“Cognovit” Provisions

An equipment manufacturer sells a piece of equipment to a business customer on credit. The customer fails to make payment, and the manufacturer sends a demand letter warning that legal action will be taken if payment is not received within ten days. The period expires without payment, and on the 11th day the  manufacturer sues the customer and gets a judgment the same day. The customer received no summons and was not afforded a hearing at which defenses and counterclaims could have been raised (e.g., breach of representations and warranties, rights of setoff, etc.). Further, with only very narrow exceptions, the customer has no right of appeal. How did the manufacturer get a judgment so quickly? The answer is that the sales contract contained a cognovit provision.

Those who have borrowed money commercially in the State of Ohio have probably seen the terms “cognovit” or “warrant of attorney” in their credit documents.  Prohibited in many states, including Kentucky and Indiana, but generally allowed and prevalent in Ohio, cognovit notes are potent weapons for creditors and should be understood by commercial creditors and debtors alike. This article explains the meaning of cognovit provisions and why creditors desire them and debtors should appreciate their significance and make sure that they are getting adequate consideration in return. It also touches on some jurisdictional considerations for those borrowing or extending credit across the state lines of Ohio, Kentucky, and Indiana.

When a debtor signs an instrument containing a cognovit provision, the debtor: (1) waives the right to receive notice and have a hearing; (2) allows the creditor to appoint an attorney to confess judgment against the debtor; and (3) waives most defenses, counter-claims, rights to setoff, and rights of appeal.

Without a cognovit, the creditor would be required to serve the debtor with the complaint, and the debtor would have a certain number of days (28 days in Ohio) to respond and raise defenses and counterclaims. This would be followed by  discovery, motions to the court, and a bench or jury trial. Following trial, either party could appeal. The process can be time consuming and costly, to say the least, which is what makes cognovits so attractive for creditors. By conceding liability and waiving the rights of notice and hearing, the debtor saves the creditor the time and expense of a lawsuit if the debtor defaults. It is essentially a shortcut to a judgment.

Why would a debtor agree to a cognovit? It is a matter of business negotiation and cost-benefit analysis. The debtor, in negotiating the best possible terms (e.g., lowest price and interest rate), may agree to a cognovit as consideration for more favorable terms. The creditor, understanding the value of a cognovit in terms of collecting on the debt, may be more likely to give more favorable terms to the debtor if the contract includes a cognovit provision. In the equipment scenario above, where the seller of the equipment is also the creditor, the customer gives up a lot by agreeing to a cognovit, because of the potential  defenses and counterclaims inherent in that type of transaction. For example, the equipment could be defective. By contrast, the customer getting a commercial loan from a bank gives up less with a cognovit because the universe of potential defenses against making payment is small by comparison. The bottom line is that the law in Ohio generally respects the business deal worked out between the parties. Provided that the cognovit was voluntarily, knowingly, and intelligently given, and provided it strictly adheres to certain statutory requirements, it will generally be upheld as part of the negotiated bargain between debtor and creditor.

Parties desiring to incorporate a cognovit provision in their credit arrangement must strictly follow the statutory requirements of Ohio Revised Code § 2323.13. Among the requirements is an explicit warning statement directly above the   debtor’s signature.

The parties also need to take into account jurisdictional considerations. While cognovits are generally allowed for commercial transactions in Ohio, they are  prohibited in Indiana and Kentucky. In fact, it is a Class B Misdemeanor in Indiana for a creditor to include a cognovit provision in a credit instrument, punishable by imprisonment for up to 180 days and a fine of up to $1,000. In neither state, however, is inclusion of a cognovit fatal to the contract as a whole. Rather, the court will strike the cognovit provision and enforce the balance of the contract. In a tri-state area such as Greater Cincinnati, where much business is transacted across state lines (e.g., an Ohio bank lends to Kentucky borrowers), the question of which state law governs is critical.

Courts use two main factors to determine which state has jurisdiction: (1) the place of execution of the credit instrument and (2) the place of performance (i.e., the place where payment is to be made). If both are in Ohio, regardless of where the parties reside, it is usually safe to say that Ohio law will apply and the cognovit will stand. The creditor can get its judgment in Ohio and if the debtor resides or has property in Kentucky, take it to Kentucky and have it honored and enforced by Kentucky courts under the full faith and credit clause of the U.S. Constitution.

On the other hand, if either the place of execution or the place of performance is Indiana or Kentucky, enforceability of the cognovit is less certain because judicial decisions are somewhat murky. In those situations, it is particularly important for the creditor to consult with legal counsel before entering into the contract.

A cognovit is a powerful tool for the creditor. The debtor needs to understand and appreciate what the cognovit means and include it in the list of items to be negotiated. To be effective, the cognovit provision must comply with applicable law and strictly adhere to certain statutory requirements. Parties entering into a credit arrangement with a cognovit provision may wish to consult with legal counsel to determine whether it is appropriate and whether applicable statutory and jurisdictional requirements are satisfied.