In this post, we’ll take a look at hedging practice when it comes to pre-settlement financing.
Let’s say you’re in Las Vegas this summer and you place a bet on the New York Giants to win the Super Bowl with a 15-to-1 odds. That is, you bet $ 1,000 to win $ 15,000. But a stroke of luck, the Giants make it through the playoffs and find themselves facing Peyton Manning and the Colts for the big game. If the Giants win, you win $ 15,000. If they lose, you lose the $ 1,000 bet.
A cover play in this scenario would be to bet against the Giants in the Super Bowl. This way, you are a guaranteed winner. If the Giants win, you still win the $ 15,000 minus the game day bet on the Colts. If the Colts win, you win the game day bet minus your $ 1,000 ante on the Giants. This “hedging” of your bet guarantees you a profit on your position. This is just an example of coverage.
In fact, risk takers use hedging as a way to manage risk every day. Hedging can be defined, in the markets, as a position taken that attempts to compensate for exposure to price fluctuations with the intention of minimizing exposure to risk. An example could be buying options against a long position in a stock, so that if the price of the stock falls, the options become more valuable. But hedging can be a much broader concept than its application to financial or commodity markets.
Let’s take an example using a cash advance against a pending lawsuit. These types of transactions are often referred to as “Lawsuit Financing,” “Case Loans,” or “Pre-Settlement Financing.” Essentially, a plaintiff takes money against the future benefits of his case. In exchange for the cash now, you give up your right to a certain amount in the future if you win. On the surface, this resembles an independent hedge in that it guarantees a recovery from the final resolution of the claim. Because the plaintiff does not have to pay if the case is unsuccessful, he is ensuring a guaranteed return. So we know that it can be used to mitigate the risk of loss, but let’s explore further.
Traditional hedging involves risk management. And there is a cost associated with this management. In the markets, the cost is to buy that option or to shorten a part of the position. The same may be true for lawsuit financing Contracts: Cost is the amount to be reimbursed minus the amount the plaintiff receives. So now we see that the comparison is valid. The financing agreement can achieve similar goals for claimants.
The question then is: Is hedging cash advance financing a good deal, and if so, for whom?
In the real world of litigation financing, very few plaintiffs intentionally cover their position. The purpose of lawsuit loans is to help plaintiffs pay their expenses while taking their cases to court. By alleviating financial burdens, the theory is that plaintiffs can endure the lengthy and lengthy litigation process. The vast majority of pre-deal financing clients need the money to pay for bills, medical expenses, home improvements, cars, or other daily expenses. Protecting yourself against losing the case is usually the last thing on your mind when applying for a case loan.
Also, this technique is very expensive. When you consider the costs associated with most legal funds, you will find that this type of financing is often the last resort for plaintiffs who are struggling with cash. Although some finance companies offer very reasonable rates, most charge more than 50% annually when fees are included. For this reason, coverage in this regard is an expensive proposition.
However, there is money for plaintiffs at a “fair rate” if your case qualifies. In this circumstance, the benefits are likely to outweigh the costs. However, only preferred cases qualify for these low rates and the traditional reasons for obtaining case loans still apply.
Also, because these cases are less “risky”, there may really be no reason to intentionally hedge the position. The purpose of hedging is to limit the risk of loss and secure a gain if possible. But at what cost? Making an expensive bet against a case that already has a 95% chance of recovery may not be really careful. Ultimately, the customer must decide.
I hope this post was entertaining and informative. In the final analysis, using lawsuit loans to protect against potential loss from a legal proceeding comes down to weighing the costs. This type of determination is not an exact science and is best evaluated by the person in the best position to understand the risk / reward: the plaintiff himself.
Thank you for your interest in legal financing.
pmc