What Is Limited Recourse Debt?
Limited recourse debt is a debt in which the creditor has limited claims on the loan if the borrower defaults. Limited recourse debt sits in between secured debt and unsecured debt in terms of the backing behind the loan. Limited recourse debt is also referred to as partial recourse debt.
- Limited recourse debt is debt upon which a creditor can claim certain but not all assets of the borrower if the borrower defaults.
- Full recourse debt allows creditors to claim any assets of the borrower to fully cover the unpaid portion of a loan.
- Limited recourse debt only allows for a claim on assets specified in the loan contract even if their value does not cover the unpaid portion of a loan.
- Limited recourse debt sits between secured debt and unsecured debt in regards to the payout hierarchy.
Understanding Limited Recourse Debt
Recourse debt is debt that is secured by collateral from the borrower. In the case of a default, the lender has the right to collect from the debtor’s assets or pursue legal action. Recourse debt can either be full or limited. Full recourse debt allows the lender to seize and sell the debtor’s assets, including assets that were acquired through the original loan, up to the full amount of the unpaid debt.
Limited recourse debt allows the lender to only collect on assets that are named in the original loan contractual agreement. In effect, this type of debt gives the lender a limited amount of recourse to the borrower’s other assets if they default on the debt. If the borrower defaults on their payments, the lender can exercise its rights concerning the collateral pledged. The lender’s recovery is limited to only that collateral.
In other words, if the collateral is insufficient to make up for the unpaid portion of the loan amount, the lender has limited or no claim against any other assets. The borrower is not personally liable for the shortfall between the amount of unpaid debt and the amount realized on the collateral.
Limited recourse debt falls between an unsecured and secured loan, where claims on the debt sit below secured lenders and above both shareholders and unsecured lenders in terms of payout hierarchy. As a result of its relative safety, limited recourse debt has interest rates that are typically lower than unsecured debt.
Limited recourse debt is secured up to a certain amount. For example, a loan on which 40% of the principal is collateralized is a limited recourse loan. Often, a limited recourse debt contract is structured so that the debt transitions to unsecured, or non-recourse debt pending the completion of a specific event. That event may be the completion of a project or the establishment of a specific revenue stream for which the debt was issued.
For example, terms for limited recourse debt for a large project such as a power plant could mean that a creditor is guaranteed to receive 25% of the principal in any default up until completion of the power plant. If the borrower defaults on any debt before the power plant is complete, the creditor has the right to claim ownership of any assets listed in the contractual agreement. Once the power plant is complete, the loan can switch from a limited recourse loan to a non-recourse loan, where the creditor no longer has any claim on assets. This is so because the risk of the project has significantly decreased now that the plant is in operation and generating cash flow that can be used to furnish the debt.