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Testimony in Support of SB 216 (DOC)

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					                                     Testimony Opposing House Bill 873
                                    Maryland Civil Litigation Funding Act

                                             Mark Kaufman
                                    Commissioner of Financial Regulation

                                 March 3, 2010—House Judiciary Committee

        Chairman Vallario, Vice Chairman Dumais, and members of the Committee, we are before you
today in opposition to the passage of House Bill 873.

        HB 873 would expose Maryland consumers to a high-cost, potentially predatory, financial
product. It would do so by removing litigation funding transactions from the definition of loan under the
Commercial Law Article, with the result of exempting these transactions from the current usury cap of
33% in the Consumer Loan Law. Instead, HB 873 substitutes an alternative system of rate caps which,
while they are not referred to as such, allow interest rates which exceed 150%.

        As we have reviewed these transactions, which involve the extension of funds to be repaid from
the proceeds of a lawsuit, we have found them to contain key attributes of debt. The funding is an
advance. It has interest so the obligation grows over time. It is a preferred claim on the proceeds of the
suit (versus an equity share of those proceeds). To the consumer, it looks like debt, acts like debt, and is
repayable like debt – very high cost debt at that.

        Proponents counter that the transaction is not a loan but rather an “advance.” They contend that
the transaction is different because it is non-re-course. While we readily acknowledge that the
obligation is non-recourse, we also point out that loans are also non-recourse. Business loans secured by
real estate are often non-recourse, but they are loans nonetheless. Likewise in the consumer context,
reverse mortgage loans are non-recourse. In a reverse mortgage, senior citizens obtain advances which
are repaid from the equity in the home. The Federal Housing Administration (FHA) runs a well
established program through lenders for reverse mortgages, known as the Home Equity Conversion
Mortgages (HECM) and its description is illustrative.

          “The HECM mortgage is a “non-recourse loan.” This means that the borrower (or his
          or her estate) will never owe more than the loan balance or value of the property,
          whichever is less; and no assets other than the home must be used to repay the debt.”1

        Replace the word “property” in this definition with “lawsuit,” and the comparison becomes
clear. “This means that the borrower will never owe more than the loan balance or the value of the
LAWSUIT, whichever is less, and no other assets must be used to repay the debt.” So if the value of the
lawsuit proves to be zero, the counterparty owes nothing.

        These are the terms of a litigation funding transaction. As a result, we have taken, and continue
to take enforcement actions related to these products to implement the state’s longstanding usury limits.
1
    HUD Handbook 4235.1 REV-1, Home Equity Conversion Mortgages, Paragraph 1-3C
         HB 873 states clearly that no civil litigation funding transaction shall be deemed to be a loan
subject to the restrictions governing a loan. Those restrictions notably include the state’s usury cap.
So, in essence, HB 873 seeks a special carve-out from the longstanding usury cap for loans against
lawsuits. We confront efforts to avoid the cap with regularity. Just last year, for example, legislation
was passed to clarify that lenders could not split origination and funding of a loan in an effort to avoid
the cap. While those hearings were conducted before the House Committee on Economic Matters, the
will of the legislature has been consistent for three decades. In good times and in bad times, through the
hyper-inflation of the 1980s and the economic downturns of the 1990s and earlier this decade, the
General Assembly has left these levels untouched. We believe that the longstanding nature of the usury
statute is important to recognize as you consider authorizing 100% plus interest rate loans.

        HB 873 seeks to provide the elements of consumer protection in disclosure, cancellation, and
registration. Moreover, it contains a series of rate caps to replace the usury provisions. I would observe
that these caps are extremely high, in excess of 100% depending on the outcomes. More importantly,
however, I point out that this system of caps and restrictions will have a huge impact on litigation. If I
dial these restrictions up or down, I drive litigation incentives. Stop interest accruals after 6 months and
there’s no incentive to settle. Let interest accrue at higher rates and there’s more incentive to settle.
While I can point out these tradeoffs, the Office of the Commissioner of Financial Regulation is poorly
positioned to set them.

        If these non-recourse transactions are not debt, it can only be because of their equity element –
something of the purchase of a lawsuit. I understand that the purchase of interests in lawsuits raise
issues of legal ethics, the conduct of litigation, and the regulation of attorneys. These are matters
historically within the jurisdiction of the courts, the Bar Association, and the Attorney Grievance
Commission, not the Secretary of State or the Commissioner of Financial Regulation. Likewise, I note
that one cannot undertake a financial transaction involving a lawsuit AFTER settlement, a so-called
“Structured Settlement,” under Maryland law without court approval. Yet, no such court oversight is
provided if a transaction is executed pre-settlement under HB 873. In fact, many of the litigation
funding contracts that we have reviewed have mandatory arbitration clauses which would be allowed to
persist under HB 873. As a condition of getting the money, the borrower must agree that any dispute
will be settled not by Maryland’s judiciary, but rather by the arbitration system of the home state of the
funding company.

        If litigation funding transactions are to be treated as purchases of lawsuits not loans, they should
be regulated. However, the fairness, protections, ethics and other elements surrounding that sort of
transaction would seem to be the clear the province of the judiciary.

        In sum, we believe that HB 873 weakens the authority of the Commissioner and the existing
protections in place for consumers. It would expose consumers to interest rates for funding products
much greater than those permitted under current law. To the extent these products are loans, consumers
already have the most meaningful protections available, a usury cap of 33%. If these protections are to
be eliminated based on a notion that non-recourse debt is more akin to equity, then the bill fails to
establish proper oversight through the judiciary to fill the void.

       We urge this Committee to issue an unfavorable report on HB 873.



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