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The Ohio Legislature Wisely Enacts a Law to Supersede an Ohio Supreme Court Decision that Had Limited How Litigation Could Be Funded


Tuesday, Sept. 09, 2008

This year, Ohio wisely corrected a mistake that was made by its Supreme Court five years ago.

In 2003, in the Rancman decision, the Ohio high court held that the "non-recourse" funding of litigation violated the common law of the state. This decision shut down an entire industry that had fulfilled an important social function. I argued five years ago that the decision was wrong. Now, Ohio has overruled that decision by legislation.

In this column, I will review the new law, and ask a few questions about its limited scope.

How the Non-Recourse Funding of Litigation Works

To understand the Ohio Supreme Court decision, it's important to understand how non-recourse funding works:

Bob, a pedestrian, is struck by a driver and injured. He sues the driver for $21,000. If Bob wins the lawsuit, he typically will pay his lawyer 33% ($7,000) plus any costs associated with the prosecution of his claim. Let's assume for the sake of argument that Bob's costs are $1000. This means that Bob expects to "net" $13,000 from his suit. Of course, if he goes to trial, he could get $0 from the jury, in which case his net will be zero. If he settles the suit for less than $21,000, then his net will also be less than his expected $13,000. And if he goes to trial and wins beyond his expectations, then his net would be above $13,000.

A non-recourse funder could offer to "monetize" Bob's expected future net gain by offering Bob some money today in exchange for Bob's promise to repay the funder a much larger sum in repayment if, and only if, Bob nets above $0. So, for example, a non-recourse funder might offer Bob $3000 now in exchange for the first $5000 Bob nets from his lawsuit.

Why might Bob accept this offer? First, he never risks any money "out of pocket"-the only dollars he will have to pay the funder are dollars that came from the lawsuit. If he loses the lawsuit, the funder gets nothing. (That is the "non-recourse" component of the arrangement.)

Second, the $3000 Bob receives now might be more valuable to him than the $5000 he will have to give to the funder later. This is especially true if Bob expects to net more than $5000. Of course, many variables will affect whether you think Bob is getting a good deal. The basic structure, though, is pretty simple.

Why the Ohio Supreme Court Struck Down Non-Recourse Funding as Illegal

The Ohio Supreme Court held that deals like the one I described above violate Ohio's public policy against "champerty and maintenance." "Maintenance" is the officious intermeddling by a stranger into a private lawsuit, and "champerty" is the pursuit of maintenance for profit.

In support of its holding, the Ohio Supreme Court recited the usual rhetoric about how the possibility of outside funding might "stir up" frivolous litigation, but no one, not even the court itself, could possibly take that argument seriously. Non-recourse funders will logically only bet on suits they think will win - after all, they have no recourse if there is a loss. And generally, the suits likely to win are meritorious, not frivolous - the more meritorious, the better, from the funder's point of view.

The real concern expressed by the Ohio Supreme Court was thus a different one: the concern that once having sold off a piece of their lawsuit, litigants like Bob would have less incentive to settle their suits. The reasoning goes something like this: If Bob has to pay his lawyer 33% of his award, and he has to recoup $1000 in costs, then Bob has no reason to settle his suit for less than $9000. If he settles for less, then he won't see any of that money because it will all go to his lawyer, or to costs, or to his non-recourse lender. So Bob is likely to dig his heels in, even if a settlement offer of $8000 is reasonable, because, as the Ohio Supreme Court noted, what would Bob have to lose by going to trial? If he loses at trial, he owes nothing to his lawyers or to the non-recourse funder. At worst, he is out $1000 in costs.

The New Ohio Statute: Permitting Non-Recourse Funding of Lawsuits, But With Clear Disclosure, a Non-Interference Obligation, and an Option to Cancel

The new statute in Ohio makes legal exactly the kind of transaction described above. In effect, it leaves it to the marketplace to decide whether certain cases are worth monetizing or not. Its main reforms are that it requires the non-recourse funders to make it very clear to their customers the costs and benefits of the deal, so customers can best decide whether to monetize their lawsuit, depending on various factors relating to the case and on their own immediate need for money.

The law requires, for example, that non-recourse funders permit their clients to cancel their deal within five days of signing with no penalty, in case they think twice about what they have done. It requires the funders to promise that they will not interfere with the conduct of their client's lawsuits, including their settlement decisions. It requires the attorney handling the client's lawsuit to review the non-recourse-funding contract with the client. It requires the annualized interest rate to be stated clearly, and it requires the client's attorney to review that figure with the client.

The law makes plain that the legislature trusts the people of Ohio and their attorneys to makes decisions that are in their own best interest when it comes to giving up a piece of their possible recovery in a lawsuit. This is as it should be, since the sort of paternalism that motivated the Ohio Supreme Court in Rancman is inconsistent with the idea that individuals and the marketplace provide the most trustworthy outcomes if they are provided with full information.

Why the Ohio Legislature Was Correct to Reject the Ohio Supreme Court's Concern About Resistance to Settlement

But what about the Ohio Supreme Court's stated concern that citizens who monetize their suits will resist settlement? The Ohio legislature obviously did not think that this concern was so great that it justified making illegal an otherwise beneficial transaction between fully informed adults. I believe its decision to pass the law despite this concern was the correct one, for there are a number of reasons this concern may be somewhat misplaced.

First of all, settlement is not a good in itself. While you don't want cases dragging on for no reason, you also don't want plaintiffs settling too cheap because they are running out of money for food and rent.

Second, but more important, consider my example above: Bob may not care about the choice between taking a weak case to trial and settling for less than $9000, but his lawyer will. In practice, lawyers have a lot of influence on their clients' decisions about whether to settle. If Bob is thinking of rejecting any reasonable settlement offer just because of the non-recourse contract he signed, his lawyer may try to steer Bob back to doing the right thing. After all, if Bob insists on going to trial, and the case is a loser, then the lawyer is going to waste even more of her time and receive no compensation, whereas if the case settled for $8000, at least she would get $2,666 in fees.

This may explain why the new law refers only to non-recourse loans arising from contingency fee arrangements - which, in turn, are only employed with respect to classic tort claims such as the ones that would arise out of Bob's accident. It would seem that the drafters of the Ohio law understood that in the unique relationship forged by the contingency fee, the client's lawyer will be the best guarantee against the risk of the client's resistance to accepting reasonable settlement offers.

What Ohio Should Do Next: Making a Good Law Better

My only complaint is that the Ohio law does not go far enough. I think that the benefits of permitting plaintiffs to monetize their claims are so large that any kind of lawsuit should be open to the non-recourse funding industry in Ohio, not just suits brought under a contingency fee arrangement. If a client wants to pay her lawyer an hourly rate to sue a company in a contract or property dispute, why should the client not be able to immediately monetize his or her expected damages, just as a plaintiff in a personal injury suit could?

The fear that was raised by the Ohio Supreme Court-that clients who monetize will resist reasonable settlements-is probably greatly exaggerated. In any event, it can be addressed -even in cases where the client's lawyer's own financial interest would not be harmed in the event of the client being driven to reject reasonable settlements because they would owe most of the recovery to a non-recourse funder.

In sum, the Ohio law corrects a great injustice inflicted on the state by its high court five years ago, but the legislature could, and should, take it one step further.

Anthony J. Sebok, a FindLaw columnist, is a Professor at Benjamin N. Cardozo School of Law in New York City. His other columns on tort issues may be found in the archive of his columns on this site.

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