What is a Limited Recourse Debt
Limited recourse debt is a debt in which the creditor has limited claims on the loan in the event of default. Limited recourse debt sits in between secured bonds and unsecured bonds in terms of the backing behind the loan.
Limited recourse debt is also referred to as partial recourse debt.
Breaking Down Limited Recourse Debt
Recourse debt is debt that is secured by collateral from the borrower. In the case of 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 in the event of default. If the borrower defaults on his or her payments, the lender can exercise its rights concerning the collateral pledged; however, the lender’s recovery is limited to the 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 the parent company. The borrower is not personally liable for any shortfall between the amount of unpaid debt and the amount realized on the collateral.
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. A limited recourse debt falls somewhere between an unsecured and secured loan, and has interest rates that are typically lower than unsecured debt because of its relative safety. 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 the event of a default up until completion of the power plant.
Claims on limited recourse debt sit below secured debtholders and above both shareholders and unsecured bondholders in terms of payout hierarchy.