Lawsuit financing is illegal, Ohio high court says.

The Ohio Supreme Court has unanimously affirmed that lawsuit financing in the state is illegal, basing its ruling on a theory that was not argued in any of the lower courts. The court declared the practice of advancing funds secured only by an interest in a pending lawsuit--and in this case, at a rate exceeding 180 percent per year--to be maintenance and champerty, both of which are prohibited by state statutes. (Rancman v. Interim Settlement Funding Corp., 789 N.E.2d 217 (Ohio 200:4).)

The two defendant companies are part of an emerging industry that provides cash to plaintiffs while their lawsuits are pending; in exchange the companies receive a portion of any settlement of verdict. The plaintiff, Roberta Rancman of Akron, Ohio, sought to have her contract with the defendants invalidated, arguing that the amount due under the contract constituted an excessive interest rate.

"[The plaintiff] argues, and the courts below held, that certain contingent advances on settlements are impermissible loans because the [financing companies] incurred virtually no risk in the transactions and because the potential profit on the advances exceeds the legally permissible interest rate," wrote Justice Maureen O'Connor. "[The companies] adamantly contend that the advances are investments, not loans, and note that there is no statute limiting the return on an investment."

But the court found that distinction to be irrelevant.

"It is unnecessary for the resolution of this case to determine the threshold level of risk necessary for a contingent advance to be treated as an investment rather than a loan," O'Connor wrote. "The advances here are void as champerty and maintenance regardless of whether they are loans of investments."

The court defined "maintenance" as assistance provided to a litigant by a party that does not have a bona fide interest in a case, and "champerty"--a form of maintenance--as assistance provided in exchange for a share of the potential award.

Surprisingly, none of the lower courts considered the issue of maintenance and champerty, instead agreeing with Rancman that the transactions were illegal under state usury laws.

"I think the supreme court wanted to stop the practice," said Akron lawyer Walter Kaufmann, who represented Rancman. "They found a legal theory that allowed them to do it completely." If the court had adopted the usury theory, he said, lawsuit-financing companies would have found loopholes and exceptions that would have allowed them to restructure and remain in business.

Rancman refused payment on contracts she had made with two financing companies that advanced money to her secured by the outcome of her case against State Farm Insurance Co. She had been injured As a passenger in a single-car accident and had filed suit against State Farm, claiming uninsured-motorist benefits under her estranged husband's motor vehicle policy.

Rather than wait for the resolution of the lawsuit, Rancman--against the specific advice of her attorneys--contacted Ohio-based Interim Settlement Funding Corp. about obtaining an advance on her pending claim.

Interim, on behalf of a second company, Future Settlement Funding Corp. (FSF) of Henderson, Nevada, forwarded $6,000 to Rancman in exchange for the first $16,800 she would recover if her case was resolved within 12 months, $22,200 if resolved within 18 months, of $27,600 if resolved within 24 months. The company forwarded Rancman an additional $1,000 secured by the next $2,800 she expected to collect on her claim. Rancman had no obligation to Interim if the case was not resolved in her favor.

After Rancman settled with State Farm for $100,000, she re turned the advances, with 8 percent interest. She then filed suit against the two companies, seeking rescission of the contracts and a declaratory judgment that the defendants' sales practices were "unfair, deceptive, and unconscionable."

During a two-day trial before a magistrate, Rancman's lawyers argued that lending money at such a high rate of return amounted to usury, regardless of the risk involved. The magistrate agreed, concluding that the transactions were loans that violated Ohio's usury law and provisions of the state's Small Loan Act.

After adopting the magistrate's findings, the common pleas court ordered repayment of the principal at 8 percent interest per year. The court of appeals agreed that the transactions constituted loans, and because neither defendant had obtained a license as required by the Small Loan Act, the loans were void and the defendants were prohibited from collecting any principal, interest, or charges.

Kaufmann said the companies argued that the transaction was not a loan but rather a "contingent cash advance" and that because of the shared risk involved, usury laws did not apply. However, he said, the supreme court used the risk argument against the companies, saying that if they were sharing in the plaintiff's risk that her case would be unsuccessful, then the transaction was champertous and illegal.

"The [lawsuit-financing] industry can no longer write contingent agreements in the state of Ohio," Kaufmann said. The companies "have to write them as straight loan agreements." He noted that making a loan secured by the outcome of a lawsuit is not necessarily against public policy as long as the lender is licensed, clearly states that the transaction is a loan, and charges only a legal rate of interest.

"These companies really preyed on desperate people," he said. "They knew exactly who their targets were, and they structured their deals in such a way that they were virtually assured that they were going to get their money."