Limited recourse: Overview, definition, and example
What is limited recourse?
Limited recourse refers to a type of financial arrangement where a lender or creditor can only claim repayment from specific assets or parties, rather than pursuing the full range of assets or other parties involved. This means that if the borrower defaults on the agreement, the lender’s ability to recover the owed amount is limited to certain agreed-upon assets or guarantees, rather than the borrower’s entire financial resources.
For example, in a loan with limited recourse, a lender may only be able to seize specific collateral (such as a piece of property or equipment) if the borrower fails to repay the loan, rather than having the right to pursue the borrower’s other assets.
Why is limited recourse important?
Limited recourse provides protection for borrowers by limiting the risk of losing all of their assets in case of a default. It also encourages lenders to be more selective in their lending terms, ensuring that the collateral offered is sufficient to cover the risk.
For businesses and investors, limited recourse is an important consideration when structuring deals or loans, as it helps define the extent of liability and risk. It can make borrowing more accessible to businesses, especially those with fewer assets to pledge, by limiting the exposure of the borrower.
Understanding limited recourse through an example
Imagine a real estate developer takes out a loan to fund a construction project. The loan is structured with limited recourse, meaning the lender can only claim the property being developed as collateral if the developer defaults. If the property’s value is insufficient to cover the full loan amount, the lender cannot go after the developer’s other assets, such as their personal savings or other business holdings.
In another example, a startup company raises capital by issuing convertible debt with limited recourse. The investors can only recover their investment by converting the debt into equity in the company, not by pursuing the company’s other assets if the business fails.
An example of a limited recourse clause
Here’s how a limited recourse clause might appear in a loan agreement:
“The Borrower’s liability under this Agreement shall be limited to the collateral specified in Schedule A. In the event of default, the Lender’s recourse is limited to recovery from the specified collateral and shall not extend to any other assets of the Borrower or its affiliates.”
Conclusion
Limited recourse helps define the scope of liability in financial transactions, providing a safeguard for borrowers by ensuring that creditors’ claims are limited to specific assets or collateral. This arrangement is beneficial for businesses, as it reduces the potential financial risks they face in case of a default.
For lenders, limited recourse helps manage risk by focusing their claims on specific assets. It is a common structure in certain types of financing, such as project finance or asset-backed loans.
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.