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Finding that the arrangement did not run afoul of New York usury laws, the U.S. Court of Appeals for the Third Circuit has ruled that a litigation funder is entitled to a chunk of the proceeds from a plaintiff's settlement of a legal malpractice lawsuit against Reed Smith.

A three-judge panel of the court on Tuesday affirmed a Western District of Pennsylvania judge's ruling in Obermayer Rebmann Maxwell & Hippel v. West that two related litigation funding entities, Fast Trak Investment Co. and RJC Funding, were entitled to a portion of the settlement far in excess of the amount the companies fronted to John H.C. West III during the course of his litigation against Reed Smith.

The appeals court, sitting in diversity jurisdiction, applied New York law as set forth in the funding agreements and found that the payments made by Fast Trak and RJC to West did not constitute loans under the state's usury laws because West had no obligation to pay them back unless he made a recovery in the Reed Smith litigation.

“New York recognizes the absolute right to repayment or some form of security for
the debt as a defining characteristic of a loan,” Judge Jane Richards Roth wrote for the panel. “Its courts have explicitly stated that '[f]or a true loan it is essential to provide for repayment absolutely and at all events or that the principal in some way be secured…' Thus, a transaction that neither guarantees the lender an absolute right to repayment nor provides it with security for the debt is not a loan, and as a result, cannot be subject to New York's usury laws. The agreements at issue in this case clearly demonstrate that Fast Trak had no absolute right to repayment.”

Roth was joined by Judges Thomas Hardiman and D. Michael Fisher.

During the course of the litigation against Reed Smith, according to Roth's opinion, West received a total of $164,000 from Fast Trak and RJC, pursuant to several contractual agreements, each of which included a provision stating, “The purchaser has agreed to purchase from seller a portion of the proceeds [derived from the Reed Smith litigation] for monetary consideration.”

When the Reed Smith case settled in December 2014, the litigation funders sent West a payoff letter indicating that he owed them a total of $373,885, Roth said. West, however, refused to pay, arguing that the agreements were usurious. Obermayer Rebmann Maxwell & Hippel, as West's counsel at the time, received the settlement funds and deposited them into the district court.

The litigation funders filed cross-claims against Obermayer Rebmann and West, but Obermayer Rebmann was ultimately dismissed from the case. The district court subsequently granted the funders' motion for summary judgment and West appealed, claiming the agreements were unenforceable because they were usurious loans.

But Roth said the agreements were not loans because they “explicitly provide that West was required to repay Fast Trak if, and only if, he recovered money in the Reed Smith litigation.”

“Fast Trak's right to repayment, then, was contingent on the success of the Reed Smith suit and was not absolute,” the judge said. “Had West recovered nothing, Fast Trak would have had no contractual right to repayment. Accordingly, the disputed transactions were not 'loans' and are therefore not subject to New York's usury statute.”

Roth also rejected West's argument that the district court erred in setting a payment schedule that allowed for biannual increases beginning on the date of the funders' initial purchase, rather than on the date of West's recovery.

“The district court concluded that interpreting the agreements as establishing that the repayment increases did not begin until the date of West's recovery would create tension between the payment schedule and the provisions requiring West to satisfy his repayment obligation within five days of receiving the relevant proceed. We agree,” Roth said. “Second, the record establishes that West understood that the repayment increases would be based on the dates of purchase rather than on the date of West's actual recovery.”

Roth also waved off West's claim that the biannual payment increases ceased once Obermayer Rebmann deposited the funds with the district court, rather than continuing through the date of judgment, as the lower court found.

“We are unpersuaded by West's attempt to evade his contractual obligations,” Roth said. “The parties' agreements establish that the repayment increases were to continue until West's obligations were satisfied. Such satisfaction did not occur until the date of the district court's judgment.”

Counsel for West, James Cooney of the Law Offices of Robert O. Lampl in Pittsburgh, said he believed that, had Pennsylvania law been applied, the court would have found that the agreements constituted usurious loans.

Counsel for Fast Trak and RJC, Thomas Fleming of Olshan Frome Wolosky in New York, could not immediately be reached for comment.