In the vast realm of commercial real estate loans valued at over $2,000 billion in 2021, businesses have relied on these financial lifelines to secure properties and kickstart their organizations, ultimately generating revenue and profit. However, the landscape of commercial loans is constantly evolving, with terms and risks that borrowers should be aware of. One such consideration is the distinction between recourse and non-recourse loans.
Recourse and Non-Recourse Loans: Understanding the Difference
Recourse loans, typically used for construction or short-term financing, require borrowers to provide collateral and assume personal liability for repayment. If a borrower defaults and the collateral fails to cover the debt, the lender has the right to seize the borrower’s personal assets, including wages. On the other hand, non-recourse loans are more common for stable commercial properties or post-construction stages. These loans rely on the value of the collateral, offering less risk to lenders. While default is not expected, if it does occur, the lender can only seek repayment through the value of the collateral.
The Intricacies of Carve-Out Guarantees
However, the bright line between recourse and non-recourse is often blurred by carve-out guarantees, also known as “Bad Boy Guaranties.” These provisions carve out specific events where the borrower’s non-recourse protection does not apply. Originally, these events revolved around wrongful actions such as tampering with collateral value before defaulting. Fraud, misrepresentation, canceling insurance, and criminal acts were added to the list, essentially converting the non-recourse loan into a recourse loan. Today, these carve-out events extend to a range of actions, turning the distinction between recourse and non-recourse loans complex and multifaceted.
New Non-Recourse Carve-Outs: A Deeper Dive
New non-recourse carve-outs can be divided into two categories. The first category involves events that strip all non-recourse protection, leaving the borrower and guarantor fully liable. This occurs when the borrower files for bankruptcy or enters into agreements for involuntary bankruptcy or receivership.
The second category includes events that may trigger full liability but are less definitive:
- Not granting the lender permission to inspect the mortgaged property.
- Failing to provide agreed-upon financial information to the lender.
- Encumbering the property with a voluntary lien.
- Transferring the property or ownership interest in ways prohibited by the loan terms.
Negotiating Carve-Out Terms: Protecting Borrowers
When working with lenders to negotiate carve-out terms in non-recourse loans, borrowers should aim to protect themselves by requesting specific provisions. These provisions include:
- Limiting liability to the actual loss suffered by the lender, excluding bankruptcy.
- Excluding recourse liability in cases where property income fails to cover taxes or required maintenance.
- Requesting reasonable notice and an opportunity to rectify issues before recourse liability is triggered.
- Ensuring insolvency or late payment of debts doesn’t automatically result in recourse liability.
- Limiting recourse liability for improper transfers of the property.
- Subjecting distributions paid to owners before default to “claw-back.”
Understanding the intricacies of non-recourse loans has become paramount for borrowers. Lenders are increasingly implementing complex carve-outs to mitigate their risks. It falls upon borrowers and guarantors to thoroughly grasp the loan’s terms, implications, and how they align with their specific projects and circumstances.
Moving Forward with Confidence
Carve-out guarantees exist to protect lenders and their investments. For investors seeking commercial loans, carefully reviewing these guarantees is essential. Understanding when lenders can take action against a borrower and what actions may trigger recourse liability can help investors safeguard their assets. Seeking assistance from legal professionals can also provide greater clarity and ensure full comprehension of contractual obligations. With a solid contract in hand, investors can confidently build their asset portfolios.
When engaging in commercial real estate investments, having trustworthy partners who can guide you through securing the right financing options is vital. At Garrity Traina, our platform strives to provide precisely that. With a wide network of lenders and an extensive range of loan programs, Garrity Traina empowers investors to find the best deal to fuel their real estate ventures.
Get a Free Multifamily loan quote today and embark on a successful commercial real estate journey.