'Confession of Judgment' in a Business Loan? Stop Before You Sign!
A couple in the Tampa Bay area got a loan for $36,762 for their real estate business. Even though they had never missed a payment the lender convinced a court to freeze their bank account and took $52,886.93 from them (far more than they paid, considering they had already made payments). How could this happen?
The husband and wife had signed a confession of judgment, which legally gave the lender the right to take their money after convincing a court that they had missed a payment. (See this article in the Tampa Bay Times for more details.)
What's a Confession of Judgment?
A 'confession of judgment' (also called a cognovit note but not to be confused with a consent judgment) is a document signed by a borrower that waives the right to due process if a debt is unpaid. The term "confession of judgment" or consent decree, means that the signer confesses and accepts the judgment (the decision of the court). This confession of judgment might also be a personal guarantee, in which the borrower pledges personal funds if the loan isn't repaid.
If you sign a confession of judgment, you are basically saying you automatically admit that you broke the contract. The penalty written into the contract can be imposed on you without any opportunity to tell your side or reach a compromise. It's like confessing you killed someone without getting a chance to have a trial.
Confessions of Judgment are Under State Law
'Confession of judgment' language is part of a loan agreement, specifically in a promissory note. This language is regulated by states. Not many states (including Florida) allow confession of judgment language, but New York, where the Tampa couple's loan company had its main office, does.
Some states allow confessions of judgment in limited areas; Pennsylvania, for example, allows confession of judgment clauses in commercial (business transactions). Sometimes the state law allows a period of time (30 days, for example) to allow the debtor to file motions and work out a repayment plan.
How Does a Confession of Judgment Work?
This concept isn't difficult but it's strange, so let's look at how this all happens.
- A company gets a business loan from a lender. The company signs documents with the confession of judgment language during the loan approval process.
- At some point maybe the borrower pays a day late (but not always). The lender goes to a court (in New York, in this case) and gets someone (maybe just a court clerk) to agree that the borrower is in default on the loan. That is, the borrower didn't comply with the terms requiring how the money is to be paid back.
- So the confession of judgment language is acted upon by the court, and the lender takes the judgment order to force a bank to freeze the debtor's funds and give these funds to the lender.
- No, the lender doesn't have to notify the borrower that their money is going to be taken.
A story in Bloomberg Business says of this practice:
...these lenders have co-opted New York’s court system and turned it into a high-speed debt-collection machine. Government officials enable the whole scheme.
The Bloomberg story reports that "In one month, a single clerk's office in Orange County, New York, issued 176 judgments against small businesses in 38 states and Puerto Rico."
What Does a Confession of Judgment Language Look Like?
Here's a brief example of the language in a promissory note that includes a confession of judgment, from an American Bar Association document (WORD form). At the top of the form, this language appears:
THIS INSTRUMENT CONTAINS A CONFESSION OF JUDGMENT PROVISION WHICH CONSTITUTES A WAIVER OF IMPORTANT RIGHTS YOU MAY HAVE AS A DEBTOR AND ALLOWS THE CREDITOR TO OBTAIN A JUDGMENT AGAINST YOU WITHOUT ANY FURTHER NOTICE.
Further down in the document there is language allowing the debtor to authorize an attorney "to confess judgment against the Debtors in favor of the Surety (basically, the lender) for the full amount of the ..Loan...without stay of execution or right of appeal, and expressly waiving ...relief from the ... immediate enforcement of a judgment...."
How Can the Business Get Its Money Back?
It can be almost impossible. In the case of the couple in Tampa, they lost their business and had to declare bankruptcy because all their cash had been taken. To fight this injustice, the debtor needs an attorney, and how do you pay this person when you don't have any money? Since the whole process was legal, and the lender can prove that the debtor signed, there's little that can be done.
What Can Be Done Before Signing
Since the financial recession in 2008, some lenders require confession of judgment language in business loans to prevent debtors from walking away from the business and the loan. Some suggestions:
- Ask about the lender. Check them out. These lenders often offer great rates that banks can't match but they are more likely to require confession of judgment language.
- Find out where the lender's headquarters are (what state) and what their laws are regarding confessions of judgment.
- If the lender won't remove the clause, ask what other guarantees you can give. If there's no opportunity for compromise, you might want to walk away from the loan.
- Get an attorney to review the documents before you sign. It's better (and cheaper) to pay an attorney before the fact than to pay to try to get your money back.