Goutham Balaraman, Ph.D.
Chief Information Officer
What is Consumer Legal Funding?
Consumer legal funding companies provide funds to individuals to cover basic living expenses while pursuing legal claims. In return for those funds, legal funding companies purchase an interest in any proceeds individuals may recover on their legal claims. Individuals agree to make payments to the funding companies for any recovered proceeds. The individuals have no obligation to make payments if they do not obtain a recovery. In other words, the funding arrangement is “non-recourse”, and they must make payments only from the recovered proceeds.
A funding agreement between individuals and consumer legal funding companies outlines payments due. The payments reflect the funding company’s initial cost of purchasing the interest in the legal claim proceeds (sometimes referred to as an “administrative fee”) and its internal cost of obtaining the funds for the purchase. The payments that are due under the contract increase over time. This reflects the increasing costs of funds for the company and the costs of servicing the funding contract until the individual’s legal claim is resolved. These dollar increases in the payments due over time are often expressed as a percentage of the initial purchase price. They are sometimes referred to as a “percentage fee” or “usage rate”.
This article will review pricing practices employed by the consumer legal funding companies and provide the reader with tools to make sense of legal funding contracts.
What Are Percentage Fees? Simple vs. Compound Fee Accrual
Let’s look at two consumer legal contracts with fictitious companies, Alpha and Beta, that differ only in the percentage fee charged. An individual needs $1000 to cover immediate expenses, and the purchase cost charged by both companies is $250. The purchase price for the contracts with both companies is $1,250. Alpha charges a percentage fee of 2.5% with monthly compounding, while that of Beta is 36% simple interest. The annualized percentage fee for the contracts with Alpha and Beta is 34.49% and 36%, respectively. The schedule of purchased proceeds comparing Alpha Co. and Beta Co. is shown below. At 12 months, the amount owed under contract with Alpha is lower. However, the agreement with Alpha becomes more expensive than Beta from 18 months and after due to compound rate accrual.
|Schedule||Alpha Co.||Beta Co.|
|12 Months||$ 1,681.11||$ 1,700|
|18 Months||$ 1,949.57||$ 1,925|
|24 Months||$ 2,260.91||$ 2,150|
|36 Months||$ 3,040.67||$ 2,600|
What Are Common Legal Funding Pricing Terms?
The disclosure statement section in a non-recourse funding agreement outlines the schedule of purchased proceeds. The pricing structure embedded in the non-recourse funding contract determines the schedule of purchased proceeds. The pricing structure comprises different terminologies which are explained below.
Funded Amount: The amount of funds provided to or for the benefit of the individual under the non-recourse funding agreement.
Purchase Cost: The cost to the individual for the fulfillment and delivery of the funded amount by the consumer legal funding company. The purchase cost is charged upfront in a non-recourse funding agreement to help cover the origination cost. Some examples of origination expenses include document preparation fee, processing fee, application fee, underwriting fee, courier fee, wire fee, case monitoring fee and/or administrative fee. These charges can be (and often are) added to the funded amount and are not due at the time of funding.
How Do Purchase Costs Matter Over Percentage Fees?
Let’s look at two separate funding contracts with fictitious companies, Alpha and Beta, that differ in their purchase cost and the percentage fee for a $1000 funded amount. Alpha’s arrangement charges a purchase cost upfront of $200, and its percentage fee is 34% compounded annually. Beta’s contract charges a purchase cost upfront of $300, and its percentage fee is 32% compounded annually. Beta’s percentage fee is 2% lower than Alpha’s, so you might assume that Beta’s contract is “cheaper” for the customer. That’s not correct because of the upfront purchase cost charged by Beta, which is $100 more than that of Alpha. As shown in the schedule of purchased proceeds below, Beta’s higher purchase cost makes its funding more expensive than Alpha, despite its lower percentage fee.
|Schedule||Alpha Co.||Beta Co.|
|12 Months||$ 1,608.00||$ 1,716.00|
|18 Months||$ 1,861.39||$ 1,971.53|
|24 Months||$ 2,154.72||$ 2,265.12|
|36 Months||$ 2,887.33||$ 2,989.96|
Purchase Price: The sum of the funded amount and any purchase cost. This is the total amount of consideration paid by the consumer litigation funding company for purchasing the purchased proceeds. The interest in the proceeds from an individual’s legal claim purchased by a consumer legal funding company under the non-recourse funding agreement is outlined in the schedule of purchased proceeds.
Percentage Fee: The repayment schedule of the advanced amount grows based on a percentage fee which is a percentage with an accrual method. The standard accrual methods found in non-recourse funding contracts for the percentage fee are simple or compound fee accrual (see Exhibit 1 for an example). The simple fee accrual only accumulates on the purchase price. In contrast, the compound fee accrual accumulates on the purchase price plus the accumulated amount at the percentage fee.
Purchase Price Cap: Legal claims can take years to settle. During that time, the percentage fee can continue to accrue and grow into a few multiples of the original funded amount. Some contracts employ a purchase price cap to mitigate the impact of fee accrual. The purchase price cap is expressed as a multiple of the purchase price. For example, a funding contract has a purchase price of $1,000 with a percentage fee of 36% compounded annually. If the case is settled 4 years after funding, the amount owed would be $3,421.02 without a purchase price cap. With a purchase price cap of 2.5x, the amount owed at the end of 4 years would be $2,500.
How Do Percentage Fees Matter Over Purchase Costs?
Let’s look at another example like the one discussed in Exhibit 2, for $5,000 funded instead of $1,000. Alpha’s contract charges an upfront purchase cost of $200, and its percentage fee is 34% compounded annually. Beta’s contract charges a purchase cost upfront of $300, and its percentage fee is 32% compounded annually. Alpha’s purchase cost is lower by $100, a relatively small amount compared to the funded amount of $5000. As shown in the schedule of purchased proceeds below, Alpha’s higher percentage fee makes it more “expensive” for repayment 18 months or later, despite the lower purchase cost.
|Schedule||Alpha Co.||Beta Co.|
|12 Months||$ 6,968.00||$ 6,996.00|
|18 Months||$ 8,066.04||$ 8,037.79|
|24 Months||$ 9,337.12||$ 9,234.72|
|36 Months||$ 12,511.74||$ 12,189.83|
Minimum Payment: Legal funding contracts sometimes require a minimum payment contingent on the successful settlement of the underlying legal claim. This is usually to offset some of the origination cost associated with the funding process. For example, an individual is advanced $1000 with $200 in upfront purchase cost, a percentage fee of 3% compounding monthly, and a minimum payment of $1430. If the underlying legal claim is settled two months after the funded date, $1430 would be owed even though the percentage fee accumulates only to $1273.08 at the end of 2 months.
We looked at the various components that make up pricing in a consumer legal funding contract. In Appendix A, we summarize the pricing practices of different consumer legal funding companies.
How to Compare Legal Funding Pricing
In consumer loan products such as mortgages or personal loans, Annual Percentage Rate (APR) calculation factors in the interest, upfront fees, and any fees paid during the life of the loan. The APR allows an easy way for a borrower to compare the loan product offered by different financial institutions to determine the more favorable option. Some litigation funding contracts quote an annual percentage rate; based on our analysis, these contracts did not follow the consumer loan definition for APR by factoring in upfront purchase cost and ongoing percentage fee. The purchase cost, the percentage fee, and any purchase price cap should be factored in an APR for it to be amenable to comparing offerings by different funding companies.
While comparing litigation funding contract options at hand, it is important to make a holistic comparison incorporating purchase cost and percentage fee to determine the best option for the client. Exhibit 2 demonstrates the impact higher purchase costs can have on the schedule of purchased proceeds, even if the percentage fee is low. A better way to compare these products is to calculate the APR under the assumption that the purchased proceeds are paid in month 36 using the following definition:
The funded amount in the denominator is the total amount advanced to the claimant and excludes any upfront purchase cost. The total repayment amount at month 36 in the numerator is the amount that is due if the purchased proceeds are paid in month 36. For the contracts specified in Exhibit 2, the APR calculations at the end of month 36 can be calculated as shown below.
The APR calculation for Alpha at month 36 can be calculated in Excel using the following formula:
POWER (2887.33/1000, 1/3) – 1
The APR for examples discussed in Exhibits 1, 2, and 3 for Alpha and Beta Co. under the assumption that the purchased proceeds are paid in month 36 is summarized in the table below. Based on this APR value, it is easy to spot the “expensive” option for the client.
|Exhibit||Alpha Co.||Beta Co.|
|Exhibit 1||44.86 %||37.51 %|
|Exhibit 2||42.40 %||44.06 %|
|Exhibit 3||35.76 %||34.59 %|
In this article, we share an overview of the pricing practices in consumer legal funding contracts and discuss different components used in pricing consumer legal funding contracts. Illustrations as part of Exhibits 1, 2, and 3 demonstrate the nuances of how various pricing components can have a rather drastic impact on estimated payments. In the last section, we discuss the APR calculation to provide the reader with a framework to compare different legal funding contracts even if the terms are not identical.
Appendix A: Comparison of pricing practices across multiple funding contracts.
|Funding Contract||Purchase Cost||Percentage Fee||Purchase Price Cap|
|BFG Funding Group||Monthly Compounding||N/A|
|Cash4Cases Inc||Monthly Compounding||N/A|
|EvenUp Cash||Annual Compounding||N/A|
|Hope Funding||Fixed Two Buckets||Yes|
|Prime Case||Monthly Compounding||N/A|
|Resolution Funding||Monthly Compounding||N/A|
|Signal Funding||Fixed Three Buckets||Yes|
|US Claims||Semi-Annual Compounding||Yes|
|Cartiga||Simple / Annual Compounding||Yes|