Third-Party Funding of Individual Lawsuits: A Rational Dialogue Kirby Griffis Hollingsworth LLP THE SCENE: Boardroom of Rational Actor Widgets Co. RAWCO makes widgets, which have many useful applications but can fail, causing injuries. Sitting at the table are FERNAND SMITH, the president of the company, RICH BOSNER, the head of the company s legal department, and DONALD GOSE, their longtime outside lawyer who, among other things, defends them in personal injury lawsuits. They are discussing a number of legal matters, including a personal-injury lawsuit brought by George Sharkey, a local plaintiff s lawyer, on behalf of Arthur Groaner, a plumber who was injured when a RAWCO widget came apart unexpectedly. SMITH has degrees in economics and business from the University of Chicago and makes decisions based on an analysis of the economic costs and benefits. BOSNER is very used to his bosses methods of making decisions, though he is less wedded to those methods than SMITH is; he is a also a sound legal generalist. GOSE is a seasoned trial lawyer with lots of practical experience. SMITH: Okay, next item on the agenda, the Groaner lawsuit. Remind me what the issue is there. BOSNER: That s a personal injury lawsuit over one of our TD-39 widgets. It came apart at the C-joint while Groaner was using it, and the recoil broke his arm and put him in the hospital for a couple of days. He has medical expenses, a claim for pain and suffering, and is asking for punitive damages, though there may not be much to that. GOSE: Right, this lawsuit is brought by George Sharkey, who I ve dealt with a number of times in the past, including in two cases for RAWCO. He s a rational guy. It s a standard move for him to ask for punitive damages in the complaint, but he s no crusader. I don t see a basis for punitives here and I expect he d be willing to drop that if we want to talk settlement with him. SMITH: Well, what s the case worth? GOSE: His medical expenses and lost work are about $11,000. Pain and suffering, for this sort of thing in this jurisdiction, would double that, as my best educated guess. I m not counting anything for the punitives claim. So $11,000 in provable damages, and probably $22,000 in realistic total damages. SMITH: Do we have a defense? GOSE: We haven t taken discovery yet, because we didn t want to go to that expense without your approval, so we can t be sure. There s a chance that Groaner was misusing the TD-39; we
all know that happens. Finding that out and being able to get the jury to accept it is another thing. All things considered, I d say there s a 20% chance of winning the case no liability if we go to trial. SMITH: Okay, so the value is 80% of $22,000, which is $17,600. What would the trial cost? BOSNER: Under our arrangement with Donald for widget PI cases, probably $30,000. I ve already run the numbers for you, applying our usual factors: the likelihood of upward and downward deviation from the expected pain and suffering award, the present value of deterring future litigation by defending the case using our standard multiplier for TD-class widget suits, the impact on sales of a settlement vs. a trial win vs. a trial loss, adjusted by Donald s 20% chance of victory, and the financial impact on productivity of lost time for depositions of employees. With those factors all in play, the net expected cost to RAWCO of defending the lawsuit is $17,650. SMITH: Good. Easy decision; we have $50 of headroom. We settle. Get us the best deal you can, Donald, up to $17,600. Next issue. GOSE: Wait a minute, guys. There s a problem. SMITH: What? GOSE: I could do the deal with Sharkey. But he s not the only one with an interest here. When I called Sharkey to ask him to send over their proof of damages, he told me that Groaner had gotten a loan from some outfit called EZ-Cash secured by the lawsuit. SMITH: So what does that have to do with us? GOSE: It makes Groaner not want to settle the suit. He got $5,000 in cash. He doesn t have to pay it back if he loses at trial. If he wins, though, EZ-Cash gets the first $10,000 of his recovery. The recovery also has to pay Sharkey, who charges 40%. SMITH: Let me get this straight. Groaner keeps $5,000 no matter what, and doesn t have to give it back or use it to pay fees to Sharkey or EZ-Cash? SMITH: But he doesn t get another dollar unless they get a recovery of $16,667? BOSNER: Did you just do that in your head? SMITH: Obviously. GOSE: Well, I had to use a spreadsheet last night, but that figure is right. $16,667 is the first recovery that pays Groaner anything, and if the recovery was exactly that, and there was nothing else to pay, he d get only 20 cents. 2
BOSNER: And of course there is something else to pay. We haven t mentioned the costs of the lawsuit, or Cigna s $7,500 lien on a recovery for its costs for medical care. GOSE: Correct. That makes it even worse. Sharkey will take his costs out of Groaner s portion of any recovery, which makes the amount needed to actually pay Groaner anything even higher. And Sharkey will bargain Cigna down at least 50%, but that s just another claim on the assets before Groaner gets a penny. SMITH: So what s the bottom line here? GOSE: Groaner won t settle the case for less than $25,000. SMITH: This is ridiculous. We just established that the case isn t worth that much. GOSE: Groaner doesn t care about that. He has his $5,000 no matter what happens, and the only way he has a chance to get any more money is a settlement or verdict in the $25,000 range. SMITH: What are the chances of that? BOSNER: [Consulting his charts] You ll remember that our pain-and-suffering bell curve has broad shoulders, because it depends so much on the composition of the jury and the mood they re in. $25,000 or higher is absolutely a possible verdict, but only about 5% likely. SMITH: What does the plaintiff s lawyer say about this? GOSE: I had a little chat about it with Sharkey. I don t think he likes it, because he d rather settle the case for what it s worth and move on. He makes money by moving inventory, not by trying every case. But he ll respect his client s wishes. SMITH: Why doesn t he just make Groaner take a reasonable deal? GOSE: A lot of lawyers would, and a lot of them have deals in their retention agreements that make the client turn over their right to make settlement decisions to the lawyer. But Sharkey doesn t operate that way. He ll make a firm recommendation, but he won t push beyond that. BOSNER: How does EZ-Cash get to do this? They re getting a 100% return on their investment in under a year? That s usury, isn t it? GOSE: Actually, the case law mostly says no to that. It certainly would be usury if Groaner had to repay the money no matter what, but in fact he only has to repay it if he wins or gets a settlement. So that technically means that EZ-Cash s payment is not a loan, and not subject to usury laws. BOSNER: Outrageous. 3
SMITH: It s outrageous that it is preventing us from settling the case. But aside from that, there s nothing outrageous about EZ-Cash s arrangement with Groaner. Groaner presumably has calculated that $5,000 is worth more to him now than is $10,000 in six or eight months. GOSE: Well, I don t know how much calculating he did. He s a plumber, not a company president with a degree in economics like you. But companies like EZ-Cash do say something like that when they re lobbying to be allowed to do what they do: that they provide cash which enables plaintiffs like Groaner to bring suits that they couldn t otherwise afford. BOSNER: But they don t? GOSE: Of course they don t. Look at this one: Sharkey has the case on a contingent fee basis. Groaner didn t give Sharkey a penny from that $5,000. BOSNER: Isn t this barratry or something? SMITH: What s that? BOSNER: It s an archaic tort. Drumming up worthless lawsuits, basically. GOSE: It s not exactly barratry, but it is champerty. Champerty is. MODERATOR: Beyond the scope of this discussion. GOSE: Beyond the scope of this discussion, right. SMITH: I think I m getting a headache. Let s review this to make sure I understand. The case is worth $17,600, and we want to settle for that amount or less. Sharkey would take a settlement in that range. Normally, we would settle the case, Sharkey would get his cut, Cigna would get reimbursed for the reduced amount they usually negotiate with Sharkey, and Groaner would get about twice as much money as he would have gotten if he hadn t made a deal with EZ-Cash. Right? SMITH: But because of this EZ-Cash thing, we have to go to trial even though we don t want to and Sharkey doesn t want to. We all have to spend money on that. The court has to spend time dealing with us. A jury has to be picked and waste their time on this. And Groaner has a 95% chance of not making another penny. Right? SMITH: So we re basically going to trial to make EZ-Cash s investment pay off for them. GOSE: Right again. 4
BOSNER: There ought to be a law. SMITH: [Winces, but doesn t respond.] GOSE: I ll tell you something else. Sharkey told me he was going to add questions to his case screening process about lawsuit loans, and strongly consider not taking cases where the plaintiff has gotten money from a lawsuit lender. Also, he s going to add language to his retention agreement saying that the plaintiff can t get a lawsuit loan without his approval. SMITH: That s interesting. I don t know if you know this, Donald, because you ve only dealt with the lawsuit side of things, of course, but we have formulae that we apply to decide what safety improvements to make to products, too. GOSE: I wouldn t have expected anything less. SMITH: No, of course not. You know that widget failure is usually caused by wear on the C- joint from mechanical stresses over time. We ve run simulations of different formulations of alloys for the C-joint, and there s pretty much a linear improvement in safety as tungsten is added to the steel, from 0 to 18%. But costs go up sharply the more tungsten you add, and of course consumers are pretty averse to paying for safety with higher widget prices. BOSNER: Except when something goes wrong. SMITH: Except after the fact, of course, but that s just a product of lack of training and proper perspective. We try to get the balance exactly right up front, and don t worry about being second-guessed later. GOSE: So how does litigation cost figure into that? SMITH: It s a complex factor I ll show you the formula later if you like but it takes into account a number of things, including the cost to RAWCO of the litigation, the anticipated impact of litigation on regulatory oversight and action, and the drain on R&D of having to fund the legal department. I was just thinking that, after we run the numbers, a development like outside funding for plaintiffs would increase our litigation costs and thus cause us to increase our tungsten percentage slightly to compensate by reducing future accidents. But now that you tell me Sharkey might cut back on bringing lawsuits, I don t know. If the plaintiffs bar reduces the number of suits that it brings because of this, the overall effect might be in the other direction. Maybe we ll cut the tungsten percentage. We ll have to run some projections. BOSNER: I know how you could hedge it, either way. SMITH: Of course. Buy EZ-Cash. We ll look into it. BOSNER: Thanks for coming, Donald. GOSE: Always a pleasure, gentleman. 5