Economics Of The Lawsuit Factory
For months now, the press has dissected the assembly line litigation model of the foreclosure boom, in which banks hustled foreclosures through the court system with less oversight than a busdriver collecting tickets. But there’s also a concurrent boom in consumer credit litigation, a crush of lawsuits aimed at squeezing out at least some fractional return from busted credit cards and consumer loans.
The most prominent players in this are probably not lenders but debt buyers, who buy charged off debt for a few cents on the dollar. In 2009, just one such company, the Encore Capital Group filed 385,000 lawsuits, the number I’ve highlighted here. Almost without exception, the debtors in these cases have no lawyers; the vast majority don’t even show up for a hearing, turning many state courts into factories for default judgments.
Encore is a public company, and thanks to its financial statements (here’s the last annual report) we can glean a lot of insight into the economics of assembly line litigation and see just how much the business model relies on rocket dockets and debtors who don’t mount a defense.
You might expect that the mass lawsuit model would be a goldmine for debt buyers. They buy debt for a tiny fraction of the face value—Encore, for instance, pays an average of about 4 cents on the dollar for charged off credit card debts. Then they turn around and chase debtors for the full amount. But it turns out that mass litigation, with all its collateral damage, turns out to be a surprisingly low margin business.
Just how much does Encore get from an average lawsuit? The obvious thing to do would be to divide the total Encore collected from litigation in 2009 ($232,667,000) by its 385,000 lawsuits. But it takes time to file a lawsuit, collect a judgment and garnish wages.
So to be more precise, let’s take the 314,000 cases that went to Encore’s legal channel in 2006. From 2006 to 2009, Encore collected $188 million on these. A few more million will trickle in for 2010 and 2011, putting the total at a little over $200 million. For 314,000 lawsuits, that comes to about $694 per case.
But now factor in the expenses. Out of its winnings, Encore will pay 40.8% in commissions to lawyers. Then there are the costs of the court system—fees to file the case, serve the summons, and enter the judgment. These seem to run about 20 percent of expenses (it’s hard to get a more precise number from Encore’s public documents; for 2008, the total was 19.9%). So, that means:
$694 in collections per lawsuit
minus $283 in commissions to lawyers (40.8%)
minus $139 in court costs (20%)
$272 in collections after court and attorney costs
Remember, that does not include what Encore pays to buy the debt in the first place. Encore doesn’t break down the face value of the accounts that go to Even if Encore was to get this debt for free, it would make just $272 per lawsuit. Or you can think of this another way: it’s the total recovery there is to split between the debt buyer and the credit card company.
Not much, is it? For creditors, any return on a bad debt is better than none. The bigger social question, though, is whether it’s worth the misery it creates. That minimal return comes in the main—I would bet almost entirely—from seized bank accounts and garnished wages.
Is this just or not? I don’t know. Without doubt, Most of the people Encore sues do in fact owe the money. In practice, though, most people who can pay their debts do so because they are reflected on their credit record. So assembly line litigation affects mainly those debtors for whom paying would cause great hardship. In those cases, for the small return to creditors, there is substantial social cost.
Some people are made homeless when the last money in their account is seized to satisfy a judgment. Others, trying to avoid wage garnishment, move between off the books jobs and stay in the marginal economy. On top of that there are the costs borne by taxpayers in making them pay (see this story of the Minnesota county that routinely imprisons debtors).
If indeed these social costs are excessive, one possible solution here—which I have not seen proposed—is simply to raise the costs of litigation. Just tripling filing fees and the like would cut into that $272 return enough to make most suits uneconomic for a company like Encore.
Some folks might worry that these costs are often assessed as part of the judgement against a debtor. In real life, though these kinds of lawsuits wind up recovering only a fraction of the judgement, so in practice for most suits it would be the plaintiffs—who’d have to budget for higher court expenses.
This would leave only those cases in which a substantial amount of money is at stake and the plaintiffs believe the debtor might realistically pay it—the cases, in other words, that the legal system is built for. Debt buyers have made mass litigation work by turning lawsuits into a low cost, high volume business. Those who worry about the social effects of this volume of litigation may want to think seriously about how to raise the costs.
PS: I’ve used the 2009 numbers for the Encore Capital Group because those are the latest available. The 2010 annual report should be out soon, and I’ll try to update this post with those numbers.