Dating to the Middle Ages, confessions of judgment helped lenders collect debts without going to trial. The arcane legal document proved so controversial that many states banned them decades ago.
But they are making a comeback. Some crafty entrepreneurs recently dusted them off and are reaping big rewards.
Small business owners, in particular, be aware. Signing a confession of judgment can cost you nearly everything, a reality showcased in a fascinating Bloomberg Businessweek cover story.
The nightmare starts with a high-interest cash advance and spirals down from there.
Businessweek put it this way:
"Rather than breaking legs, these lenders have co-opted New York's court system and turned it into a high-speed debt-collection machine. … Armed with a confession, a lender can, without proof, accuse the borrowers of not paying and legally seize their assets before they know what happened."
New York is the epicenter, but that doesn't make us immune here in Florida. Our state won't enforce a confession of judgment, but New York will "accept them from anywhere," Businessweek warned.
In fact, the article begins with Janelle and Doug Duncan, who ran a real estate agency in the Tampa Bay area. They borrowed $36,762 from ABC Merchant Solutions, one of dozens of companies affiliated with Yellowstone Capital, co-founded by David Glass. Once busted by the FBI for insider trading, Glass was the inspiration for the 2000 stock-fixing movie Boiler Room, staring Giovanni Ribisi and Ben Affleck.
Before lending the money, ABC Merchant Solutions and the other companies have clients like the Duncans sign confessions of judgment enforceable in New York. They call the loans cash advances, which often don't draw as much scrutiny from regulators as traditional loans. They also allow the lenders to charge much higher annual interest rates, 400 percent in some cases.
If the clients fail to make payments or otherwise breach the terms of the contract, the documents allow the companies to go to a clerk of court in New York to freeze bank accounts and seize cash. They don't have to go before a judge, nor do the small business owners get a chance to defend themselves in court before losing access to their money.
The Duncans were paying back the loan in $800 increments automatically pulled from their bank account each day. They had not missed a payment and have documents to back it up, according to the Businessweek article.
Still, ABC Merchant Solutions said the couple missed one $800 payment. The lender used the confession of judgment to freeze the Duncans' bank accounts and eventually took $52,886.93, far more than the original amount, especially after factoring in the thousands of dollars the Duncans had already made in daily payments.
ABC froze the accounts just three days after the lender alleged that the Duncans had missed a payment, said Hillsborough attorney Jeffrey Dowd, who the couple met with after they discovered they couldn't access their money.
"The Duncans didn't miss a payment, but these lenders move at even the slightest inclination that someone isn't going to pay the money back," Dowd told me. "There are no checks or balances and very few ways for business owners to push back."
The swift process, combined with added fees, allows the lenders in some cases to make more money — and faster — than if the borrower had paid it all back, even at a 400 percent annual interest rate. Businessweek referred to it as a "profit engine."
"By seizing (the Duncans') bank accounts, Yellowstone had managed to collect its money ahead of schedule and tack on $9,990 in extra fees," Businessweek reported. "In about three months, the company and its affiliates almost doubled their money."
The article details how New York's court system enables the process: Court clerks rubber stamp the confessions. When business owners appeal, judges tend to rule against them, saying they waived their rights by signing the document. The state marshal gets a 5 percent fee for its collection services, a job that netted the top collector $1.7 million last year, seven times more than the New York City mayor's salary.
"New York's legal system has a flaw in it that basically allows these lenders to prey on people who are in a desperate situation," Dowd said. "They know that once they freeze the accounts, the small business owners won't have any money left to put up a legal fight."
Many banks go along, too, routinely freezing their clients' bank accounts, sometimes without telling them why. That money is often the business' lifeline. Without access to it, they can't survive. The Duncan's, for instance, had to close their real estate business.
While the process is legal, small business owners have complained that the lenders have forged signatures, altered documents and made up stories about clients defaulting on payments, all in an effort to make more money.
This is no one off, either. Businessweek found more than 25,000 judgments filed in New York since 2012 — most in the last two years — worth an estimated $1.5 billion.
Dowd's advice to any small business owner thinking of signing a confession of judgment:
"Don't do it!"
Contact Graham Brink at firstname.lastname@example.org. Follow @GrahamBrink.