Jargon Watch: Nonrecourse vs. Recourse Loans
If the old maxim neither a borrower nor a lender be was taken seriously, there’d probably be no commercial real estate market. The capital that enables our industry’s transactions is overwhelmingly a borrowed commodity. To borrow usually means to pay back, and the many rules and rituals surrounding the promise of payback have filled books, consumed careers and rewarded careful study with an understanding of what makes the property market really tick.[As always, take absolutely none of what you read here at The Source as legal or fiduciary advice and always, always retain qualified legal counsel!]
Borrowers with partners prefer to borrow in such a way as to limit liability to the bare minimum in the event of a foreclosure. Going in, it’s very important that parties choose and agree upon a set of outcomes in the event the property goes south. Perhaps biggest among the issues is the question about what to do with foreclosure and default risk.
If a partnership is doing the borrowing, usually that risk is sought to be placed away from personal liability on the part of individual partners. As such, a nonrecourse loan is often requested.
A nonrecourse loan is where the borrower is not personally liable for any losses on the part of the lender associated with the foreclosure of a property. It’s an agreement that says the lender’s only legal recourse to compensate against any such losses is to sell the property, as opposed to coming after the borrowing partnership for payment. Nonrecourse loans are commonly limited to half of the loan-to-value ratio and are used to finance projects with high capital expenditures.
(Note however that lender losses caused by any fraud or misrepresentation on the part of borrowers may in many cases be recouped legally even if a nonrecourse loan is agreed to. State law varies quite a bit here.)
Alternatively, a recourse loan is where the borrower is responsible unconditionally for any loss or deficiency incurred by the lender. Collateral may or may not be in the cards for a recourse loan, but it’s generally always at the bottom of a nonrecourse loan.