Representative Nydia Velazquez, a Democrat from New York, chairs a hearing of the House Small Business Committee in Washington, D.C., U.S., on Wednesday, June 30, 2010. (Bloomberg)

Congress must act to protect small businesses from predatory lenders who seize their assets without warning using a legal instrument called a confession of judgment, U.S. Representative Nydia Velazquez said Wednesday.

“By ending confessions of judgment in commercial lending, we can stop some of the abuses that are crippling honest small-business owners,” Velazquez, a Democrat from New York, said at a House Small Business Committee hearing in Washington. “I find it appalling that New York state law has made our state a magnet for dishonest lenders.”

Velazquez, chairwoman of the committee, and Roger Marshall, a Republican from Kansas, have introduced a bill that would ban confessions of judgment in business loans. Ohio Democrat Sherrod Brown and Florida Republican Marco Rubio have made a similar proposal in the Senate.

The law was drafted in response to Bloomberg News articles last year about abuses by unregulated companies offering a form of financing called a merchant cash advance that can cost as much as 400% annualized. Some lenders require customers to sign such confessions to get loans. By signing, borrowers forfeit their right to defend themselves in court. In recent years, lenders have used confessions to win more than 32,000 judgments in New York courts, mostly against small out-of-state businesses.

Armed with a confession, lenders can accuse borrowers of not paying and legally seize their assets before they know what’s happened. The Bloomberg articles described forged or materially altered confessions falsely accusing borrowers of missing payments and overstating the balance due.

“My clients are very good at what they do. They know how to fix a boat. They know how to install a sink,” said Shane Heskin, a lawyer at White & Williams LLP in Philadelphia who represents small-business borrowers. “But that doesn’t mean they know how to read a contract in 8-point font. It doesn’t mean they know the legal ramifications of signing a confession of judgment.”

Federal regulators banned the use of confessions for consumer loans in 1985. The proposed bill, called the Small Business Lending Fairness Act, would extend the ban to commercial transactions. Last week New York lawmakers approved a bill that prohibits the use of confessions of judgment against individuals and businesses located outside of the state. Some other states, including Pennsylvania and California, allow confessions but have more protections for borrowers.

Hosea Harvey, a law professor at Temple University, said the line between consumers and small businesses has blurred. Many freelancers such as car-service drivers are classified as business owners. Congress should consider extending consumer protections, such as a ban on confessions, to apply to small businesses, he said.

“Contractual provisions that deny due process can punish small businesses and serve no compelling purpose,” Harvey said. “The proposed solution is neither partisan nor anti-business.”

Jerry Bush, a plumbing contractor from Roanoke, Virginia, who was interviewed for one of the Bloomberg News articles, also testified at the hearing. He described how he attempted suicide after he lost his business to predatory lenders and said he didn’t understand the consequences of signing a confession.

“Nobody explained what all they could do if they want to,” Bush said.

(Adds testimony of Hosea Harvey starting in eighth paragraph.)

To contact the reporters on this story: Zeke Faux in New York at zfaux@bloomberg.net;Zachary R. Mider in New York at zmider1@bloomberg.net

To contact the editors responsible for this story: Jeffrey D Grocott at jgrocott2@bloomberg.net, Robert Friedman, Joe Schneider

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