Recourse Options

Understanding Recourse Options in Commercial Mortgages

In the realm of commercial real estate finance, recourse refers to the lender's legal right to collect the balance of a loan from the borrower’s personal or corporate assets if the primary collateral (the property) is insufficient to cover the debt after a default. Recourse options determine the extent of a borrower’s personal liability and define the level of risk shared between the lender and the property owner.

1. Full Recourse Loans

In a full recourse mortgage, the borrower and any guarantors are personally responsible for the entire loan amount. If the borrower defaults and a foreclosure sale of the property does not generate enough proceeds to pay off the outstanding debt, the lender can pursue a deficiency judgment. This allows the lender to seize other assets, such as:

• Personal bank accounts and investments.
• Other real estate holdings.
• Business income and corporate assets.
• Future wages (in certain jurisdictions).

Full recourse loans are common for construction projects, properties with unstable cash flows, or smaller commercial loans where the borrower’s personal credit is a primary factor in the approval process.

2. Non-Recourse Loans

A non-recourse loan limits the lender’s recovery efforts solely to the property used as collateral. If the borrower defaults, the lender can foreclose on the property and take possession, but they cannot pursue the borrower’s personal assets to satisfy any remaining balance. These loans are highly sought after by Real Estate Investment Trusts (REITs) and sophisticated investors because they shield personal wealth from market downturns.

Because the lender takes on higher risk, non-recourse loans typically require:

• Higher credit standards.
• Lower Loan-to-Value (LTV) ratios.
• Stabilized properties with proven income streams.
• Higher interest rates or fees compared to recourse options.

3. Partial Recourse

Partial recourse is a middle-ground option where the borrower guarantees only a specific percentage of the loan. For example, a borrower might agree to a 25% recourse guarantee. In this scenario, if a default occurs and a deficiency remains, the lender can only pursue the borrower for up to 25% of the original loan amount or the remaining balance, whichever is stipulated in the contract.

4. "Bad Boy" Carve-Outs

Even in a non-recourse agreement, lenders almost always include "Bad Boy" Carve-outs. These are specific clauses that convert a non-recourse loan into a full recourse loan if the borrower commits certain "bad" acts. These acts generally include:

• Fraud or material misrepresentation.
• Gross negligence or environmental contamination.
• Misappropriation of insurance proceeds or tenant security deposits.
• Filing for voluntary bankruptcy to stall a foreclosure.
• Unauthorized transfer of the property or ownership interests.

Why Recourse Options Matter

Choosing between recourse and non-recourse options involves a trade-off between risk and cost. A borrower willing to sign a personal guarantee (recourse) may receive more favorable terms, such as a lower interest rate or a higher loan amount. Conversely, an investor looking to protect their broader portfolio may prefer the safety of a non-recourse loan, even if it comes with stricter underwriting requirements and slightly higher costs.