(Bloomberg) -- Lawmakers in Connecticut this week moved to end a powerful debt-collection tactic that allows lenders to lock up the bank accounts of small businesses across the country.
The state House of Representatives passed a bill restricting the use of so-called prejudgment attachments on June 7 after the Senate approved it earlier in the week. The bill now goes to Governor Ned Lamont.
The measure was inspired by a Bloomberg Businessweek story last year highlighting the increased use of such instruments in Connecticut by out-of-state lenders to collect debts, said Representative Jason Doucette, a proponent of the bill and chairman of the legislature’s banking committee.
“The tactic is quite aggressive,” he said.
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The lenders using the Connecticut tactic are in the lightly regulated merchant cash-advance industry, which provides high-interest loans for small businesses. The industry relied on a similar legal tactic using New York courts until lawmakers in Albany curtailed the practice in 2019. Since then, cash-advance firms have been renting mailboxes in Connecticut to obtain prejudgment attachments there. The tactic allows them to freeze borrowers’ bank accounts anywhere in the country.
Connecticut law allows courts to restrain defendants’ property at the start of lawsuits to prevent them from shifting assets beyond the reach of the court. Ordinarily, such a prejudgment attachment is granted by a judge after a hearing attended by both parties and after the judge determines the plaintiff has a good case.
Some cash-advance firms began including language in their loan agreements requiring borrowers waive their right to such a hearing. That means lenders can unilaterally restrain a borrower’s bank accounts whenever they want, without getting a judge’s approval or filing anything in court. Typically, borrowers find out about the action only when they learn they are locked out of their bank accounts. Court records show cash-advance firms have used the tactic hundreds of times.
“The result of this tactic is often catastrophic,” Shane Heskin, a lawyer for small-business borrowers, wrote in a court filing last year. Desperate to make payroll or pay bills, small businesses are sometimes forced to shoulder more debt on onerous terms to unlock their accounts, Heskin wrote. His statements came in a pending lawsuit arguing that the tactic violates a borrower’s constitutional right to due process.
The bill that cleared the legislature this week would prohibit commercial financing contracts from requiring borrowers to waive their right to a hearing over a prejudgment attachment or other prejudgment remedy. The provision would take effect in July 2024. It was tucked into a broader bill aimed at the merchant cash-advance industry requiring lenders to disclose certain financial terms and to register with the state banking commissioner.
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