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This is a guest post by Ronald Sinai, the founder and CEO of Nova Legal Funding, a national lawsuit funding company based in Los Angeles. Prior to entering the legal finance field, Ron was a student at the University of California, Berkeley where he earned a Bachelor’s degree in 2014.

Personal injury law is a big business in the United States. With every traffic accident or slip and fall, a ‘lawsuit economy’ emerges in expectation for the looming monetary compensation for the plaintiff. Attorneys, medical treatment centers and litigation service providers make up the bulk of this network. This post will tackle the latest, fastest growing and most disruptive industry to enter the lawsuit economy: pre-settlement funding companies.

Pre-settlement funding is a financial lifeline for plaintiffs involved in personal injury litigation. It’s a cash advance on the future proceeds of a settlement for people who can’t wait years for their cases to finalize. Plaintiffs often use the advance to pay for living necessities, medical bills and other immediate financial obligations. Repayment to the funder is wholly contingent on the case being settled out of court or won in trial. The plaintiff repays nothing if the case is lost, making it a risky non-recourse investment for the funding company.

As a principal in a funding company, I felt obliged to contact Cathy after hearing her speak on Slate.com’s Money Podcast and reading her negative blog post about my industry. While it may surprise you, my intent in reaching out was not to correct her. In fact, her worries are completely valid and for good reason. Little-to-no oversight by regulators has allowed bad players in the legal finance industry to employ business models that place profits over ethics. Over time, such practices justifiably resulted in a bad name for the industry, with some comparing this otherwise justice-equalizing tool with payday loans.

It’s important that we don’t throw the baby out with the bathwater. Simply because a lack of regulation led to a swarm of bad actors doesn’t mean pre-settlement funding should go away. When done correctly, embracing the fundamental benefits of lawsuit funding can help our justice system become more equitable and accessible to everyone.

On the value of plaintiff funding

Funding does more than ensure fair and complete compensation for the injured—it ensures that our justice system is blind to an individual’s economic standing.

Pre-settlement funding empowers small plaintiffs against big insurance companies. Just as attorneys litigate and treatment centers heal, the funder adds value to the case by granting the plaintiff financial stability. Solid financial footing helps them reject early lowball settlement offers from insurance companies, who always seek to take advantage of a person’s vulnerable economic position.

No matter how obvious the negligence or big the damages, insurance companies always delay compensation. It’s the oldest and most effective trick in the book: gain leverage by inducing desperation. The adjuster capitalizes on this desperation by offering the plaintiff a lowball offer in exchange for a quick and early payout. Funding the plaintiff takes the leverage away from the adjuster, which results in a big win for the small guy.

On the problem with plaintiff funding

No matter how great the premise of consumer legal finance might be, a lack of oversight will continue to allow bad players to charge unreasonable rates and make the service abusive rather than valuable.

As an operator in the space, I know what deals are being made and under what terms. I’ve seen countless of funding agreements from dozens of companies since the inception of my business. Plaintiffs who previously received funding from other sources come to us in hopes of refinancing their expensive paper. I don’t have hard data, but the average rate seems to be 3-4% compounded monthly or 35-40% every six month period. That’s not including a possible broker fee (10-20% of funding) and an application fee of $250-$400.

Even worse, most companies charge rates that are uncorrelated with the risk profile of each individual case. In other words, a litigious person with a questionable slip and fall at Wal Mart will get the same rate as a victim who was rear-ended while stopped at a red light.

The “fund-everything-at-high-rates” business model

Companies that charge high rates have the luxury of relying less on proper underwriting than they do on volume. This business model is attractive for many reasons. First, higher rates makes it easier to swallow loser cases, which reduces underwriting requirements and drives an increase in deal flow. Relaxed underwriting also means hiring less attorneys, which leads to a massive reduction in overhead.

Secondly, a lack of proper underwriting makes the process hassle-free for the plaintiff’s busy attorney, who wants nothing more than to get the funding process over with. Believe it or not, attorneys whose clients bug them enough for cash will take a quicker funding process over lower rates every time. Same goes for the plaintiff: they like what is fast, not what is affordable. They only realize the mistake when it comes time to repay the funder.

The fix? Enforce rate caps, force careful underwriting.

Not all funders behave recklessly. At my firm, for example, we offer a fixed payoff schedule for 10-15% each consecutive 6-month period. At these rates, our underwriting has to be lock-tight in order to turn a profit. A call with the attorney needs to be arranged, all liens must be inspected, and a variety of documents must be submitted by the law firm before a deal is made.

This forces us to only fund meritorious claims where plaintiffs suffer serious damages, and negligence is clear. By this logic, rate caps will do more than stop unreasonable rates. They will also make it impossible for frivolous lawsuits to get funding and hurt our economy.