As a business owner, you’re probably used to putting your signature on a lot of documents. This is especially true if you’ve ever signed a commercial lease or taken out a business loan, line of credit, or merchant cash advance for your company.
There’s just one problem. Most financial agreements are filled with legal jargon that you probably won’t fully understand unless you commit a few years of your life (and perhaps around $30,000–$50,000) to attend law school.
Of course, you can always pay an attorney to review financial agreements for you before you sign them. But for many small business owners, this isn’t an expense they’re willing to pay or feel able to afford.
Nonetheless, you can take a few steps to try to protect yourself before you sign on the dotted line. While it may be unrealistic to expect to fully understand everything that’s written in a financial agreement, you can learn about a few potential red flags you should look for in the future.
One infamous (and dangerous) clause you should always search for before signing any financial contract is known as a confession of judgment.
Spoiler alert: A confession of judgment is, indeed, just as scary as it sounds.
Note: This post is for informational purposes and isn’t a substitute for legal advice. You should contact an attorney for advice pertaining to any particular legal question, issue, or problem.
What Is a Confession of Judgment?
A confession of judgment is a document a lender or landlord might ask you to sign when you take out a business loan or commercial lease. Merchant cash advance providers and other alternative funding providers may ask you to sign one as well. (And by “ask,” we mean that they might tuck the clause inside your contract and hope you sign it without asking any questions.)
A confession of judgment takes away your right to defend yourself before a judge if the company ever decides to sue you for not paying your debt. To add insult to injury, the contract you sign may also state that you agree to pay the attorney’s fees and any court costs charged for the process.
When you sign a confession of judgment, you’re essentially agreeing to let a judgment be entered against you without fighting back. Your creditor’s attorney doesn’t need proof. They have your signed confession. In fact, your creditor’s attorney could go to the courthouse and ask for a judgment to be placed against you without even a heads up.
Some confessions of judgment will also include a personal guarantee which could extend liability for the debt beyond your business and into your personal finances and credit. This means that not only could your business’ assets be at stake in the event it doesn’t pay a debt, your personal assets, like your bank account or home, might be on the line as well. Unlike UCC Filings, which is a legal notice a lender files with the secretary of state when they have a security interest against one of your assets.
How Does a Confession of Judgment Work?
When you sign a confession of judgment, you’re essentially saying that the other party can enter a judgment against you in the event of a default. Under more aggressive agreements, a late payment might even be enough to trigger the clause.
Your creditor (or more likely their legal counsel) can go to court and enter a judgment without sending you notice in advance. Not only can the judgment be entered without notice, the other party may be able to skip steps (aka procedural requirements) that are normally required when a company files a judgment against a debtor such as:
- Filing a complaint
- Serving the defendant (that’s you)
- Taking discovery
- Having a trial
All of the steps above might be skipped over if you sign this dangerous agreement.
How Is This Legal?
It’s understandable that lenders and landlords need to protect themselves from loss and bad debt. Yet while credit checks, collateral requirements, and even a personal guarantee are generally acceptable ways for companies to reduce their financial risk when extending credit, many believe that a confession of judgment crosses the line.
Confessions of judgment are considered to be predatory lending practices and aren’t permitted in many states. The federal government doesn’t allow them to be included in consumer loan agreements at all. Yet in other states, most notoriously New York, the courts are often willing to enforce them (though possibly for only certain types of business debt and only for certain amounts of time).
Bloomberg reports a disturbing story of how Janelle and Doug Duncan, owners of a struggling Florida-based real estate company, learned about a confession of judgment they had unknowingly signed with a predatory cash advance company. Unfortunately for the Duncans, they only learned of the clause when their bank accounts were frozen and over $52,000 suddenly vanished without their knowledge or consent.
Thanks to the Bloomberg exposé, “Sign Here to Lose Everything,” lawmakers are attempting to crack down on the shady collection tactic. However, many say the confession of judgment epidemic isn’t ending quickly enough. It’s a huge problem which has allowed some merchant-cash advance companies to take advantage of tens of thousands of small business owners across the U.S.
Should You Sign a Confession of Judgment?
In short, no. Signing a confession of judgment isn’t a good idea, no matter how badly you need the money.
If a lender or landlord asks you to sign a confession of judgment, you can try negotiating to have the clause removed from your agreement. Don’t be afraid to shop around for other options if a lender or landlord isn’t willing to remove the requirement. Even with limited credit or a poor credit rating, you may still be able to find a lender who doesn’t engage in this aggressive practice.
You can set up a free Nav account to get matched to the right business financing options based on your credit profile. Finally, make it a goal to start building a better business credit profile for the future. As your commercial credit rating improves, the risk of doing business with you is reduced in the eyes of lenders. You’ll unlock the door to more (and better) financing options, little by little as your credit improves over time.
This article was originally written on May 23, 2019 and updated on January 27, 2021.