Confession of Judgement vs. Sellers Notes - Don't do it

April 06, 2024

by a searcher in USA

We are in the process of shutting down a business due in Virginia due to issues with the previous owner. The details are painful and lengthy including multiple bankruptcies and losing our home due to the personal guarantees. The important part of this post is recognizing how the previous owner was able to shut down our business by leveraging a confession of judgement attached to the sellers note. We had a standby creditor agreement with the SBA for the 7A loan. It didn't matter. I will never sign another confession of judgement and urge everyone else to evaluate the risk. Don't let an attorney tell you that a standby creditor agreement will prevent a confession of judgement from being executed by the court. It won't. The court has no obligation to verify any related parts of the purchase agreement. When a confession of judgement is exercised, all that creditor has to do is provide that document to the court which will then Garnish all company accounts affiliated with the transaction. That happened to us. It effectively and instantly froze all cash which included our bank accounts, LOC and $5m of AR. We have been stuck in the legal system for months with no positive outcome in sight.

A couple quick answers to questions in the comments-

The SBA loan was in good standing. The seller's note payments were contingent upon meeting a 1.5 DSCR. We had not met that due to first year investment and the typical J curve. This was communicated to all parties. The sellers wanted their payments anyway and began litigation which ended with the execution of the confession of judgement.

There sellers unilaterally pursued this action which did in fact violate the terms of the SBA loan. A PSA can not prevent a bad actor from doing harm despite what may be ruled as right/wrong later. The lender was not very active in pursuing their claims during this ordeal. Challenging any of this after the fact is meaningless once a company is insolvent.

We did in fact draw a very weak judge in this matter.

Reply by a lender
from Eastern Illinois University in 900 E Diehl Rd, Naperville, IL 60563, USA

With over 25-years in lending I am surprised they were able to get a confession of judgement to stick in court. Typically it is impossible to get you to waive your rights in advance. Most courts reject it unless it is part of settlement. Also, I would think your senior lender would have standing to enter court and sue on your and their behalf as well if the subordination agreement was violated. One of the biggest challenges that exists in lending from a legal perspective is gettng in front of judges that actually understand business law. Sometimes if you get a bad judge or there is some hitch in the laws in your state, things do not go as everyone would expect. I hope you can find a way through it. It really sucks.

Reply by an intermediary
from The University of Chicago in Chicago, IL, USA

Thanks for sharing. I just did AI search on Confession Of Judgement. COJ is draconian. I never heard of it in my 30+ years as M&A Intermediary.
If I could ask, were you on default with SBA or just with the Seller?
Many sub-debt agreements have a clause that they can't go to court unless senior oks it. Did you have such clause?

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