by John Darer® CLU ChFC MSSC RSP CLTC
The Structured Settlement Factoring Audit Technique Guide has an all new revised edition! The guide contains loads of useful information for someone who wants to understand the basis for Structured Settlement Protection Acts and IRC 5891, a section of the Internal Revenue Code that is often cited by settlement professionals, industry commentators and some factoring representatives, but occasionally in a context that provides the misinformation that "IRC 5891 made factoring legal".
Let's start with a little history...
The IRS, citing ABA Judges’ Journal, Spring 2005 Vol. 44, No. 2 pp. 19-31, “Transfers of Structured Settlement Payment Rights: What Judges Should Know About Structured Settlement Protection Acts”, authored by Daniel W. Hindert and Craig H. Ulman states:
"Through aggressive advertising, specialized finance companies – now commonly referred to as factoring companies – began persuading structured settlement recipients (referred to herein as “payees”) to trade future payments for present cash.
To circumvent the restrictions on assignment of payment rights, factoring companies arranged for payees to redirect their payments to factoring company addresses. The factoring companies would then collect the payments (endorsing checks in the payee’s names, using powers of attorney and signature stamps) without informing insurers that payment rights had been assigned.
Many payees who dealt with factoring companies were exploited. By fashioning transactions as purchases of future payment rights or as loans originated in states with generous usury laws, factoring companies often charged sharp discounts to payees who were ill equipped to appreciate the value of their future payments or to understand the onerous terms of factoring agreements. In some cases, factoring companies charged discounts equivalent to annual interest rates as high as 70 percent. (as an aside, see J.G. Wentworth S.S.C. v. Jones, Jefferson Cty., S.W.3d 309, 315 (Ky. Ct. App. 2000) (“[i]n the four cases here the rate of return to Wentworth varied between 36 and 68 percent per year”); Windsor‐Thomas Group Inc. v. Parker, 782 So.2d 478 (Fla. 2d DCA 2001) (finding that from “a functional viewpoint, this agreement is a secured promissory note with an annual interest rate of approximately 100 percent.”-credit to Jason Lazarus, Esq. for locating these cases).
"Payees who defaulted often were sued in remote forums specified in the factoring companies’ form contracts. In many cases, these actions commenced with entry of confessed judgments against payees. Insurers responsible for making ostensibly nonassignable settlement payments became embroiled in collection actions brought by factoring companies. Insurers also faced uncertain tax consequences and risks of multiple liability when assigned settlement payments became subject to competing claims"
So as one can clearly see factoring was not illegal prior to IRC 5891. Though the IRS acknowledges that people were exploited, there is no mention that anyone was arrested for their "exploits".
THE IRS itself very clearly states...
"IRC section 5891(a) imposes a tax ...The purpose of IRC section 5891, is to deter the purchasers of payment rights under structured settlements from taking advantage of recipients who are entitled to receive tax free (structured) settlement payments, including (structured) payments under settlements received by victims of the 9/11 terrorist attack. The tax is basically a penalty tax imposed on purchasers of payment rights under structured settlements. The practical effect of section 5891 is to compel such purchasers to comply with State structured protection acts (“SSPAs”), which require that transfers of structured settlement payment rights receive advance court (or administrative authority) approval".
Structured Settlement Factoring Audit Technique Guide Revised August 2009
A sample of Structured Settlement Watchdog articles concerning "IRC 5891 manure spreading" by members of our industry