Ninth Circuit Questions Whether Litigation Funding Advances Made Against a Portfolio of Cases Runs Afoul of New York Usury Laws
No Sure Thing!
Ninth Circuit questions whether litigation funding advances made against a portfolio of cases runs afoul of New York usury laws.
On June 11, 2020, the U.S. Court of Appeals for the Ninth Circuit certified a question for the New York Court of Appeals: whether a litigation financing agreement qualified as a “loan” or “cover for usury” under New York law where repayment of advanced funds may come from attorney fees in unrelated litigation, and therefore runs afoul of the state’s usury laws.
“Applying these state-law doctrines to a novel type of contract—secured financing agreements like the ones in this case—is a job most suitable for the highest court of the state whose law is in question,” a panel of the federal appeals court wrote in a 25-page order.
The question arose from an appeal by Santa Rosa, California, attorney Richard Sax of a lower court’s decision that the contracts Sax entered with litigation funder Fast Trak were enforceable and thus not usurious loans.
According to court documents, the agreements included conditional payment obligations for separate cases, which “well exceed” New York’s civil statutory maximum of 16% interest per year, as well as the 25% annual cap under the state’s criminal usury statutes. If the contracts are characterized as loans, they would be void and unenforceable.
Sax had said that unless he lost all of his other cases, Fast Trak would still be able to collect on matters unrelated to the litigation it had funded, potentially draining his firm and sending him into bankruptcy.
A district court judge had ruled against Sax, finding that the contracts, “however unconscionable,” did not meet the criteria to be considered loans under New York law.
The Fast Trak panel observed that, “to constitute a ‘loan’ under the usury statute, the purported lender must have the right to collect from the purported borrower in absolute terms . . . . Because Fast Trak has the right to collect from Sax only if he or his clients obtain sufficient proceeds, Fast Trak argues, the transactions cannot constitute a ‘loan.’” Fast Trak at *6 (emphasis in original).
But the panel questioned whether Sax’s obligation to pay was sufficiently “guaranteed” by the terms of the agreement and thus might be treated as a loan under New York law. Id. at *7.
The crux of the question for the Ninth Circuit, then, was whether there was a genuine risk that Fast Trak might not be repaid – because of the uncertainties of litigation and resultant litigation proceeds or attorney fees – or if its risk of nonpayment was so low that the contract should be characterized as a loan. Id. at *7-*8.
The panel observed that “there is a nonfrivolous argument that the ‘real purpose’ of these transactions is a loan rather than the purchase of contingent assets: Fast Trak wired funds to Sax; Fast Trak secured future payment by Sax with the potential proceeds in a large number of Sax’s cases, thereby making Sax’s obligation to pay Fast Trak arguably likely.” Fast Trak at *8. The panel noted that Sax “made a colorable argument that repayment to Fast Trak is all but guaranteed.” Id. The panel may not have been convinced by Fast Trak’s position that, “as long as there is some possibility that the assets listed in the agreements will not yield full payment to Fast Trak, the transaction cannot qualify as a loan and Sax cannot sustain a usury defense.” Id. (emphasis in original).
The Ninth Circuit panel said the New York Court of Appeals had never directly addressed the issue, and without controlling precedent was unable to predict how the New York court might rule.
“Whether New York law permits a defense of usury in these circumstances is a question for which no controlling precedent of the Court of Appeals exists. Because the resolution of this question will determine the result of this case, we believe certification is proper,” the panel said. Id. at *10.
Some Considerations for Litigation Funders
Fast Trak has been stayed pending a decision by the New York Court of Appeals. In the meantime, however, funders may wish to consider whether litigation funding arrangements such as those between Sax and Gast Trak may raise concerns for a court.
For example, for the most part, corporations and LLCs cannot raise a civil usury defense. Sax is a sole proprietor. However, if Sax were a corporation or LLC, criminal usury might still be asserted as a defense. If successful, it is “an open question under New York law whether a criminally usurious loan is void ab initio or whether a successful defense based on criminal usury results merely in the cancellation of the interest obligation or in a revised obligation to pay a non-usurious rate.”
In addition, a substantial number of lawsuits Sax was involved with constituted the pool of cases that could give rise to repayment to Fast Trak. Perhaps a better practice, to minimize any perceived “guaranty” of repayment, might be for a funder to advance against a smaller basket of select cases rather than against all, or most, of a lawyer’s or law firm’s cases.
Another concern is the extent to which a court might scrutinize litigation funding arrangements: where would such an analysis end? Among the advantages of litigation funding is that a plaintiff can bring a lawsuit that it otherwise could not afford, enables counsel to work on a contingency or hybrid fee basis, and permits parties to allocate the potential benefits and risks of litigation as they deem appropriate under particular circumstances.
Sax argued that Fast Trak’s portfolio was so robust that it “predictably and effectively guaranteed repayment.” But portfolios present substantial risks, just as single cases do. Litigants and law firms look to share that risk with funders, and savvy funders are sophisticated, able to bear the uncertainties inherent in litigation while being adept at assessing the risks of litigation.
But if a litigation funder makes an advance to the best lawyer in town or for a meritorious case, might that litigation funding arrangement be more likely to be recharacterized as a loan? How much risk must a funder take to ensure an advance is not characterized as a loan? And must funders now worry not only about the cases they fund but also whether counsel may later have remorse about the funds that enabled counsel to prosecute a lawsuit?
 Fast Trak Investment Company, LLC v. Sax, 2020 WL 3092063 (9th Cir. 2020) (“Fast Trak”).
 New York law provides certain exemptions to its usury laws, for example certain loans to corporations for business purposes and certain loans in excess of $2,500,000. See N.Y. Gen. Oblig. Law §§ 5-526(1) and 5-501(6)(b).
 Adar Bays, LLC v. 5Barz Int’l, Inc., No. 16 CIV. 6231 (NRB), 2018 WL 3962831, at *4 (S.D.N.Y. Aug. 16, 2018) quoting Carlone v. Lion & the Bull Films, Inc., 861 F. Supp. 2d 312, 321 (S.D.N.Y. 2012) (citing Venture Mortg. Fund, L.P. v. Schmutz, 282 F.3d 185, 189 (2d Cir. 2002) (internal quotation marks omitted); see also Funding Group, Inc. v. WaterChef, Inc., 19 Misc.3d 483, 490-491, 852 N.Y.S.2d 736, 740-742 (N.Y. Sup. Ct. N.Y. County 2008) (“The criminal usury statute… does not expressly void a loan that exceeds it maximum rate.”).
John J. Hanley focuses his practice on first and second lien financings; private placements of debt and equity securities; and the purchase and sale of loans, securities, trade claims and other illiquid assets. His clients include business development companies, specialty lenders, investment banks, hedge funds, actively managed CLOs, special purpose vehicles, and other financial institutions. John structures, negotiates and drafts term and revolving credit facilities, commitment letters, consents, waivers, assignments, “big boy” letters, proceeds letters and a range of agreements, including guarantee, intercreditor, subscription, purchase and sale, participation and confidentiality agreements. Read more about John here.
Douglas Schneller handles a broad range of complex transactional matters involving bank finance and lending; restructuring, bankruptcy and insolvency; intercreditor and subordination arrangements, including for mezzanine, leveraged, multi-lien and unitranche financings; claims analysis and reconciliation; and purchases and sales of par and distressed assets such as bank loans, notes, accounts receivable, trade claims, bankruptcy claims, and equity interests. He also counsels clients on a range of other transactional matters, including trade and receivable finance (including default-triggered puts and vendor/account receivable and trade financing); bankruptcy transactional matters including distressed investing, rescue and debtor-in-possession finance, and sales under Bankruptcy Code Section 363; corporate trust and agency; structured products; private placements; portfolio management and monitoring; and securities law matters. Read more about Douglas here.
Attorney Advertising. This document is not intended to be and is not considered to be legal advice. Transmission of this document is not intended to create, and receipt does not establish an attorney-client relationship. Prior results do not guarantee a similar outcome.