Non-recourse: Overview, definition, and example
What is non-recourse?
Non-recourse refers to a type of financial arrangement where the lender’s ability to recover funds in the event of a default is limited to the specific collateral pledged for the loan. The borrower has no personal liability, meaning the lender cannot pursue the borrower’s other assets beyond the collateral. Non-recourse terms are typically seen in loans, project financing, or certain investments.
For example, in a non-recourse loan secured by real estate, the lender can seize the property if the borrower defaults but cannot go after the borrower’s other assets to recover any remaining unpaid balance.
Why is non-recourse important?
Non-recourse arrangements are important because they limit the borrower’s liability, providing a layer of financial protection. Borrowers know their risk is capped at the pledged collateral, which can encourage investment in higher-risk ventures.
For lenders, non-recourse terms present a higher risk since they can only recover funds through the collateral. This risk is often mitigated by requiring high-value or high-quality collateral and conducting thorough due diligence. Non-recourse provisions also clearly define the rights and obligations of both parties, ensuring transparency in the financial relationship.
Understanding non-recourse through an example
Imagine a property developer secures a non-recourse loan to fund the construction of a commercial building. The loan is secured by the property itself. If the developer defaults, the lender can foreclose on the property to recover the loan amount but cannot pursue the developer’s personal assets.
In another example, an energy company uses project financing to fund a solar power plant. The financing is structured as non-recourse, meaning the lenders can only claim the power plant’s assets or revenue streams in case of default, not the company’s other assets.
An example of a non-recourse clause
Here’s how a non-recourse clause might appear in a loan agreement:
“This Loan is non-recourse, and the Lender’s sole recourse in the event of default shall be limited to the Collateral described in Exhibit A. The Lender shall have no claim against the Borrower or its other assets beyond the Collateral.”
Conclusion
Non-recourse arrangements provide significant benefits to borrowers by limiting liability to pledged collateral, fostering financial protection and flexibility. For lenders, they require careful evaluation of collateral value and associated risks. Clearly defining non-recourse terms in agreements ensures transparency, sets expectations, and aligns the rights and obligations of both parties, supporting fair and structured financial relationships.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.