The difference between recourse and non-recourse debt
/What is Recourse Debt?
In a recourse debt arrangement, the lender can seize the assets of the borrower if the borrower is unable to pay back a loan. Depending on the arrangement, the lender may also be able to seize the assets of anyone else who has guaranteed the debt. However, a recourse arrangement may only allow the lender to attach specifically identified borrower assets, beyond which the lender has no ability to obtain additional borrower assets. In this case, the existence of a recourse feature may not provide complete risk mitigation for the lender.
What is Non-Recourse Debt?
In a non-recourse debt arrangement, the lender has no legal ability to seize the assets of a borrower who is unable to pay back a loan. In this case, the lender’s only option is to revise the debt deal down to a level that the borrower will find affordable, such as an extended payment period and/or a reduced interest rate. It is much more likely that the lender will have to write off some or all of a non-recourse loan when a borrower is having trouble paying it back.
Comparing Recourse and Non-Course Debt
Recourse debt refers to an agreement where the lender can attach borrower assets, while non-recourse debt refers to an agreement where the lender cannot do so (other than for assets specified as collateral). The differences between these concepts are as follows:
Ability to take borrower assets. The key difference between recourse and non-recourse debt is the ability of the lender to take the assets of the borrower if the debt is not paid. Non-recourse debt favors the borrower, while recourse debt favors the lender.
Based on lending environment. A lender is most able to impose a recourse debt agreement on a borrower when the borrower is unable to obtain financing elsewhere on better terms, and especially when the borrower is in difficult financial circumstances. Conversely, a borrower may be able to demand non-recourse debt terms if it can select from many lenders and has such excellent financial results and asset reserves that it can justify its demands.
Interest rate differences. A lender may be more willing to grant credit under a recourse loan at a lower interest rate than would be the case with a non-recourse loan, since the lender's risk of repayment is reduced under a non-recourse situation. Consequently, some borrowers are more willing to accept recourse terms in exchange for a reduced interest rate and/or other, more lenient borrowing terms. Alternatively, a lender may be willing to grant less credit under a non-recourse agreement, usually only up to the amount of any collateral posted against the note. Since the lender has no recourse above the amount of the collateral, it is too risky to extend additional credit.
A lender has more power in a tight credit market, and so is more capable of imposing recourse terms. The reason is that fewer lenders are willing to issue funds, which minimizes the level of competition among lenders for the business of borrowers.
Related AccountingTools Courses
FAQs
Can a Lender Convert Nonrecourse Debt into Recourse Debt?
Generally, a lender cannot convert nonrecourse debt into recourse debt unless specific conditions are met. These conditions often include borrower fraud, misrepresentation, or violations of the loan agreement, known as "carve-outs" or "bad boy" provisions. If such violations occur, the borrower may become personally liable despite the original nonrecourse terms.
Related Articles
Accounting for a Non Interest Bearing Note
Accounting for Debt Issuance Costs