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Caveat Emptor: Legal Funder Beware

Republished with permission from Legal Funding Central

Caveat emptor: let the buyer beware. It’s not often that a legal phrase enters the common vernacular — and it happens even less often when that phrase is in Latin. But this one has, and for good reason: it’s great advice. Whenever you make any kind of purchase, you should be wary of who’s selling it to you — and why. The phrase even applies to legal funding: let the buyer — the funder — beware the seller — the attorney or litigant seeking funding.

There’s no doubt about it: there are a lot of risks to consider when making a legal funding “purchase” — which is one of the reasons why legal funding will always be relatively expensive, compared to traditional financing options. We usually consider the risks that plaintiffs face when we think of legal funding, but funders themselves often have immense risks to consider. One such risk is the potential for an information asymmetry that favors the litigant or attorney. That is, when the seller — a litigant or attorney — has vital information that the buyer — the funding company or investor — doesn’t. Caveat emptor, indeed.

Consider this example: a plaintiff with a motor vehicle accident case seeks legal funding. He knows that the accident was actually his fault, and that his injuries were not as bad as he claims. He understands that his case may end in his favor if nobody realizes the truth, but he may want to hedge his bet now, in case someone does find out and he has no recovery.  Since legal funding is non-recourse, he could, feasibly, receive an advance and never have to pay it back. Sounds like a win-win for him — and a legal funder’s nightmare.

Unlike some types of investments, evaluating a legal funding investment is primarily a qualitative endeavor.  And the earlier on in the case, the less the facts have been established, the more opportunity there is for people to take advantage.  This is one reason that many legal funding companies only advance very little amounts early in a case, or else wait for a case’s facts to become established before making a funding decision at all.

Of course, contingency attorneys also have a similar risk when they take on a new client.  While legal funders invest their money in cases, contingency attorneys invest their time.  Not only that, but contingency attorneys often take cases right when the incident happens – when the risk of disinformation or misinformation is the highest.  However, unlike funders, who can only get their money back if a case succeeds, attorneys oftentimes have options to cut their loses as soon as they find out facts that were not entirely disclosed to them.

Information asymmetry not only affects the funding of individual cases, but affects the legal funding market as a whole.The risk that any given funding will be based on bad information drives up rates for all funding.  And there’s virtually no market at all for securitizing legal funding contracts – ironically in large part because potential buyers of those tranches of contracts are worried about what the legal funding companies who originated those fundings know that they don’t.

To paraphrase the Greek philosopher Socrates, “you can’t know what you don’t know.” And he never even had to evaluate a lawsuit.