The Colorado Supreme Court has ruled that two litigation financing programs are non-recourse “loans,” not purchases, and therefore subject to licensing and other requirements of the state’s Uniform Consumer Credit Code (UCCC). The decision is significant not only because it conflicts with well-established law in other states, but also because regulators and consumer class action lawyers could attempt to extend its reasoning to merchant cash advances (MCAs) and other transactions that are structured as sales rather than loans.
In Oasis Legal Finance Group, LLC v. Coffman, two litigation finance companies sued Colorado’s UCCC administrator and Attorney General seeking a determination that their financing transactions were not loans, and therefore did not violate the UCCC. After the court of appeals affirmed the trial court’s holding that the transactions were loans subject to the UCCC, the Supreme Court granted certiorari.
In the underlying transactions, the finance companies purchased from individual plaintiffs in pending personal injury lawsuits an “interest” in the amounts they might recover. The companies did not purchase the claims the plaintiffs were asserting, they disclaimed any right to control the litigation, and they prohibited the financing money from being used to prosecute the litigation. The agreements defined the “interest” being purchased as an amount of money determined by a payment schedule. The amounts in the schedule increased with the length of time it took to conclude the litigation. Each of the agreements expressly stated that the transaction was not a loan, and that the plaintiff’s obligation was contingent on the outcome of the lawsuit, so that the company’s recovery on the investment would not exceed the plaintiff’s recovery in the litigation, and it would be zero if the plaintiff lost.
The Supreme Court first looked at the UCCC’s definition of “loan” which includes “the creation of a debt by the lender’s payment of or agreement to pay money to the consumer.” Based on this definition and the definition of “debt” in other Colorado statutes, the Court concluded that, for purposes of the UCCC, “a debt is an obligation to repay.” It found that the financing transactions “create debt because the plaintiffs receive a payment of money and, in exchange, they commit to fully compensate the finance companies from the future litigation proceeds.” However, noting that debt “is necessary but not sufficient” for a transaction to be a “loan” under the UCCC, the Court found that the transactions “have other characteristics of loans” and “cannot plausibly be labeled sales or assignments.”
Rejecting well-settled law in other states, the Court was unwilling to find “controlling significance” in the transactions’ structure as nonrecourse obligations. According to the Court, because the UCCC’s language does not require a debtor to have an unconditional obligation to repay, “[l]itigation finance agreements create debt because they create repayment obligations. This is so notwithstanding the litigation finance companies’ embrace of risks that, from time to time, require them to adjust or cancel some plaintiffs’ obligations. Most of the time, plaintiffs repay the full amount borrowed—and more.”
In characterizing the financing transactions as “loans” subject to the UCCC, the Court found it “significant that the obligation increases with the passage of time.” According to the Court, the charges added by the companies to the amount advanced “function as interest” and the “growth in the repayment obligation over time is a finance charge and a hallmark of a consumer loan under the UCCC.” The Court also rejected the companies’ argument that the transactions were sales or assignments because they did not transfer ownership rights. In the Court’s view, by allowing the plaintiffs to continue to control the litigation, the transactions provide the companies “only with the rights that any creditor would have to receive payment of the amount due.”
It is important to note that the UCCC applies only to consumer loans, and that the decision did not address the issue of “absolute repayability,” which is a separate element of a usury claim which is defeated by the nonrecourse aspect of these transactions. Nevertheless, the reasoning in Oasis could influence result-oriented judges hearing challenges to MCAs and other financing structured as a sale, despite material differences between those transactions and the litigation financing products at issue in Oasis. We also note that several prominent consumer litigation groups filed an amicus brief confirming their focus on transactions of this nature, therefore highlighting the risk of future class actions and regulatory attacks. For these reasons, it is important that parties involved in such financing consult counsel to ensure that their transactions are properly structured to make them less vulnerable to an Oasis-like challenge.
Ballard Spahr’s Consumer Financial Services Group is nationally recognized for its guidance in structuring and documenting consumer financial services products, including litigation finance products, merchant cash advances, and other financing vehicles structured as sales rather than loans. The Group is widely recognized for its experience with the full range of federal and state consumer credit laws, and its skill in litigation defense and avoidanc.
For more information, please contact CFS Practice Leader Alan S. Kaplinsky, CFS Practice Leader Jeremy T. Rosenblum, Scott M. Pearson, Mark J. Furletti, or Sarah B. Wallace.