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Georgia Supreme Court Ruling Is Helpful Precedent for Litigation Financing Industry

Consistent with the weight of authority, the Georgia Supreme Court has ruled that certain litigation financing agreements structured as asset sales were not disguised "loans," and therefore not subject to the state's Industrial Loan Act (ILA) or Payday Lending Act (PLA). The decision is significant because it is helpful precedent not only for litigation financing providers facing similar challenges but also for providers of merchant cash advances and companies involved in other transactions structured as sales rather than loans.

In Ruth v. Cherokee Funding, LLC, both plaintiffs were injured in separate car accidents but retained the same attorney to file lawsuits on their behalf. The plaintiffs entered into financing agreements with Cherokee Funding in which the company agreed to provide them funds for personal expenses. The agreements provided that the plaintiffs had no obligation to repay the funds if they recovered nothing in their lawsuits, but, if they did recover damages, they would be required to repay the amounts provided by Cherokee Funding—together with a monthly use fee (which the Supreme Court characterized as interest) and certain other fees, up to the amount of their recoveries. The plaintiffs' dismissal of the lawsuits and retention of the funds received from Cherokee Funding would not cause them to be in default under the financing agreements.

After settling their lawsuits for unspecified amounts, the plaintiffs filed a putative class action against Cherokee Funding alleging that the financing agreements violated the ILA and PLA. The trial court granted in part and denied in part Cherokee Funding's motion to dismiss, concluding that the PLA applied but not the ILA. Having granted Cherokee Funding's application for interlocutory appeal, the Court of Appeals concluded that neither statute applied because the transaction was not a loan and instead was as an "investment contract." The plaintiffs then filed a petition for a writ of certiorari to the Georgia Supreme Court, which agreed "to consider whether the Court of Appeals correctly understood the scope of the [ILA] and the [PLA]."

The court looked at the ILA's definition of a "loan" as "any advance of money in an amount of $3,000 or less under a contract requiring repayment and any and all renewals of refinancing thereof or any part thereof." It also reviewed the PLA's language, which does not expressly define the term "loan" but provides that the PLA "shall apply with respect to all transactions in which funds are advanced to be repaid at a later date." The Georgia Supreme Court concluded that Cherokee Funding's financing agreement was neither "a contract requiring repayment" for purposes of the ILA nor a transaction "in which funds are advanced to be repaid" for purposes of the PLA because the agreement involved "a contingent and limited obligation of repayment."

The court also addressed the plaintiffs' argument that "the contingent repayment obligation in their financing agreements is illusory because Cherokee Funding only makes loans…when the risk that the contingency will fail to arise is close to null." It commented that "it is easy to imagine an agreement with a sham contingent repayment provision that reflects an attempt to evade the usury laws" and that, when faced with a claim that such a provision is a sham, a court "should look beyond the text of the agreement to [review the substance] and perhaps find an unlawful loan, notwithstanding the contingency." The court found, however, that—based on the pleadings before it—the case did not present such a claim, observing that the plaintiffs' complaint did not allege that the financing agreements' contingencies were illusory or that there was no chance the plaintiffs would be unsuccessful in their lawsuits.

Litigation financing providers continue to face the risk of future private lawsuits and regulatory attacks. In July 2018, the New York Department of Financial Services raised concerns about litigation financing and suggested that legislation containing consumer safeguards was needed. Such risks underscore the need for parties involved in litigation financing and other financing transactions structured as sales rather than loans to consult legal counsel to ensure that their transactions are properly structured to make them less vulnerable to usury and similar challenges.

Copyright © by Ballard Spahr LLPNational Law Review, Volume VIII, Number 310


About this Author

Kaplinksy, partner, New York, finance

Alan S. Kaplinsky is Co-Practice Leader of the firm's Consumer Financial Services Group, which has more than 115 lawyers. Mr. Kaplinsky devotes his practice exclusively to counseling financial institutions on bank regulatory and transactional matters, particularly consumer financial services law, and defending financial institutions that have been sued by consumers in individual and class action lawsuits and by government enforcement agencies. Visit Mr. Kaplinsky's profile in Wikipedia.

Jeremy T Rosenblum, consumer financial services group, finance partner, Philadelphia, Pennsylvania, Ballard Spahr, UDAAP, TILA

Jeremy T. Rosenblum is Co-Practice Leader of the firm's Consumer Financial Services Group. He has devoted the past 30 years in private practice to representing the consumer financial services industry.

Mr. Rosenblum's practice focuses on federal and state lending and consumer practices laws, with emphasis on the interplay between federal and state laws, joint ventures between banks and nonbank financial services providers, the development and documentation of new financial services products (especially products designed to serve the needs of unbanked and under-banked consumers), bank overdraft practices and disclosures, geographic expansion initiatives, and compliance with federal and state consumer protection and usury laws, including "UDAAP" statutes prohibiting unfair, deceptive, and abusive acts and practices; the Truth in Lending Act (TILA); the Electronic Funds Transfer Act; E-SIGN; the Equal Credit Opportunity Act; and the Fair Credit Reporting Act (FCRA).

Mr. Rosenblum's practice involves regular dealings with industry trade groups and regulators. In this regard, he has drafted a number of amicus curiae briefs, to the U.S. Supreme Court and other courts, on behalf of a number of industry and business trade groups, including the American Bankers Association, the Consumer Bankers Association, the U.S. Chamber of Commerce, the Mortgage Bankers Association, the Financial Services Roundtable, and the American Financial Services Association.

In addition to his consumer financial services regulatory and litigation practice, Mr. Rosenblum represents banks, thrifts, and other entities in charter transactions; mergers, acquisitions, and conversions; asset securitizations; purchases of loan servicing rights; and public offerings and private placements of equity and debt instruments.

Scott Pearson, Ballard Spahr Law Firm, Los Angeles, Business Litigation Attorney

Scott Pearson focuses his practice on the defense of regulatory enforcement actions and class actions, other complex business litigation, and regulatory compliance counseling. Martindale-Hubbell rates Mr. Pearson "at the highest level of professional excellence." He has been called "a true expert in complex litigation and consumer class actions" and "a no-nonsense bulldog lawyer who is highly respected by his peers and the judiciary."

Prominent companies regularly entrust Mr. Pearson with matters involving bet-the-company exposure or extreme...

James Kim, Ballard Spahr Law Firm, Los Angeles, Financial Law Litigation Attorney
Of Counsel

Mr. Kim advises companies and individuals in matters involving financial regulation and litigation, and the myriad of federal consumer financial laws, such as Title X of Dodd-Frank (UDAAP), TILA, RESPA, EFTA, and the FDCPA. He has represented clients in examinations and investigations with the Consumer Financial Protection Bureau (CFPB), Federal Deposit Insurance Corporation (FDIC), Office of the Comptroller of the Currency (OCC), U.S. Department of Justice (DOJ), U.S. Securities and Exchange Commission (SEC), and various state and local agencies. His practice focuses on...