Cognovit Note Perils

Many business people do not realize that when they get a business loan from a bank, the bank usually insists on taking a personal guarantee.  Often, the bank insists that the personal guarantee be tied to the signing of a cognovit note. This is a special type of promissory note or IOU in which it is agreed that the signer waives most defense and prior notices. In the event that the bank declares default, cognovits notes allows the bank to take personal judgment against the business person almost immediately without having to give notice or wait the customary 28 days for answer or defense. In a suit on a cognovit note, the business person is not given any opportunity to get any notice or make any answer before judgment is taken. However, the Judge deciding Henry v Stimmels 2013-Ohio-1607, reminds that cognovit notes can be challenged on the grounds of neglect, newly discovered evidence or fraud. Moreover, cognovit judgments can only be based on payment default and not any other type of contract breach. As part of obtaining a cognovit judgment, the bank must also attach a copy of the note or make it available for the court's inspection. The bank must also allege that the judgment is sought for non-payment. WHAT HAPPENED: In this case the breach alleged was non-payment of real estate tax and a drop in the guarantor’s net worth. The court said that since non-payment of money to the bank was the only basis on which a congnovit judgment could be taken, if the bank wanted to take legal action, it could not use the cognovits terms. Instead, legal action would have to follow the normal course involved with serving summons with complaint and allowing 28 days for an answer or defense.    

DEBT COLLECTION PERILS

If the basis of the collection action is a business debt, then you may avoid the formal consumer warning, which reads: NOTICE:  This is an attempt to collect a debt.  Any information obtained will be used for that purpose.  Unless, within thirty (30) days of your receipt of this notice, you dispute the validity of this debt, or any portion thereof, the debt will be assumed to be valid.  If you notify this office in writing within the thirty-day period that the debt, or any portion thereof, is disputed, we will obtain verification of the basis of the debt or a copy of the judgment upon which the debt is based, if any, and will mail a copy of such verification or judgment to you. When this wording is a preface to a lawsuit, another warning should say: NOTICE:  Disputing the validity of this debt will not change the time provided by the summons to answer this lawsuit. If you do not answer this complaint within time, a judgment may be taken against you independent of any verification of debt. If there is any question about if a debt is business or consumer, it is best to including the formal wording. Doing so will not change a business debt into a consumer one butt will be a step toward insuring that consumer protection laws are not violated. Consumer remedies for violation of consumer protection laws include Fair Debt Collections counterclaims and Unfair Consumer Practices Act counterclaims.  However, a business defending against a debt collection lawsuit may be limited to a simple denial unless the alleged debt is based on some type of fraud. In any event, if a debt is disputed, it’s better to defend or settle the lawsuit before judgment. Otherwise, the result may be post-judgment debt enforcement.  If you are the target of collections, reviewing your options with a knowledgeable attorney early-on may be worthwhile. Likewise, if you are a business collecting a debt, make sure that your debt collector will not get you tied-up in a debt collection counterclaim. 

A Clear Contract May Not Avoid a Lawsuit Over Its Terms

A printer filed a small claims action against a customer for non-payment of a printing order. The dispute occurred because printer used the prior year’s date on the material produced instead of the current year’s date. The printer defended the bill saying that the content was supplied by the customer and any error the customer’s fault. The customer resisted by insisting that the printer should have sent a proof to the customer for review prior to printing.  Applying law, the court, in Mek v DePaul 2013-Ohio-4486, said that when parties have agreed about issues critical to the transaction, the courts will determine the meaning of ambiguous terms according to the parties’ mutual understanding, the custom and practice in the trade or community, or other established legal principals.  Applying this rule, the court said that since the contract did not provide for a proof and since the contract specified that all terms were in the writing, the customer was out of luck and judgment was affirmed for the printer. IMPACT:   Even if contracts are clear, perhaps consumer transaction should be drafted go above and beyond. Businesses should try to draft consumer contract at a standard way above the minimum in order to avoid the chance of having to litigate consumer collections. 

When is a corporation really just a partnership?

Two guys opened a store as “handshake” partners. The business worked so well that they purchased a store building plus some other real estate and equipment. Instead of showing that the business made the purchases, they deeded the real estate directly into their joint personal names and the equipment was held personally by one or the other. While the business was growing they incorporated without making any mention as to the contribution of the equipment or the disposition of the real estate.  When one divorced, the spouse insisted the business be split.  The spouse claimed that since everything was in “partnership” it could always be split but the other guy claimed that since everything was really in “corporation” the most she could get was the value of shares. A court decided the answer in Baker v Gaul 2013-Ohio-4287. Looking at tax returns and intentions, this court said it was all corporate property.  However, this decision was based on facts elicited at trial and the next trial could go differently. A simple corporate buy-sell agreement between the two guys might have avoided a nasty court battle precipitated by a divorcing spouse. The CPA might give you a simple incorporation but the lawyer can advise about rights between business associates, corporate asset disposition and asset protection. 

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