When Loans Are Involved in Lawsuits: How Consumer Litigation Funding Affects Lawsuits in the U.S. 

By | August 26, 2022

The U.S. is one of the world’s most litigious countries. According to a 2010 New York Times article, “we spend about 2.2% of gross domestic product, roughly $310 billion a year, or about $1,000 for each person in the country on tort litigation, much higher than any other country.” The defendant of a tort claim is commonly an insurance company or a corporation, and a tort claim might take up to several years to resolve. Consumers, who often lose vital income due to an inability to work as the result of injuries or property damage, are often financially constrained when trying to pay for their daily expenses, such as utility bills, mortgage payments, rent, or extensive medical expenses since insurance companies do not typically help them cover those expenses upfront. With most U.S. households living paycheck to paycheck, it is very common for consumers to become constrained financially after an injury. Hence, consumers often cannot afford to fight lengthy and tedious litigation and hence choose to settle with insurance companies for a much smaller compensation in exchange for quicker cash rather than further pursue the claim to its actual value. Indeed, many tort claims are settled out of court. In other words, during the bargaining process between the plaintiff and the insurance company, the plaintiff could be at a financial disadvantage due to financial constraints. 

What happens if individuals have third-party financial support (or a loan) when pursuing a tort claim? This is where Consumer Litigation Funding (CLF) plays a role. In my new paper, I study how CLF affects lawsuit caseloads and outcomes in court in the U.S. 

What is Consumer Litigation Funding?  

CLF provides non-recourse cash advances to consumers to pay daily expenses when pursuing tort claims. In return, when consumers get compensation from their claims (awards from trials or settlements), they pay back the CLF companies the principal and interest. However, it’s a non-recourse contract in the sense that if the consumers do not win the case, they are not obligated to pay the CLF company anything.  

Why do we care about CLF? 

CLF can play a critical role in helping consumers obtain the justice they deserve. However, critics are concerned that CLF will lead to more tort lawsuits and overburden civil courts. 

Theoretically, whether access to CLF makes a consumer plaintiff more likely to bring their case to court for litigation is unclear. On the one hand, when a consumer plaintiff has access to CLF, the consumer’s need for cash from the claim is less urgent. As a result, the plaintiff can pursue the case for its full value by bringing the case to court. On the other hand, the lawsuit negotiation is, in fact, a game among four parties: the plaintiff, the defendant, the plaintiff’s attorney, and the CLF company. A theoretical model built by Daughety and Reinganum (2014) predicts that when the plaintiff has private information about damages, the optimal plaintiff-funder CLF contract induces all plaintiff types to make the same demand, which results in a full settlement. In other words, their model predicts that CLF induces settlement rather than litigation. Intuitively speaking, if the insurance company knows that the consumer is funded by CLF companies and could pursue the case to its full value, the insurance company would be motivated to settle early to avoid the extensive costs of going to court and trial. With these two conflicting theories, whether access to CLF increases or decreases the likelihood of a consumer plaintiff bringing a tort claim (hence, the caseload in court) remains an open question. Furthermore, if CLF results in more lawsuits in the court system, does that promote justice or lead to more frivolous lawsuits? 

What are the laws and regulations regarding CLF? 

Federal and state legislatures in the U.S. have been debating how CLF affects caseloads and legal outcomes in court as well as how to regulate the industry. The debate continues mainly because we know little about the implications of the CLF industry.  

States are ramping up their oversight over CLF. There are mainly four types of regulation applicable to CLF: prohibition and validation, interest rate caps, disclosure, and licensing. Prohibition invalidates CLF contracts in that state. Interest rate caps impose an interest rate limit at which CLF companies can charge consumers. Disclosure requires that CLF contracts be more transparent and sometimes be revealed as evidence in court. Licensing requires that CLF companies have licenses to practice CLF business.  

Among these four types of laws and regulations, prohibition and interest rate caps are a negative shock that resulted in a significant decrease in CLF business in the states that passed such laws. For example, in 2003, the Ohio Supreme Court denied the validity of CLF contracts in Rancman v. Interim Settlement Corp during a trial. In another example, in 2005, the New York Supreme Court imposed an interest rate cap on CLF contracts in Echeverria v. Estate of Lindner because the Court determined that CLF contracts should follow the state’s usury law. The states’ usury statutes used in this study impose an interest rate cap ranging from 7% to 30%, and CLF’s annual percentage rates (APR) are commonly over 150% (Garber, 2010). Therefore, the caps used in this study are binding for high-cost funders and cause low-cost funders to scale back on high-risk advances. After these two types of laws were passed, many CLF funders pulled their funding away from those states, reducing the total supply of CLF loans.  

Empirical findings in this study 

In my study, I take advantage of six states’ prohibition and interest rate caps laws (which resulted in a decrease in the supply of CLF) as quasi-experiments and examine how the number of tort lawsuits changes and how the plaintiff’s win rates at trial change after the laws were implemented. I obtained novel county-level lawsuit data from 1,080 counties from 2000 to 2018, which includes about one-third of the U.S. population. Court caseload data are from each State’s Court Administrative Offices, and plaintiff win rate and duration data are from a proprietary data source, Premonition, a litigation analytics company.  

I apply a difference-in-differences analysis of the number of tort lawsuits filed in court and find evidence that in the two years after the states restricted CLF, for every 10,000 people in a county in a treated state (that passed laws restricting CLF), 1.28 fewer tort lawsuits were filed in court compared to a county in a control state (that did not pass laws restricting CLF). I further use counties in neighboring states that are within 100 miles of the treated counties as control counties. I find that for every 10,000 people in a county in a treated state, 2.71 fewer tort lawsuits were filed in court compared to a county in a control state — an 18.7% drop in the number of tort lawsuits filed. That means that, on average, for a county like Maricopa County in Arizona, which had a population of 4.018 million in 2015, there were about 1,089 fewer tort lawsuits filed per year during the first two years after the restriction of CLF. If we use the lower bound of $15,000 in litigation costs for each tort case, that is a $16.3 million dollar reduction in litigation costs in that county per year. I also run a few other robustness tests, and the results are consistent. Overall, the evidence supports the notion that access to CLF results in consumers being more likely to bring tort lawsuits to court. 

Furthermore, I conduct a difference-in-differences analysis of plaintiff’s win rate in civil lawsuits to examine the outcome of lawsuits due to CLF. Plaintiff’s win rate has been an enduring use in both theoretical and empirical research to study the changes in legal rules. I find that following the state laws that restricted CLF, the proportion of civil lawsuits going to trial did not change. However, the plaintiff’s win rate, defined as the proportion of trials in which the verdicts or judgments favor the plaintiffs, significantly increased by 5.9%. This is a big increase, as the average plaintiff win rate before the law changes is around 55%. Such findings are consistent with the notion that the plaintiff’s win rate drops due to access to CLF. 

Finally, I also find that the average duration of civil lawsuits, defined as the number of days from the lawsuit filing date to the disposition date, significantly dropped after the state law changes restricting CLF.  

Implications of the findings 

First, I find that more tort lawsuits are brought to court due to access to CLF. This shows that the incentives of the consumer plaintiffs to hold out on settlement due to lessened financial constraints could play a bigger role than the incentives of the defendants to settle. Second, I find that plaintiff win rate in civil lawsuits drops due to access to CLF. There are two possible explanations for this. One possible explanation is that CLF incentivizes plaintiffs (and their lawyers) to be more risk-taking in pursuing a case (potentially for higher compensation). This doesn’t necessarily mean the lawsuit is frivolous but could mean that the case has high value and is worth pursuing, even though the chance of winning is lower. This might be because consumer plaintiffs now have financial backing from CLF companies to pursue the casePlaintiffs are more willing to take risks due to the risk sharing of the CLF companies. ; without CLF, they might not be willing to take such risks. Another possible explanation is that plaintiffs’ behaviors change when funded by CLF. Specifically, plaintiffs utilizing CLF may behave less seriously and professionally during the litigation process before and at trial than if they have not been financed by CLF. They may be somewhat indifferent about whether or not they win the case because they have already received cash advances from CLF companies, and even if they lose the case, they don’t need to repay the loan. This could result in delays or incomplete preparation of evidence, and the plaintiff’s misbehavior at trial could encourage bias or prejudice in the decisions of the judge or jury against them. In other words, the problem of moral hazard might exist in such loan relationships. 

Overall, this study documents how access to external funding affects one important category of consumers’ socioeconomic decisions: legal decisions. The empirical evidence in this paper helps address the conflicting theories on economic agents’ decisions in equilibrium when consumers have access to CLF. There are only a few empirical papers studying CLF, and none addresses the question of whether CLF makes a tort claim more or less likely to be filed in court. This study fills the gap and serves as an initial step to address this question and provides evidence that CLF results in higher court caseloads and lower plaintiff’s win rates at trial, which concerns both litigation costs (which are ultimately paid by taxpayers) and civil justice in our society. Finally, policymakers have been concerned about CLF bringing more lawsuits to society. This study serves as an important first empirical step in addressing these important questions. It could have important policy implications within the U.S. and in foreign countries that have used or plan to use CLF. In future research, scholars could benefit from detailed settlement terms data to further explore the mechanisms underlying the CLF effects documented in this study and pin down the net effects of CLF.  


Mengming (Michael) Dong is an Assistant Professor of Finance at the College of Business at California State University Long Beach, and a Visiting Scholar at the Jones Graduate School of Business at Rice University 

This post is adapted from the author’s paper, “Consumers’ Financial Constraints, Lawsuit Decisions, and the Civil Justice System”, available on SSRN. 

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