The Second of the Twin Dangers

The Second of the Twin Dangers

           In a previous post, I gave some cautionary advice and questions relative to a borrower signing a personal guaranty. These personal guaranties are frequently required in commercial lending environments wherein the main borrower is an entity such as a corporation or an LLC.

            The second of the twin dangers is a cognovit promissory note. I realize that not all states recognize and permit cognovit promissory notes. Those states that do only allow them to be used in a business context; however, I have often seen real estate investors who are borrowing money for their business, or for a rehab or flip, willingly sign a cognovit promissory note without fully understanding what can occur.

            A properly formatted cognovit promissory note includes the warning language and agreement that the borrower will, in the event of default, allow for the lender to immediately sue and obtain judgment against them. In other words, the lender/creditor can sue on Monday and, with the filing of the lawsuit, file an answer with the court confessing or admitting to judgment requested in the lawsuit. This means that by Tuesday, the lender/creditor can have a court order signed by a judge granting them judgment in the full amount of the unpaid balance with no opportunity for the borrower to challenge, defend or question the allegations that have just been filed by the lender/creditor. It’s an open and shut case; borrower loses!! That cognovit judgment then becomes a very powerful collection tool to be used in conjunction with a personal guaranty to place liens on any other assets owned by the debtor or guarantor.

            I have also seen instances wherein bank attachments and garnishes were filed immediately thereafter based upon the filing of the lawsuit and the confession of judgment according to the terms of the cognovit note, which means it is possible for the borrower/guarantor to not even know they have been sued until after their bank account has been frozen or cleaned out. I don’t think I have to describe to you how paralyzing that can be to a borrower who is in default to have all their money taken from them and have no ability then to retain counsel to fight this situation and try to mitigate the damage.

            If you think I’m exaggerating, allow me to share with you one instance in which` I watched a lender holding a cognovit note with a personal guaranty craftily lure the borrower into default by promising a refi that he then delayed. At the closing of the refi, the lender insisted on an extra $15,000 in late fees, penalties and accrued interest, leaving the borrower with the choice of paying that extra money at the refi closing or risk having judgment immediately obtained against him for the full amount of the note he thought was going to be refinanced 60 days earlier.

            By now I trust you can understand how powerful these tools are in the hands of a lender or debt collector, particularly one who lacks morals and ethics. That’s why many states no longer permit them to be used. In those situations in which they still can be used, you, the borrower, must be informed and prepared when your lender asks for that type of note or instrument to be signed.

            In case you’re wondering, when I represent lenders in commercial transactions, I do my best to get strong personal guaranties and cognovit notes signed by the borrowers. After all, I’m doing everything I can to protect and secure my lending client’s position.

            I hope this helps you be better informed for the next time you have to make a borrowing decision.