How to avoid confessions of judgement in small business lending
Over the past few months, there’s been a lot of news coverage about a once-obscure legal document that’s been gutting small businesses nationwide. The “Confession of Judgement” (CoJ), also called a Judgement of Confession, a consent decree, or a cognovit note essentially says you automatically plead guilty if the terms of the loan contract are broken, which can be as tiny and common as missing a payment by a single day. If you sign one during the loan process, you waive your right to contest or reach a compromise with the courts or the lender—giving them the right to withdraw the full loan amount immediately.
Predatory businesses relying on CoJs don’t care about the borrower’s good faith: a bank closure, a holiday, a computer glitch, an accounting mix-up, or any other day-long delay of a required payment could trigger the clause and put you into default. CoJ purveyors are banking on the chance you’ll miss a payment. With your signed “confession” in hand, these companies use a friendly court clerk to enforce your breach of contract, seize your assets, including tacked-on fees and penalties—all without having to notify you. The Federal Trade Commission (FTC) nationally outlawed CoJs from consumer loans 35 years ago in the 1984 Credit Practices Rule recognizing the predatory nature of such clauses but left it up to the states to self-regulate the use of CoJs among small businesses.
Legislative Fixes Ban CoJs for Some SMBs, Not All
Bloomberg Business, in its illuminating investigative series on the practice, outlined the full impact CoJs have had on American small businesses in recent years. With a convenient loophole in the state of New York, local courts often found themselves granting predatory lenders full and immediate repayment of loans, and so long as that lender had a branch of operation in New York City, the City’s Marshall service was allowed to roam the country collecting debts. While the Bloomberg series recently led the New York state legislature to prohibit issuing CoJs to businesses based outside the state, New York small business owners, the nation’s second-largest small business community, are still left vulnerable to the practice, though the CoJ has to be filed in the county where the business operates.
Pennsylvania’s similar system requires a 30-day waiting period but doesn’t require notification of borrowers, who won’t find out about a judgment against them until after funds have been cleared from their bank accounts.
What to Watch For
A reputable lender will have “work-out” policies to get you back on track. When you’re negotiating a loan, ask what happens if you’re a day late or a few dollars short. Ask about the due process you’re entitled to in the event of a mishap, and your recourse if that process is violated.
Always read your contracts.
Pay special attention to the consequences of non-payment. Where do they want the court proceedings to take place? If it’s a different state than where the lender is headquartered, ask why. And always ensure there’s no mention of a confession of judgment, judgment confession, consent decree or cognovit note.
A CoJ will sometimes be added onto an existing promissory note or other documents. It’s normal to sign a document in four or five places, but diligently read the content. Look for language like this:
“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….”
Check out your potential lender.
Read the Better Business Bureau ratings and reviews from other businesses who’ve used the lender. Also, make a note of the lender’s time in business: shady companies can start dozens of subsidiaries that might only be in business a few months and close down again before their misdeeds can be documented.
Trust your gut.
Beware of anyone trying to give you a larger loan than you want or need. If your lender has more to gain by your missing a big payment than by paying back a small loan steadily, he’s not on your side. Watch for red-flag tactics and high pressure sales tricks, as well: if someone is pushing you to make a decision quickly, is unwilling to negotiate (insisting you ‘take it or leave it’) or resists your questions about the terms of the loan, the lender doesn’t have your best interests in mind.
Consult an attorney.
Small businesses, especially those seeking alternative financing, may be tempted to avoid the added expense of a consult. Better to spend that money now, though, than pay a bankruptcy lawyer after a CoJ has cleaned out your assets.
Find Trusted Sources
With more than 185,000 customers, Kabbage works diligently to ensure our customers have an exceptional experience with us. We know there are plenty of options out there to serve small businesses’ needs, which is why we helped develop the SMART Box which gives companies all the tools and figures necessary to properly cross-compare funding options in the market.
As a company dedicated to clear and transparent disclosures in small business lending, Kabbage has never, nor will it ever, force a Confession of Judgement on our customers. To ensure businesses are treated fairly and well equipped to make sound decisions for their businesses, we hope this helps keep our customers and other small businesses safe from harmful practices in the industry.