Part 3, Perfecting Security Interests: Exceptions and Enforcement

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Once created, a security interest becomes a claim or lien on the settlement proceeds. Individual tort and commercial cases can be subject to numerous liens from attorneys, medical providers, other legal finance companies, government entities, and private individuals. In addition, portfolios of cases can also be subject to liens, primarily from financial institutions and investors. Lien analysis is a vital consideration for any underwriter because even if the merits, procedural posture, and other elements of a case are compelling enough to suggest a win, an investor still risks nonpayment if other stakeholders are entitled to a priority distribution from those proceeds.

In consumer transactions, almost all lawsuits involving personal injury have liens from third parties. The primary lien is for attorney’s fees, which is typically a third of any recovery, but in some circumstances can be as high as 50 percent of the recovery. Other liens include medical providers, Medicaid, workers compensation, Social Security and disability, child support, IRS or state tax authorities, and other funding companies, among others.

In commercial deals, it is also common to see third-party liens. If the attorney is on contingency, there will be a lien from the attorney. There may be civil judgments, as well as liens from the IRS, state, and sometimes foreign tax authorities, expert witnesses and other legal services providers, as well as legal finance companies and occasionally individuals who invested in the claim.

Ultimately, lien law governs the distribution of legal finance proceeds. As I discuss in Part I, UCC liens usually trump all unperfected liens, meaning that “first in time, first in right” does not always apply. However, even this lien rule has several exceptions. For instance, the attorney’s lien always comes first, regardless of any other liens created before or after an investor becomes involved.

Federal liens (a notable example being Medicare liens) take priority over almost anything. Many attorneys will not even release funds until they have received a clearance letter from Medicare. State liens are also a concern for providers. One of the most common state liens is for child support, where the plaintiff owes their local social services agency money for the support of one or more children. As a general rule, child support liens will trump legal finance liens, even where one can show the legal finance lien occurred and was perfected before the support lien. As a matter of public policy, the legal finance lien will be subject to the child’s interests.

An understanding of lien law and a thorough lien search are both essential to a well-conceived underwriting methodology. Underwriters must inquire with plaintiffs and their legal teams, and conduct independent research to obtain an accurate record of present and possible future encumbrances to the recovery proceeds. Many of the liens can be discovered by performing a background check on all the plaintiffs (individual or corporate) that will be parties to the investment agreement, using Bloomberg Law, Intelius, LexisNexis, and Westlaw.  In larger deals, funding companies may require plaintiffs to furnish their credit reports to discover any liens, judgments, bankruptcies, or potential future claims.

From a collections perspective, when fighting for its proper share of assigned proceeds, providers must review information received from the attorney thoroughly, sorting through the liens and making a distinction between statutory, perfected, and unperfected liens, and those not listed in the contract or those that have followed the non-recourse investment. The existence of a lien and its amount should be verified by examining third-party records.

Whenever a question regarding lien priority or a challenge of liens arises, a useful tool can be found in the funding agreement itself. The time when an investor can make the greatest impact is often before the investment is actually made. Ensuring that the proper remedies are outlined in the agreement before a problem arises is crucial to strengthening the funder’s side of the bargain at a later date. Requiring a plaintiff’s attorney to list existing liens prior to the investment will preclude certain unforeseeable issues from surfacing once the case is resolved.

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