Non-recourse obligations: Overview, definition, and example
What are non-recourse obligations?
Non-recourse obligations refer to a type of financial arrangement where the borrower is not personally liable for repayment beyond the pledged collateral. In other words, if the borrower defaults on the loan or obligation, the lender can only claim the collateral pledged as security and cannot go after the borrower’s other assets or personal wealth. This is typically seen in certain types of loans or debt instruments, such as secured loans or bonds, where the lender’s recovery is limited to the collateral itself.
In simpler terms, non-recourse obligations mean that the borrower’s responsibility to repay is limited to specific assets. If they can’t pay, the lender cannot pursue them for further repayment.
Why are non-recourse obligations important?
Non-recourse obligations are important because they provide protection to the borrower. Since the borrower’s personal assets or other resources are not at risk, non-recourse obligations can be an attractive option for businesses or individuals who want to limit their financial exposure. However, these types of obligations typically come with higher interest rates or stricter terms for the borrower to balance the lender's increased risk.
For SMB owners, understanding non-recourse obligations can be useful when considering financing options that limit personal or business liability.
Understanding non-recourse obligations through an example
Imagine your business takes out a non-recourse loan to purchase equipment. The loan is secured by the equipment itself, meaning if your company defaults on the loan, the lender can only seize the equipment but cannot go after other assets or income of the business to recover the remaining debt. If the equipment’s value is insufficient to cover the loan balance, the lender cannot claim any other assets from your business.
In this example, the non-recourse nature of the loan protects the business’s other assets from being claimed in the event of default.
Example of a non-recourse obligations clause
Here’s an example of what a non-recourse obligations clause might look like in a loan agreement:
“This Loan is a non-recourse obligation of the Borrower. In the event of a default, the Lender’s sole remedy shall be to take possession of the collateral, described in Exhibit A, and sell it to recover the outstanding loan balance. The Lender shall have no claim against the Borrower’s other assets or property.”
Conclusion
Non-recourse obligations are a valuable tool for limiting the financial risk of borrowers by ensuring that repayment is only required from the pledged collateral. For SMB owners, understanding non-recourse obligations can provide opportunities to access financing while protecting other assets and minimizing liability. However, these types of loans or obligations often come with stricter terms or higher interest rates, so it's essential to weigh the pros and cons when considering this type of financial arrangement.
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.