When your business needs money fast, the paperwork tends to get skimmed. That is how a lot of owners end up signing a confession of judgment without knowing it. If you don’t know what language indicates the presence of a clause like that, you could inadvertently sign a document that lets the lender seize your assets without any warning if they convince a court you’ve violated the terms. In plain terms, a confession of judgment (also called a COJ) is a contract provision that waives a borrower’s right to litigate a dispute. It is a clause in some business loans and commercial contracts, which lets the lender skip the court system and just seize the borrower’s bank account if the borrower defaults.
Let’s break it down. First, let’s imagine the borrower defaults on the loan. In a normal case, the lender would have to file a lawsuit against the borrower. He’s entitled to have his day in court and argue he’s not liable, and the lender would have to prove it. But a confession of judgment takes that away. Because you signed the confession, you can’t contest it later. In a way, a confession of judgment is a shortcut. It allows the lender to cut right to the chase.
Where are they allowed? They’re illegal for consumer loans (thanks to the FTC), but state law controls them for business loans. These days they’re allowed in these states: Maryland, Michigan, Illinois, New Jersey, Minnesota, Ohio, Pennsylvania, Virginia, and Texas. Pennsylvania specifically allows them in UCC transactions. SBA loans, or bank loans, usually don’t include a COJ because they require collateral to ensure repayment. You are most likely to find them in a promissory note issued after a business loan, a loan for business equipment, or a merchant cash advance. You can also find them in a loan between friends or family.
Equipment financing companies can instantly repossess equipment using a confession of judgment. And commercial landlords, too, can use it to instantly evict a business that misses payments. They use confession of judgment because it saves them the time and money if the borrower defaults. Otherwise, they may need to go through multiple hearings and hire a lawyer to recover the original amount borrowed, and the fees can even end up exceeding the loan itself.
Enter Judgment Against You
You sign a Confession of Judgment, and it doesn’t take effect as long as you strictly follow the contract terms. If you miss a payment or otherwise breach the contract, your lender just needs to go to the court clerk’s office to enter judgment against you, based on the contract you signed. No trial is needed. So if you miss a payment, the lender can just withdraw the balance from your bank account without even telling you first, including any additional fees.
When you sign a Confession of Judgment, you admit in advance that you’ve broken the terms of the contract. That means you can’t set up a legal defense to the judgment in court, and you can’t negotiate with the lender. If your lender doesn’t have your best interests at heart, they can file it after a mere hiccup in your ability to make payments, like a computer glitch, a bank closing, or an accounting mistake. Missing a payment by one day is enough to let the lender file.
Since that judgment takes almost no proof, lenders can sometimes file a Confession of Judgment even if you haven’t missed a payment or breached the contract in any other way. It’s legal, but it leaves the borrower stranded with almost no resources, which makes it hard for them to get the help they need to prove that the confession was filed in error. If your business signs one, the lender can only come after business assets to settle the debt. But if the owner signs it personally or adds personal guarantees, the lender can take personal assets, too. The lender can then freeze and withdraw funds from the borrower’s bank account without warning. The judgments are public record, which can hurt your ability to get future financing.
In Pennsylvania, there is a 30-day waiting period so the debtor can either fight it or agree to a payment plan. But PA doesn’t require a lender to tell the borrower about the filing, so you might not learn about the judgment until the lender starts collecting. There was also a loophole: a company headquartered in New York could get a confession of judgment filed in New York for an agreement signed elsewhere. Now, New York law prohibits confessing judgment against companies based outside the state. A few other states, such as Virginia, require this type of contract term to be clearly labeled. In others, including Massachusetts and Florida, it is illegal. Businesses in New York, Pennsylvania, and other states where this tactic is still allowed should beware.
Avoid Signing One
A lender does not need you to sign a confession of judgment, so avoid signing one whenever you can. Ask other businesses for reviews, check their ratings with the BBB, and see how long they have been in business to determine if they are a reliable lender. It is also important to research the rules in your own state and in the state where the lender is based. Good lenders will ensure you have due process if you miss a payment or make a mistake violating the terms of your loan contract. Ask the lender their policies on missing or late payments before you sign a loan contract. You should be wary of any lenders who push for you to take out more of a loan than you need and try to use aggressive sales tactics.
If the lender insists on a confession of judgment even if you’re willing to provide other kinds of guarantees, consider another lender. Traditional financing might not be an option if your credit is low or your business is young, but you can usually find another lender who won’t ask for a Confession of Judgment. If you want to avoid one, the best way to do it is to consult a lawyer who is familiar with small business loans. Many small businesses decide to skip this step to save money, but it’s much cheaper to have a lawyer look at your loan documents before you sign them than it is to try to get your assets back after a judgment. The lawyer can also advise you on ways to negotiate your loan agreement to protect you against other unfavorable details in the loan document that could put your business assets at risk.
Fight Back Against a Confession of Judgment
It’s harder, but you can still fight back against a Confession of Judgment after signing it, as long as you get a lawyer. If a lender hits you with a Confession of Judgment, you can still mitigate its damage by paying the debt off in full or hiring a lawyer to negotiate a settlement. In some states, if you pay off the debt, the judgment will be removed. A lawyer can also help you vacate the judgment in court. If the lender didn’t accurately describe the rights you gave up with the Confession of Judgment or didn’t follow proper procedures, you can file a motion to appeal the original ruling. You can also get the judgment removed from your credit report if you can prove that you paid your debt and that the lender filed a judgment against you due to clerical errors or other mistakes.
