Recall that California Probate Code section 11604.5 allows judges to strike down "grossly unreasonable" probate loans or "order distribution on any terms that [they] ... consider equitable." (202) We did not unearth a single instance of a court exercising this prerogative. Instead, the norm--at least in Alameda County, during the period under study--appears to have been to rubber stamp probate loans. As we explain next, courts and policymakers should recognize that these transactions are, in fact, quite problematic for borrowers and the legal system.
This Part prescribes policy based on our empirical findings. It first explains why most probate loans violate the usury statutes and TILA. It then considers the more difficult issue of whether assignments of inheritance rights to firms are consistent with the champerty doctrine.
In the San Francisco Chronicles stories on probate lenders, experts opined that these firms seem to be an ingenious effort to evade the usury laws. (203) Although this accusation has also been levied against litigation lenders, most courts have held that litigation loans are immune from usury regulation. But in this Section, we explain why the result should be different for probate loans.
Usury statutes limit the amount of interest that creditors can charge on a loan. (204) These laws are notoriously complex: they vary wildly between states and are riddled with exceptions and idiosyncratic rules for particular institutions and transactions. (205) There is also no uniform maximum rate, although the ceiling for consumer loans (206) in most jurisdictions is around ten percent annual simple interest. (207) In California, Florida, Michigan, Ohio, Pennsylvania, New Jersey, New York, and Texas--which have large elderly populations and are potential hubs for probate loans (208)--caps range from six to eighteen percent. (209) Sanctions for usury violations can be severe, and include disgorgement of profits, punitive damages, and even criminal liability. (210)
However, usury laws only govern advances that saddle the borrower with "an absolute obligation to repay the principal." (211) As a result, usury statutes do not apply to transactions where the creditor's recovery of the fronted money hinges "upon a bona fide contingency." (212) As the Arizona Supreme Court put it, "An example of a debt 'contingently repayable' is posed by this situation: Borrower says to lender: Lend me $10 to bet on a horse race, and if the horse wins, I promise to pay you $15 tomorrow; if the horse loses, you get nothing." (213) This logic has spurred many courts to exempt litigation loans from usury regulation. (214) Litigation lenders forfeit their investment if the plaintiff does not settle or prevail on the merits; thus, they face the realistic possibility of coming away empty-handed. (215)
Anglo-Dutch Petroleum International, Inc. v. Haskell illustrates this line of authority. (216) Anglo-Dutch, an oil company, sued two rivals for misappropriating trade secrets and breaching a confidentiality agreement. (217) Because Anglo-Dutch needed cash to stay afloat, it sold $560,000 of its potential damages to a variety of litigation funders. (218) But when a jury issued a verdict of $81 million, Anglo-Dutch refused to honor these assignments, contending that they were not enforceable on the grounds of usury. (219) Anglo-Dutch supported this theory with evidence that some of the litigation funders had admitted that "success in the ... lawsuit was certain" and there was "no risk whatsoever." (220) A Texas appellate court rejected this argument, reasoning that mere optimism about the trial did not prove that the money was going to be repaid. (221) Instead, the court explained, Anglo-Dutch needed to demonstrate that, at the time it signed the deals, it had "obtained 'incontrovertible evidence' of its claims." (222)
Critically, though, not all contingencies are the same. As the Restatement (First) of Contracts provides, lenders cannot shield usurious transactions by predicating their recovery on conditions that are unlikely to occur:
A creditor who takes the chance of losing all or part of the sum to which he would be entitled if he bargained for the return of his money with the highest permissible rate of interest is allowed to contract for greater profit. On the other hand it is not permissible to use this form of contract as a device for obtaining usurious profit. If the probability of the occurrence of the contingency on which diminished payment is promised is remote, ... the transaction is presumably usurious. (223) Courts apply this test functionally rather than formally, considering all the facts and circumstances "to determine whether the lender's profits are exposed to the requisite risk." (224) The odds that the lender will get burned "must be substantial, ... for a mere colorable hazard will not prevent the charge from being usurious. (225)
A corollary of this principle is that litigation loans fall under the usury laws if unusual circumstances suggest that the plaintiff--and thus the lender--will likely be made whole. For instance, in Echeverria v. Estate of Lindner, a day laborer fell from a scaffold on a jobsite and filed a worker's compensation claim against his employer. (226) A company called LawCash advanced him $25,000 to be repaid from his damages, with interest compounding every month at 3.85%. (227) A New York trial court held that the agreement was usurious. (228) The court noted that because the legal standard in the underlying tort matter was strict liability, "there was a very low probability that judgment would not be in favor of the plaintiff." (229)
Likewise, in Lawsuit Financial, LLC v. Curry, a Michigan appellate court held that several litigation loans were usurious. (230) Mary Curry brought a tort claim after being injured in a car crash. (231) At trial, the defendants in Curry's personal injury lawsuit admitted that they were at fault, and the jury--tasked only with calculating damages--awarded Curry $27 million. (232) The defendants challenged this verdict with a salvo of post-trial motions. (233) Before the judge ruled on these motions, Curry signed three agreements with a litigation lender, one of which pledged the greater of $887,500 or ten percent of her winnings, in return for $177,500. (234) The appellate judges noted that Curry was clearly destined to recover something from her tort lawsuit at the time the agreements were consummated:
[B]efore the advances were made, the defendants in the personal injury lawsuit had already admitted liability, the jury had already returned a $27 million verdict in [Curry]'s favor, an order of judgment had already been entered, and the only remaining issue was the amount of recovery .... Because liability had already been admitted when plaintiff advanced the funds, the fact that ... Curry would recover some damages for her injuries was already known. (235) Like the litigation loans in these cases, probate loans are "absolutely repayable." (236) Seventy-four of the seventy-seven advances (96%) in our dataset were fully reimbursed. The remaining three loans resulted in lender losses: one lender recovered $13,229 of a $20,000 payment, (237) and another took home just $9,800 from an outlay of $16,800. (238) Even more starkly, one company lost its entire investment when the personal representative stole the decedent's assets and then disappeared. (239) Yet these matters were highly unusual. In the first two, the lenders unwisely entered into assignments before the I&A was filed, thus exposing themselves to the danger that the estate would be worth less than assumed. (240) In the third, the company had advanced funds even though the personal representative had not taken out a surety bond to insure all stake holders against fraud and embezzlement. (241) The fact that firms can easily take steps to avoid repeating these kinds of mistakes suggests that they are not likely to recur. Thus, like litigation financiers who bought a stake in Echeverrias strict liability claim or Curry's unopposed negligence allegations, probate lenders are "almost guaranteed to recover" and face "low, if any risk." (242)
But even if the usury statutes apply, it does not necessarily follow that probate lenders are defying them. Unlike traditional loans, these transactions neither have a set rate nor a fixed term. (243) In fact, the annual percentage of a firm's markup depends on a fact that is unknown at the time of contracting: the number of days until the estate closes. Thus, the status of probate loans under the usury statutes depends on a second contingency: not whether the creditor will be repaid, but when. Theoretically, a case could persist for so long in the system that the company's rate of return would be minimal.
Again, though, this turns out to be a phantom condition. We were able to determine the effective annual simple interest rates for the seventy-four loans that were fully repaid. (244) Strikingly, all of them exceeded California's usury threshold of 10%. (245) In fact, as Table 3 reveals, fifty-three (72%) featured rates of more than 50%, and thirty-four (46%) topped 100%. (246) Thus, probate lenders are all but assured of usurious returns. (247)
To conform to the usury statutes, probate lenders could experiment with "usury savings clauses," which resurrect invalid loans by reducing the interest rate to the maximum permissible amount. Admittedly, some courts refuse to enforce these provisions, reasoning that they encourage lenders to charge all their customers astronomical rates and then merely "refund ... the usurious amounts" to "the few debtors who complain." (248) Yet judges are more hospitable to usury savings clauses when they seem less like attempts to launder patently illegal transactions and more like the product of genuine uncertainty about whether a loan will be usurious. Indeed, as the Florida Court of Appeals explained,...