A non-recourse liability is a secured debt where the borrower has no personal liability in the event of a default. The debt is backed with an asset that the lender can seize in the event of default, but the lender has no recourse beyond that point if the asset does not cover the debt. This type of liability is most commonly seen in financing for businesses, particularly in real estate development, where borrowers may need to take on large debts to get projects going, and want to avoid personal liability in the event of cash flow problems or other issues.
Lenders offering this type of loan usually require a high loan-to-value ratio on the asset. The goal is to avoid a situation where the asset will not cover the cost of the loan in the event of a default and seizure. Real estate is commonly chosen for a non-recourse liability, and the lender may loan up to 80% of the total appraised value of the real estate after evaluating it and determining how much risk it is willing to accept with the loan.
For borrowers, non-recourse liability has a number of advantages. The lack of personal liability means that if the borrower does have to default, the lender cannot come after personal assets, leaving the borrower's personal finances intact. This will allow the borrower to start over. It can also be useful for situations like partnerships, where members of the partnership want to keep their personal assets separate from the business in the interest of financial security, but still need to be able to access loans. The business can put up real estate as collateral with a non-recourse liability.
Businesses and individuals with this type of loan can note it in their books as a non-recourse debt. In the event of a default on non-recourse liability, lenders handle the process like other kinds of debt defaults, sending notices, working with customers on payment plans, and seizing the asset eventually if the customer fails to respond. The lender can sell the asset to recover lost funds.
There can be special tax concerns with non-recourse liability, and it is advisable to discuss such debts with an accountant. Taxation rules vary by region and the specific terms of the loan, and an accountant will have more information about how to declare a non-recourse liability and how to work with it on tax documentation. Borrowers need to be careful to abide by the tax code, as they can be accused of fraud if tax authorities suspect they are deliberately flouting the law.
