Selling structured settlements: boon or boondoggle for injury victims?

Trial attorneys are accustomed to accepting trade-offs when settling claims for injured clients. In the typical scenario, the client trades a lump sum for a stream of smaller payments spread out over time--the classic structured settlement.

But what happens when the client wants to trade back?

That option is being offered by the emerging "settlement purchase" industry, barely heard of even a few years ago. Companies that started out offering lottery winners lump sums in exchange for the right to collect their future payments have begun offering tort claimants immediate cash in return for all or part of their future income from a structured settlement payer. The trade-off for the client: The lump sum is substantially less than the present value of the payments the claimant agrees to give up.

Via cable television and the World Wide Web, news of this settlement transfer market is reaching consumers. The industry is growing and, along with it, controversy about whether these transactions are boon or boondoggle for tort claimants.

The debate has spawned an unusual alliance of insurance companies, consumer advocates, disability groups, and trial lawyers who oppose settlement transfers. Insurers, who have a vested interest in protecting their tax-favored structured settlement business, say anti-assignment clauses typically included in settlement agreements prohibit the claimant from transferring payments to another party. Insurers are refusing to honor transfers and are asking courts and lawmakers to sharply restrict these transactions.

Although they rarely see eye to eye with the insurance industry, a few state trial lawyer associations as well as consumer and disability organizations--including the Consumer Federation of America, the National Organization on Disability, and the Spinal Cord Injury Association--are also supporting restrictions.

This unlikely alliance "isn't so odd if you look at it historically," said Randy Dyer, executive vice president of the Washington, D.C.-based National Structured Settlements Trade Association (NSSTA), an organization of settlement brokers, attorneys, and insurance companies that make periodic payments to claimants. "Structured settlements have been a favorite of both of these parties in the physical injury settlement business for a long time. Both sides do it when it's right. It's the one bit of neutral territory in the tort wars."

Advocates for consumers and injured people who oppose the transactions say they defeat the purpose of structured settlements and argue that vulnerable people are being preyed upon by a largely unregulated industry.

"The profile plaintiff in these cases is someone for whom at an earlier point, for what seemed to be good reasons and with the advice of counsel, a vehicle was sought to protect the plaintiff in terms of his or her financial future," said Philadelphia attorney David Shrager, who represents a class of plaintiffs suing industry leader J.G. Wentworth & Co. over its settlement purchasing practices. "Suddenly, these people are selling out their financial protection in what is essentially a loan-sharking scheme at rates of 20, 30, or 40 percent, sometimes higher."

David Bossart, a Fargo, North Dakota, plaintiff attorney and critic of settlement transfers, said trial lawyers' "ethical, legal, and moral responsibility is not only to do the best we can to get clients fairly compensated, but to help them preserve this award. Any competent lawyer, in my view, should not [advise his or her clients to transfer a settlement]."

The settlement purchasers, also known as "factoring companies," counter that they provide a valuable service to people whose financial circumstances have changed but who find their money locked in an inflexible settlement.

"The assumption that claimants are incapable of making reasoned financial decisions if provided full information is unsupportable," according to a statement from the National Association of Settlement Purchasers (NASP), the Washington, D.C., trade organization representing the industry. "The vast majority of claimants are competent to handle their own financial affairs and do so in all other contexts.... In virtually every case, the claimant only sells enough of the future payments due to solve their immediate financial needs." NASP cites accounts by customers who say they were happy to trade future payments for cash to pay education expenses, buy homes, expand businesses, or satisfy debts.

Not all trial lawyers agree that these transactions are harmful to settlement recipients. Michael Harris, a Burlington, Vermont, plaintiff attorney, said transfers can help when clients have needs that were unanticipated at the time of settlement.

"There are people with changed life circumstances, and to have them locked into these [periodic] payments is unfair and harsh," said Harris, who represents a client seeking to force the settlement payer to honor her contract with a factoring company. "There should be a way for them to get out, and when they do so, they should do it cautiously and with advice of counsel." The view that tort claimants are too unsophisticated to make informed decisions about transfers is "too simplistic and one-sided," he added.

Eliot Gersten, an attorney in Hartford, Connecticut--a state that recently passed legislation regulating factoring transactions--agreed that circumstances might warrant the sale of future settlement income. "A decision to gain access to a lump sum should not be summarily dismissed," said Gersten, who has represented both buyers and sellers of payments under Connecticut's new procedures. "Former victims have the right to use their own money if they are adults and understand what they are getting and what they are giving up."

But opponents tell horror stories of claimants who gave up substantial future payments without full disclosure of the terms of the transaction, only to dissipate the cash quickly and end up in dire financial straits.

One customer with regrets is Jerry Magee of Magnolia, Mississippi, the lead plaintiff in the Philadelphia class action. According to court papers, Magee transferred his right to collect 48 payments of $600 each (with Wentworth keeping $400 and returning $200 to Magee) in exchange for a lump sum of $9,195. The lawsuit claims Wentworth did not adequately disclose the total amount of money Magee was handing over to the company and the "effective interest rate" Wentworth charged Magee--roughly 54 percent, according to the complaint.

"Using the lure of `cash now,' Wentworth preys upon the financially vulnerable and unsophisticated, persuading them to accept up-front payments which do not even approximate any commercially accepted concept of the fair present value of their structured settlement sums," the complaint says.

The lawsuit contends that the transactions are essentially loans from the factoring companies to the claimants and should be subject to consumer protection and lending laws. The case accuses Wentworth of usury, unfair trade practices, fraud, and violations of the federal Truth in Lending Act. (Magee v. J.G. Wentworth & Co., Inc., No. 001552 (Pa., Philadelphia County C. P., filed Nov. 10, 1998).)

Industry denial

The industry denies that it is in the lending business and that its interest rates, or "discount rates," are out of line. Robin Shapiro, general counsel of Florida-based Singer Asset Finance Co., a NASP member company, said the discount rate is the amount of interest a seller would have to earn on the lump sum to compensate for the payments given up. Typical discount rates range from 18 percent to 21 percent, NASP says, rates comparable to those charged by credit card companies.

But the calculation of the discount rate depends on how it is defined. A bill pending in Congress that would heavily tax settlement purchases defines the "factoring discount" as the difference between the amount the company pays the seller and the total of the payments the seller would have collected over time. The bill would require factoring companies to pay 50 percent of this difference as an excise tax every time they buy a payment stream.

Critics point to the logistics of the transfer as evidence that the deals are shady. Typically, the structured settlement recipient instructs the insurance company making the payments to send future checks to a new address. The new address is a post office box controlled by the factoring company, which retrieves the checks and uses a power of attorney granted by the seller to cash them.

Magee's lawsuit calls this arrangement a "subterfuge" that allows Wentworth to get around the anti-assignment clause in the settlement agreement.

Kentucky case

Last year in a separate case, a Kentucky trial court agreed and held that Wentworth's contracts with four structured settlement recipients were invalid. The claimants had failed to forward their checks to the Wentworth post office box, and the company then went to court to enforce the contract.

Judge John Potter of the Jefferson County Circuit Court said the transfers "did not constitute valid, legal assignments" and concluded that "Wentworth has attempted to accomplish by sleight of hand what it is prohibited from doing directly." He added that Wentworth paid the claimants "with the full knowledge that the assignment might not be recognized.... Presumably, this is the risk that justified using a 60 percent per year discount rate." (J.G. Wentworth S.S.C. v. Jones, Nos. 97CI5285, 97CI5509, 97CI5953, 97CI0007 (Ky., Jefferson County Cir. Ct. July 20, 1998).)

Shapiro said other courts, under common law, have invalidated contract provisions that make the receipt of payments unassignable.

"Obviously, one can't assign an obligation to pay money, but the right to receive money can be assigned or pledged to others--even in the face of a contractual provision that purports to bar a pledge or assignment," he said. "This is a very well settled concept."

He cited [sections] 9-318(4) of the Uniform Commercial Code, which states that a contract term "is ineffective if it prohibits assignment of an account or prohibits creation of a security interest in a general intangible for money due."

The settlement purchase dispute, laden with complex tax and contract issues and warring parties with major business interests at stake, has led to a flurry of legislative activity. Rep. Clay Shaw (R-Fla.) introduced the excise tax bill (H.R. 263) in the House of Representatives in January, which reflects a similar proposal in the Clinton administration's fiscal year 2000 budget. The Senate is also considering an excise tax bill.

At the state level, the two primary adversaries on the issue--NASP for the factoring companies and NSSTA for the insurance industry--are lobbying for different model legislation that would regulate the settlement purchase industry.

The bill backed by insurers calls for court approval of all settlement transfers. "Before the damage is done, a neutral third party should be allowed to look over the transaction," said NSSTA's Dyer. "We should give these transactions the light of court oversight."

Other provisions in the bill include written notification to the structured settlement recipient of the terms of the deal and proof that the seller is in financial hardship. The legislation also would require all parties, including the insurance company making the periodic payments, to consent to the transfer.

Dan Zielinski, a spokesman for the American Insurance Association (AIA), NSSTA's partner in pushing for tight restrictions, said the model bill puts some "commonsense speed bumps in the process so people understand what they might be losing" when they decide to trade away future income from a settlement.

But NASP argues that the insurers' bill is a veiled attempt to put the factoring companies out of business. "It's a ban masquerading as regulation," said Shapiro, citing in particular the provision for insurer consent to transfers.

NASP's model bill calls for full disclosure to sellers of the terms of the agreement, including the discount rate; an admonition that the seller should consult his or her own lawyer before entering into the transaction; the right to cancel the contract within three days of signing; and court approval in cases when the initial settlement was approved by a court.

"We think there's a role for the courts to play in reviewing a consumer's decision" to sell future payments, Shapiro said. "But there needs to be a tiered approach. You wouldn't expect a court to have to review and approve every settlement, no matter how small. Similarly, we don't think the courts should have to review and approve every sale, even if the consumer was only seeking to raise $10,000." He said transaction costs associated with obtaining court approval for even relatively small transfers would make closing the deal prohibitively expensive for many would-be sellers.

Lawmakers in a number of states have passed bills, but provisions vary from state to state.

Until clear-cut rules are outlined regarding settlement purchases, the best advice for consumers may be "seller beware." People considering whether to trade their future income for cash, Vermont attorney Harris said, "should get advice of counsel and decide whether or not it's really in their best interests."