As a small business owner, one of your top priorities is to obtain capital for your business, sometimes through credit. 

But whether you’re accepting a business loan, line of credit, merchant cash advance, or any other type of financing, it’s crucial that you read the fine print in your loan documents.

One of the things you’ll want to look out for is a clause known as a confession of judgment. Regardless of how much you need the money, if you find one of these in your loan agreement or promissory note, your best bet is to decline the offer and walk away.

Here’s what you need to know.

What Is a Confession of Judgment?

In a confession of judgment clause, the borrower agrees to waive their right to due process in certain cases. A confession of judgment clause can also be included in a commercial lease agreement. This means that if you default on your payments and your lender or landlord decides to sue you, you don’t have the right to defend yourself. 

In other words, the creditor or landlord can request a court order to garnish bank accounts, seize property, and take other actions to force repayment. In some cases, this can even happen without prior notice. 

The contract clause may also state that you agree to pay the plaintiff’s attorney’s fees and any costs associated with the court incurred during the process.

Finally, confession of judgment clauses can also state that you’re joint and severally liable for the debt. 

This is also known as a personal guarantee, it means that you’re personally on the hook to repay the debt if your business can’t, which means the lender or landlord can go after your personal assets too.

How Does a Confession of Judgment Work?

When you sign a loan or lease contract with a confession of judgment, you agree to allow the other party to enter into a judgment against you if you default on the loan or sometimes miss a payment. 

If you’re working with a lender or landlord that uses this type of clause, they can go to court and request a judgment against you by a judge. There’s no requirement for the lender or landlord to notify you before doing this, so you may not find out until after it’s too late.

On top of that, a confession of judgment may allow the lender or landlord’s legal team to skip certain steps of the process that are normally required when a plaintiff files a lawsuit against a borrower or tenant.

For example, they may not have to file a complaint, serve you as the defendant, take discovery, or go through the trial process. 

Not only will you be legally required to comply with the judgment, but you may also need to pay the lender or landlord’s legal fees, along with the court costs. 

What’s more, the judgment will likely show up on your commercial credit reports, making it difficult for you to get business financing and enter into other important business agreements in the future.

Confession of Judgment in a Business Loan

When you apply for a business loan, whether it’s a term loan, line of credit, merchant cash advance, or anything else, you’re basing your decision on the interest rate, repayment period, and other surface-level factors.

But if you get approved, and the lender offers you certain terms, it’s crucial that you read through the entire loan agreement before you sign the dotted line and accept the terms. 

It’s particularly important if you’re considering a merchant cash advance or another form of alternative short-term, high-interest financing. 

The good news is that many states have prohibited confession of judgment clauses on business loans because they’re associated with predatory lending practices. The federal government has outlawed the practice entirely for consumer contracts. 

But if you’re operating in a state that allows them — New York is one example — it’s crucial that you take steps to protect your business and personal assets. 

Because the last thing you want is to struggle to pay back a business loan then suddenly notice that your business or personal bank accounts have been frozen and funds have been garnished to repay the debt. 

If you notice a confession of judgment clause in your loan agreement, your best bet is to walk away. Even if you have less-than-stellar credit, there are plenty of financing options available that don’t require you to sign your rights away. 

How Can a Confession of Judgment Affect Your Business Credit Score?

If you simply sign a confession of judgment but never miss a payment, you don’t have to worry about any impact on your business credit history. 

However, if a court enters a judgment against your business, it will show up on your commercial credit reports. Even after you’ve satisfied the court order, it may still remain on your reports for several years, albeit with a notation.

It’s unclear exactly how a judgment impacts your business credit scores. But just the fact that they’re listed on your credit reports can make your life difficult. 

Anyone can look up your business credit reports, so if you’re applying for credit, you may have a hard time getting approved. The same goes if you’re applying for a lease or vendor credit. 

Even if you’re just looking for investors or are trying to partner with another company, they may balk if they find judgments on your credit reports.

Fortunately, a confession of judgment won’t impact your personal credit history at all because court judgments are no longer listed on consumer credit reports. 

However, if there’s a personal guarantee involved, the creditor may choose to report late payments or default to the consumer credit reporting agencies.

The Bottom Line

A confession of judgment is a relatively predatory practice that some lenders and landlords might use to limit their risks when working with borrowers or tenants. 

If you fall victim to a confession of judgment, not only do you face legal issues, but also legal costs, potential loss of business and personal assets, a negative mark on your business credit history, and more. 

Even if you’re confident that you’ll be able to make your loan or lease payments on time for the duration of the contract, it’s best to avoid agreements that include them — or at least attempt to negotiate to have them removed.

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