT HIS HOME IN BATAVIA, N.Y., an hour south of the Lake Ontario shore. DiSalvo's blue van was parked in the driveway of his blue house. An American flag hung on the rearview mirror of the van, and another hung over the front door of the house. DiSalvo answered the door. At 42, he is still trim, and other than a receding hairline, which he makes up for by growing his hair long in the back, he shows few signs of middle age. Despite his ostensible vigor, DiSalvo walks with a cane, a reminder of his car accident out on Route 63 in December 1997. He says he was cut off by a 17-year-old girl chatting on a cellphone. The impact from the collision broke two of his vertebrae, and while he surprised doctors by regaining his ability to walk, the accident did permanent neurological damage. As DiSalvo was his family's primary breadwinner—he had been a caretaker on an estate outside of town—the accident also crippled the family financially.

DiSalvo had a potentially lucrative lawsuit pending from the accident, but there was only so long he could put off paying the mounting bills: There were mortgage payments to make and three children to feed. Before his accident, he had been an avid sportsman, with memberships in the National Rifle Association, the New York State Rifle and Pistol Association, the National Muzzle Loading Rifle Association, the American Longrifle Association, and the North American Hunting Club. His hunting buddies pitched in to help him, leaving recently shot game in his driveway, but charity alone wasn't enough.

Given his middle-class existence before the accident, DiSalvo didn't qualify for most public assistance programs. He says that one social service caseworker told him to lose his house first and then get back to them. He filed for Social Security Disability, but the application process often takes years. Too proud to burden his relatives, he contacted men he described as "old business acquaintances."

"We're talking loan sharks," DiSalvo said, sitting at his kitchen table and speaking in his Rust Belt accent, more Chicago than New York. "Totally frickin' illegal but we didn't want to lose the house and we still wanted to feed the kids." The underworld usurers' going rate was 66 percent a month, and though the length of a typical lawsuit is measured in years, most of them demanded payments monthly.

A few loan sharks understood that DiSalvo had a chance at a large payoff, and were willing to wait for repayment until he settled his suit, but their terms were still hardly attractive. "If I got $3 million, they would get $1.5 million—period—or you don't get to walk again," he said. It was an unwelcome prospect for a man who had just learned to walk again.

DiSalvo said he called his lawyers and told them, "I got no place to go, I'm stuck." They had one last idea, but they considered it a long shot. As DiSalvo recounted it, they told him, "We heard about this place, Plaintiff Support, we don't know anything about it, but we heard they help people that have been in accidents." DiSalvo thought it was worth a try, and placed a call. He was sold immediately. "It was a no-brainer," he told me. "You would have been stupid to go with a loan shark after talking with these people."

Plaintiff Support Services is among a growing number of companies in an emerging industry known as litigation finance. PSS and companies like it nationwide help litigants by giving them cash advances. Personal injury plaintiffs, by far the most common customers of litigation finance, use the money to cover living expenses while they recover from their accident and await a verdict or settlement. Plaintiffs don't owe anything until and unless there is a settlement or a judgment in their favor, at which point they have to repay the advance—plus interest.

Sam DiSalvo's is a typical litigation finance case—an injured driver, out of work and short on savings, trying to recover damages from an auto insurance company. In the past, plaintiffs like DiSalvo have generally had to accept whatever settlement a defendant offered. A well-heeled insurance company has all the time and money in the world compared to a cash-strapped plaintiff who needs to pay the rent and feed a family. Although attorneys have been working for contingency fees since common law prohibitions against them were lifted in the mid-19th century, they are prohibited by bar association ethics rules from lending money to their clients: Such lending would make the attorney a party to the lawsuit rather than merely an advocate. And most banks won't issue loans to people whose only collateral is an unresolved lawsuit.

Litigation finance companies offer plaintiffs access to funds through high-interest cash advances. Very high-interest. New Amsterdam Capital Partners, a litigation finance firm in Manhattan charges in the 3.5 to 6 percent range per month, depending on the risk involved in the case. Increased competition in the industry has driven rates down (New Amsterdam, for example, used to charge 15 percent per month), but the lowest rate any firm offers remains a steep 3 percent. Computed out annually (12 months at 3 percent is 36 percent annually), even credit card rates, typically around 18 percent annually, look like a bargain. But since plaintiffs who lose their cases owe nothing, the advance is not technically a loan, exempting litigation finance companies from the usury laws that prohibit high-interest loans in most states.

Though they clear the usury hurdle, litigation finance companies have found themselves hemmed in by another prohibition. Third-party investments in lawsuits, known as champerty, have traditionally been forbidden in the United States, Britain, and other countries that inherited Britain's common law. Because of the personal nature of civil suits—an injured person is suing whoever caused the injury—the involvement of a profit-seeking third party who has suffered no injury has long been viewed with suspicion, if not hostility.

But laws against champerty have been falling in many states in recent years. Meanwhile the litigation finance industry, which didn't exist 15 years ago and is still relatively small (the 10 largest firms each have modest investment portfolios of just over $10 million), is growing fast—and it is changing the way personal injury lawsuits are brought in America.

This makes it controversial. Even in a society known for its litigiousness and free market ideals, litigation finance has raised eyebrows. Tort reform advocates, long worried that lawsuits have become just another business, see litigation finance as the consummation of this development. On the other side of the political spectrum, liberals worry that litigation finance firms offering usurious rates prey upon a desperate clientele.

Given this skepticism, the future of the industry is uncertain. Reversing the trend of states easing their prohibitions on champerty, the Ohio Supreme Court recently upheld the state's ban on the practice—and outlawed litigation finance completely. The Ohio decision demonstrates that the nascent industry has raised questions that have yet to be answered conclusively. Do these companies level the playing field for plaintiffs who don't have the resources to fight a war of attrition against big insurance companies? Or are they leeches on the system, making a profit by enticing plaintiffs to gamble with what is often the only asset they have left?

RECENTLY, I VISITED THE OFFICES OF PLAINTIFF SUPPORT SERVICES in a red-brick office park near SUNY-Buffalo's North Campus in Getzville, N.Y. (The company has since relocated to Amherst, also in the Buffalo area.) PSS was founded in 1992 by Ken Polowitz, a mortgage banker who realized that there was an untapped lending market in cash-strapped plaintiffs awaiting potentially massive settlements. Unlike DiSalvo's loan sharks, Polowitz's company charged fixed interest rates rather than a percentage of the final settlement.

In 2000, Joe DiNardo, a Buffalo-area personal injury lawyer, purchased PSS from Polowitz. At the time, its portfolio of cases was worth roughly $1 million, meaning that if every case were settled successfully at that moment, the company would collect $1 million in principal and interest. Leaving the practice of law to take over PSS was a forced career change for DiNardo. In the mid-'90s, his personal injury firm was earning nearly $5 million in gross receipts. But in 1997, DiNardo came under federal indictment for tax evasion and for bribing and tampering with government witnesses. According to federal prosecutors, DiNardo conspired to pay upwards of a hundred thousand dollars in kickbacks to a union leader in exchange for case referrals of union members injured on the job. (In a brazen and convoluted scheme, DiNardo tried to write the kickbacks off as a tax-deductible business expense.) Ultimately, DiNardo copped a plea, taking a tax evasion conviction and house arrest to escape jail time.

DiNardo's law school diploma from SUNY-Buffalo hung in his office, though DiNardo is still in the process of reapplying for his license to practice law, which was suspended as part of his punishment. In February he cleared the most important hurdle, successfully retaking the ethics portion of the bar exam. DiNardo admits that he was forced into the litigation finance business, but he also says that his experience as a personal injury attorney led him to believe that the industry could be a lucrative one. "I think anybody who has any direct involvement with plaintiffs. . . will come to the conclusion sooner or later that there is a service that is missing for them," he told me.

With a rate of 3 percent a month, PSS charges at the low end of the litigation finance spectrum. Based on the needs of the client, the case's potential payout, and its chances of success, PSS determines the amount it is willing to issue in cash advances. The company's chief underwriter, Helen Jones, says PSS invests in about 6 out of every 10 cases it analyzes. Yet even after winnowing down the investment opportunities, there is always risk. The case could go to trial in front of an unsympathetic jury, or a plaintiff claiming to be injured could be spotted playing a round of golf.

When settlement checks go out, the lawyers are paid first, the litigation finance company second. If the company is owed more money than the client wins, it's out of luck (though not as out of luck as the client, who ends up with nothing). To avoid this lose-lose situation, PSS tries to advance only up to 10 percent of what it estimates the case is worth. When company officials meet with a client, they use a computer program to project the interest on the cash advance, which accrues rapidly. At the company's office, I was shown a spreadsheet for a hypothetical client who had received $8,500 in monthly cash advances over six months. Less than two years after the first advance, the client owed PSS nearly $14,500—$8,500 in principal and nearly $6,000 more in interest.

PSS PRIDES ITSELF ON DOING EVERYTHING ABOVEBOARD, and the PSS clients I spoke with confirmed that the company is upfront about the interest rates it charges and what that means in real dollars. Joanne Williams, the company's chief financial officer (and indicted co-conspirator in the kickback scandal that took down DiNardo's law practice), told me, "We're looking to be the one standing after the government comes in and tries to regulate. We want to be the one that they take a look at to be the model."

Not all firms in the industry have such aspirations. Everyone involved in the business acknowledges that there are unscrupulous firms that prey on unsophisticated clients, locking them into terms that are exorbitant even by industry standards. One such firm, Future Settlement Funding Corporation of Las Vegas, is currently being sued in North Carolina by a law firm alleging that Future Settlement's secret $200,000 investment in a client's case made it impossible to reach a settlement.

Recently, trial lawyer Michael David Bland recounted in his just-folks Carolina accent his experience representing Leslie Price in a civil suit. Price was suing George Shinn, the owner of the Charlotte (now New Orleans) Hornets, who she claims sexually assaulted her in 1997. Against Bland's advice, Price turned down a $1 million settlement offer, insisting that she wouldn't settle for less than $1.2 million. Bland couldn't understand why his client was holding out for more money. The reason was that Price's contract with Future Settlement meant that only a sum of $1.2 million or more would leave her with any money after paying her attorneys and the litigation financiers. Price forced Bland to take the case to trial against his better judgment. "The outcome was horrific," Bland told me. "We got shellacked." Bland lost the case and the approximately $300,000 contingency fee he would have earned if Price had accepted the $1 million settlement.

A month after she lost at trial, Price finally explained why she turned down the initial settlement offer. Bland's firm promptly filed suit against Future Settlement, alleging that the company had interfered with the attorney-client contract. A jury found in Bland's favor, but Future Settlement is currently appealing. Ruling on a motion during the appeals process, a federal judge summed up the bizarre facts of the case: "In a twist perhaps unique in law, a court loss resulting in no award of damages was better for the client than a million-dollar settlement."

THE APPEARANCE OF IMPROPRIETY has plagued litigation finance since its rather murky inception sometime in the 1990s. Piecing together the history of the industry is challenging, in part because many of its pioneers are hard to find. Perry Walton, founder of Future Settlement, is the man who popularized the industry nationwide through a series of training seminars. Like Joe DiNardo, Walton found his way into the litigation finance business through a less than voluntary career change. Walton started his Las Vegas-based company after a conviction for extortionate collection of debt destroyed his personal finance business, Wild West Funding. According to prosecutors, Walton told an undercover police detective that he worked for loan sharks and that, "if you fuck with these people you'll end up in the desert dead."

Attempts to contact Walton by phone, mail, and in person were unsuccessful. My visit to the address listed in the Las Vegas phone book for Future Settlement Funding Corporation led me to a strip mall on the edge of town that was home to a gas station and a nail salon, but no litigation finance office. I was able to reach Bruce Benson, a Future Settlement executive who co-founded the company with Walton, but our phone conversation was short and ended abruptly. After initially confirming that he was "the Bruce Benson in Las Vegas who's in the litigation finance business," he denied any connection to Future Settlement and claimed that he had never given an interview to the Las Vegas Review-Journal, which quoted him extensively in a 2002 article.

Future Settlement may be trying to keep a low profile these days because in addition to the suit they're appealing in North Carolina, it was one of the company's contracts that led Ohio to outlaw litigation finance in that state. In 1999, the company loaned Roberta Rancman $6,000 at a minimum annual interest rate of 280 percent. Rancman had been seriously injured in a car accident, and was suing her car's insurer, State Farm. Ultimately, State Farm paid out $100,000, but Rancman refused to repay Future Settlement at the agreed-upon rate. Instead she declared her contract void. She did repay the loan, but at what she considered to be a more reasonable rate of 8 percent a year.

Future Settlement sued Rancman but the trial judge ruled in her favor. When the case was appealed to the Ohio Supreme Court, the justices backed Rancman on the grounds that Ohio's champerty law makes litigation finance illegal in the state. The Ohio Supreme Court upheld this traditional view, ruling that the champerty law, on the books since 1823, invalidated the litigation finance contract signed by Rancman. "A lawsuit is not an investment vehicle," the court wrote. "Speculating in lawsuits is prohibited by Ohio law. An intermeddler is not permitted to gorge upon the fruits of litigation."

Litigation financiers contend that they violate prohibitions on champerty only if they actively meddle in a suit (by advising a client on whether to take a particular settlement offer, for example). But the Ohio court saw any investment, no matter how hands-off, as de facto meddling. The act of investing in a suit changes the math of that suit, creating a dollar figure under which it is not in the plaintiff's interest to settle.

Litigation financiers and their defenders, however, see the Ohio case more as an indictment of unscrupulous companies than of the industry as a whole. Susan Lorde Martin, a professor of business law at Hofstra University and one of the few academics who have studied litigation finance, said the case was an instance of bad facts making bad law. She said she believed the judges "were outraged at the 280 percent that [Future Settlement was] getting. I think they just didn't like that and they were going to find against them one way or the other." Joe DiNardo of PSS said the judges "probably just threw their hands up and said, 'We can't let this happen.' I'm not sure they really thought it through." DiNardo's concerns that the defendants in Rancman were giving his industry a bad name didn't stop him from signing on to an amicus brief on their behalf. Ohio is the seventh-most populous state in the union, and PSS didn't want to lose millions of potential customers.

The questionable practices of companies like Future Settlement notwithstanding, other states are not following Ohio's lead. In recent years, many have struck down their champerty laws, arguing that the original reasons for the prohibition no longer exist. During the 1990s, as state courts in Florida and New Jersey upheld the legality of specific litigation finance contracts, courts in Massachusetts, South Carolina, and New Hampshire lifted their prohibitions on champerty altogether. The South Carolina court reasoned that "other well-developed principles of law can more effectively accomplish the goals of preventing speculation in groundless lawsuits and the filing of frivolous suits than dated notions of champerty," which it noted had not come up as a substantive matter before the court in over 170 years. The court seemed to feel that it could permit litigation finance without making it legal for an investor to act as an "officious intermeddler . . . stirring up strife or continuing a frivolous lawsuit."

LITIGATION FINANCE SUPPORTERS LIKE SUSAN LORDE MARTIN argue that far from funding frivolous cases, investors gravitate toward those cases that are most worthy of support. Adam Smith's "invisible hand" pushes profit-seeking litigation financiers to serve the common good by backing, in Martin's phrasing, "impecunious plaintiffs with meritorious claims."

PSS clients Tom and Tracie Knauer seem to fit that description. I met the Knauers at their home in suburban Buffalo. They were dressed in matching gray-and-black outfits, Tracie in a knee-length skirt, Tom in black sweatpants. Sitting on the couch in their living room, a golden retriever at their feet, Tracie explained the couple's ordeal, with Tom adding occasional comments, like a confident fifth grader piping up at a parent-teacher conference.

In 1998, Tom fell from a ladder mounted on a truck while doing electrical work for his brother's company, Knauer Electric. He landed on his head and was taken to the hospital unconscious. He came to a week later and was discharged after three months, but as Tracie says, he was not "the Tom that we knew." Tom walks with a limp and his eye movement is limited, barring him from ever working as an electrician again. But the real difference is in his personality. His short-term memory is weak. With a PalmPilot that he constantly checks, he can accomplish simple tasks such as picking up his daughter at school or doing the family's food shopping, but his mind plays tricks on him. When I left a phone message with him to set up our interview, he told Tracie that I was the "legal affairs reporter for The New York Times" and fully believed that I had told him this. Tracie has dubbed these false memories "the Tom Knauer thing," and she has learned to deal with it. After we cleared up the matter at our interview, Tom quipped, with a faint smile, "That's my story and I'm sticking to it."

While Tom's pleasant disposition and growing ability to pitch in with household chores has helped, the financial hit of losing the family's primary wage earner could not have been weathered without an influx of cash. "The phone calls never stopped, the letters never stopped," Tracie said, referring to her creditors. "We got that all cleared away when Joe's company came in."

Tracie still works seven days a week as a bookkeeper, with freelance work supplementing her full-time job. "I didn't want to use this money to live on. I wanted to use it to get out of a hot spot right then and there. And once we got to a point where we could do something about it ourselves, then we did," she said. Six years after his accident, Tom has been awarded $11 million in court to be paid by Knauer Electric's insurance company, but an appeal is pending, so Tom and Tracie haven't yet seen a penny. "We borrowed around $13,000 at over 30 percent a year. I think we're probably up to around $40,000 that we owe back now." After getting the sentence out, Tracie started to cry and went off to the kitchen in search of tissues. When she returned to the living room and composed herself, she explained, "Certainly nobody likes to pay a ton of interest, but at the time—and I don't know that it was out of desperation—at the time, it was the best situation."

THE GROWTH OF THE LITIGATION FINANCE INDUSTRY in America is a recent enough phenomenon that clients still often hear about it through word of mouth. (Tracie Knauer heard about PSS through a friend—Joe DiNardo's wife.) But the practice of investing in lawsuits is ancient, as is the debate over whether it's ethical. The prohibition on champerty dates to Greek and Roman times, when advocates had to demonstrate a personal connection to the litigant, not merely a commercial relationship. Common law rules against champerty were an important component of medieval English law—part of "12th-century tort reform," as Brooklyn Law School professor Anthony Sebok put it. These rules against champerty were the only legal barrier preventing wealthy nobles from harassing their disfavored subjects by getting them dragged into court, or from increasing their land holdings by funding suits in exchange for a share of the disputed property.

With the decline of feudalism, however, many legal and social theorists began to see the prohibition on champerty as a protector of entrenched wealth and power rather than a check on it. British political philosopher Jeremy Bentham attempted to vindicate the "hard-named and little-heard-of practice of Champerty" in his Defence of Usury, a published series of letters he wrote to Adam Smith while on a trip to czarist Russia in 1787. Bentham regarded antichamperty laws as dating from "the barbarous age . . . of feudal anarchy." Because of such laws, he wrote, "That branch of justice, which is particularly dignified with the name of equity, is only for those who can afford to throw away one fortune for the chance of recovering another. . . . Wealth has indeed the monopoly of justice against poverty." In oral arguments before the Ohio Supreme Court in 2003, the litigation finance firms' attorney echoed Bentham, albeit in less stirring language, arguing that his clients' service "helps personal injury plaintiffs level the playing field against insurance companies."

In contemporary America, litigation finance is one of those odd issues where liberals and conservatives have to choose between their hearts and their minds. Conservatives' visceral outrage at American litigiousness, especially in personal injury cases, makes them wary of litigation finance. Yet free market principles would lead them to support a free market in lawsuits. The right to sell risk you're not equipped to shoulder is a basic freedom afforded by capitalism. If you can sell the risk that your soybean crop won't come up to a commodities broker in Chicago, why shouldn't you be able to sell the risk that you'll lose your lawsuit to a litigation financier in Las Vegas?

Conservative legal scholar Walter Olson, a fellow at the Manhattan Institute, describes himself as a "skeptical observer" of the litigation finance industry. He squares his distaste for litigation finance with his conservative values by arguing for the traditional view that in the professions like medicine and law the pursuit of maximum profit must be secondary to certain principles. Olson argues that an attorney's loyalties "must be in part to the system and its integrity," not merely to his client or his firm's bottom line. As Olson put it, selling legal services is different from selling "pieces of furniture."

Liberals, though they tend to be wary of the inequality of the unfettered free market, typically defend litigation finance for leveling the playing field between poor but meritorious plaintiffs and the rich, powerful companies offering them lowball settlements. Yet Susan Lorde Martin and others acknowledge that in any lending market that targets the poor, there is the opportunity for lenders to take advantage of desperate customers. It's the difference between a soybean farmer and a sharecropper.

It is an open question whether litigation finance clients are freely selling part of the risk that they could lose their suits, or whether, in order to pay for necessities like food, shelter, and clothing, they are selling a stake in the only nonessential asset they have. While Martin is concerned about predatory lending, she takes solace in knowing that a potential litigation finance customer has an expert adviser close at hand—his attorney. Peter Choharis, a lawyer in Washington, D.C., who has written about litigation finance, agrees that the unequal bargaining position of the potential customer is "a real concern," but asks, "What's the alternative? They lose their house. Is that a better alternative?"

ONE REASON THAT LITIGATION FINANCE FIRMS have only now begun to overturn the centuries-old prohibitions against champerty may be the weakening of the American social safety net. Government welfare programs have been scaled back and private companies have become less likely to provide health insurance for their workers. Today's United States may be the only country in the developed world where people can go from comfortably middle-class to financial ruin with one car accident or workplace injury—a point made last fall by then-presidential candidate John Edwards in his "Two Americas" stump speech. "Middle-class families have gone from being able to save for retirement or buy a house, to now teetering on the edge of bankruptcy," he said. "These aren't poor Americans; they're the working middle class. And they are terrified that if something goes wrong—a lost job or a health care disaster—they're just one bad break away from falling off the cliff." Edwards claimed his trenchant understanding of middle-class American life was the result of his modest upbringing. More likely it was from his work as a personal injury lawyer, representing those formerly middle-class Americans who had fallen off the cliff.

Edwards's view is the natural conclusion one would draw from spending time around people like Tracie Knauer, who told me, "When you're in debt and you have all your credit cards, but you're making your monthly payments, life is good. You're both working and you're just doing what everybody else does. And all of a sudden that comes to a grinding halt and you find yourself in debt. All of a sudden you can't cover it anymore."

Knauer's use of a gambling metaphor was telling. Thanks perhaps to Perry Walton, Las Vegas remains a hub for the litigation finance industry. Las Vegas proved long ago that desperate people make great customers. And just like Las Vegas, which turned small-time illegal books and numbers games into a legitimate multibillion-dollar business with backing from mainstream banks, the litigation finance industry is currently in transition from a loan shark operation to an aboveboard business. Joe DiNardo of PSS and about a dozen firms in the industry are in the process of organizing ALFA, the American Litigation Finance Association, to create a code of conduct for the industry. Because of antitrust laws, the group cannot regulate rates, but it can set standards on issues like disclosure of rates and contract terms. The organization is expected to be up and running by the end of the year.

ALFA's backers see this type of self-regulation as the industry's best shot at legitimacy, if not yet respectability. As the pioneers of Las Vegas proved, it takes only legitimacy, not respectability, to make money. PSS, for one, seems well on its way. With its competitive rates and national advertising, the firm has grown from a small, local company to one that invests in cases nationwide. When DiNardo took over the firm just over a decade ago, it had a portfolio of cases worth $1 million; today that figure is $13 million. Litigation financiers, once reliant on friends and family for their investment dollars, now court Wall Street hedge funds. The litigation financiers I spoke with seemed confident the high-stakes gamblers at the foot of Manhattan will conclude that betting on ever-increasing litigiousness and desperation is a pretty safe wager.

Daniel Brook last wrote for Legal Affairs about prison rape.

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