What it means
In ordinary lending, the lender has recourse, meaning that if the asset is not enough to repay the loan, the lender can claim the rest from the borrower's other property or income. With non-recourse finance, that right is removed or heavily limited.
The lender's security is the asset itself and the cash it produces. This structure is common in project finance, such as power plants, toll roads and pipelines, where a separate project company is created to own the asset.
The sponsors put in equity and the lenders look only to the project's revenue. If the project fails, the sponsors can lose their equity but the rest of their business is shielded.
Because lenders carry the downside, they examine non-recourse deals much more closely. They test forecasts, require long-term sales contracts or guaranteed income, set strict cover ratios and often take control of the project's bank accounts.
They also tend to charge a higher interest rate and arrange higher fees than on a comparable loan with recourse. Real estate lending offers another example, where a property loan may be non-recourse to the investor personally.
Even then, there are usually exceptions called carve-outs, such as fraud, misapplication of funds or insolvency actions, which can turn the loan into a full-recourse one. For the borrower, the appeal is protection of the wider balance sheet and the ability to take on large projects without risking the whole company.
For the lender, the appeal is a clear security package and an income stream that can be monitored. Rules differ by country and by state, and some places limit what a lender can claim even under a recourse loan.
Always read the documents closely, because the wording of the recourse clause determines who bears each loss.
In practice
Real-world examples.
Example
A consortium builds a $200,000,000 solar farm through a project company. Banks lend $140,000,000 on a non-recourse basis, secured by the plant and by a 20-year contract to sell the electricity.
Example
An investor buys an apartment block for $5,000,000 using a $3,500,000 loan that is non-recourse to him personally. If the building falls in value and he hands it back to the lender, the lender cannot pursue his other assets, unless a carve-out applies.
Example
A film producer finances a $6,000,000 movie with a loan repayable only from the film's revenue. If ticket sales disappoint, the lender absorbs the shortfall and the producer's wider business is untouched. The producer loses only the time and the equity invested in the film.
Formula
Calculation
Lender loss = Outstanding loan - Net recovery from the financed asset
A property company borrows $1,000,000 on a non-recourse basis to buy a warehouse. After a downturn, the warehouse is sold for $700,000 after costs of $40,000, so the net recovery is $700,000 - $40,000 = $660,000. Lender loss = $1,000,000 - $660,000 = $340,000. Because the loan is non-recourse, the company owes nothing more, whereas with recourse the lender could claim the remaining $340,000 from the company's other assets. The $340,000 is therefore the price of the risk the lender agreed to carry, which is why it would have charged a higher interest rate at the outset.Case study
Seen in the real world.
Windrow Energy is a fictional renewable power developer invented to illustrate this idea. It wanted to build a $90,000,000 wind farm without putting its other projects at risk, so it set up a separate project company and raised $63,000,000 of non-recourse debt.
The lenders required a 15-year power purchase contract, a reserve account covering six months of payments and a minimum cover ratio of 1.30. Windrow invested $27,000,000 of its own equity.
In year four, wind speeds were lower than forecast and revenue fell short, so the project struggled to meet the cover test. The lenders agreed a restructuring, and Windrow's other businesses were unaffected because they sat outside the project company. Windrow's board later said that the ring-fenced structure was the main reason it could keep bidding for new projects.
Watch out
Common mistakes.
- Believing non-recourse means the lender has no protection at all. The lender still holds the asset as security and often has tight control of project cash flows.
- Overlooking carve-outs. Fraud, misuse of funds or voluntary bankruptcy can make the borrower liable in full.
- Assuming it is cheaper than ordinary borrowing. The lender takes more risk and normally charges more for it.
Questions
People also ask.
Who bears the loss in non-recourse finance?
The lender, up to the amount of the shortfall, since it can only claim against the financed asset.
Why do sponsors use project companies?
A separate company keeps the debt and the risks apart from the sponsor's other businesses, which protects the group.
Is non-recourse debt shown on the balance sheet?
Yes, in the project company's accounts, and depending on ownership and control it may also appear in the sponsor's consolidated figures.
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