NY Consumer Law Is First Step in Combatting Predatory Lending

New York’s new Consumer Litigation Funding Act brings much-needed change to consumer litigation funding, which has spiraled into an unsupervised and often predatory lending space.

The law, which takes effect in June, requires plain-language contracts and caps litigation funders’ payment at 25% from any settlement or judgment. While this is a critical first step to improving the industry, more needs to be done to protect plaintiffs while they pursue their case.

When the litigation funding industry began in the 1990s, it offered plaintiffs a chance to secure additional financial support during pending litigation. It can’t be used to finance litigation or cover legal expenses. It was designed to offer a lifeline, so plaintiffs don’t have to face financial ruin as they seek justice.

For middle and low-income plaintiffs, the alternatives are limited: Give up pursuing the merits of their case and accept a smaller settlement that can help cover bills and daily expenses; take on high-interest debt options; or take financial risks such as mortgaging the house if litigation takes a long time to resolve.

But the lack of regulations around litigation funding threatens to harm the very plaintiffs it was intended to help in the first place.

For-Profit Lending

There is no federal cap on interest rates that for-profit lenders can charge for consumer litigation funding. Annual percentage rates on advances in this market range from 30% and can soar as high as to 124%. For comparison, credit card APRs usually sit around 23% to 30%.

For-profit lenders get around many states’ usury laws and other consumer protections because litigation funding advances are non-recourse, meaning if the case does not settle, the plaintiff does not have to pay anything back. So, theoretically, plaintiffs won’t fall into the debt-spiral triggered by other types of high-interest advances (like payday loans).

However, these lenders find plaintiffs when they’re already in distress and have the ability to lock them into exorbitant, complex repayment schemes.

Three Scenarios

Take the hypothetical cases of three families who borrowed $10,000 with rates ranging from 15% to 50%. They received advances anticipating out-of-court settlements for medical malpractice, an area in which complex cases can take up to five years to resolve.

After three years, with balloon payoffs of principal and interest:

• Family A faces a 15% simple interest obligation totaling $14,500.00 ($4,500.00 interest).
• Family B confronts a 30% monthly compounded interest burden amounting to approximately $24,325.35 ($14,325.35 interest).
• Family C endures a 50% monthly compounded interest liability reaching about $43,474.60 ($33,474.60 interest).

For families who accept high-interest funding, like families B and C, the interest paid on the advances alone can take a large chunk of their settlement that otherwise could help them rebuild.

While these families’ stories are hypothetical, they mirror the reality of thousands of families across the country who rely on pre-settlement funding to make ends meet. New York’s new law creates some new protection for families like these.

Correcting the Market

The Consumer Litigation Funding Act had bipartisan support, co-sponsored by both Democratic and Republican state senators.

Once it takes effect on June 17, it will strengthen transparency and consumer protections by clear disclosures, cancellation rights, and limits on excessive recoveries, along with state registration and oversight.

Litigation funders won’t be able to take more than 25% from any settlement or judgment. They also must guarantee clients a 10-day right of rescission and register with the New York Department of State. They also may not interfere with settlement decisions, use misleading advertising, or refer people to specific attorneys or medical providers.

However, the bill doesn’t cap interest rates that lenders can charge, nor does it impose rules or restrictions on the types of fees that can be charged. As the legislature looks to further protect plaintiffs, these areas must be targeted for reform and additional oversight.

Litigation funding should provide plaintiffs with a bridge to seek justice, not expose them to additional risk after trauma.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law, Bloomberg Tax, and Bloomberg Government, or its owners.

Author Information

Rachel McCarthy is executive director, and Tabitha Woodruff is director of development, at the Milestone Foundation, a nonprofit consumer litigation funding organization.

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