Question

Distinguish between recourse and non recourse debt within a partnership.

Answer 1

Introduction

A recourse debt is one which gives a bit of extra power to the lender. Such debts allow the lenders to go beyond the collateral already provided to them in case there is a default in the payment of the loan. But of course, the recourse element comes into play only when the collateral is insufficient to repay the loan amount in full. Defaulting in a non-recourse loan will even result in jeopardising the borrower’s assets and even his wages till the loan amount is received. A loan which is not a recourse loan, is a non-recourse loan. In these types of loans the lender has less power. He can only recover the loan to the extent of the collateral and not beyond that.

Recourse and non-recourse loans in partnerships

Recourse debt in a partnership refers to that debt of the partnership for which at least one partner is personally liable and extend to all the borrower’s assets. The “personal liability” can arise through the operation of law. It can also arise due the personal guarantees given to the lender or the terms and conditions of the debt taken. This applies to the related party of a partner too. The partner becomes personally liable for the personal liability of a party related to that partner (via attribution rules).

For non-recourse loans, no partner is personally liable. Because the non-recourse loans are a bit risky from the perspective of the lender, they require adequate amount of collateral. In the event of default, the lender has the right to the extent of the collateral given. He does not have charge over the assets of the partnership nor is any partner personally liable.

The key determinant as to whether a loan is a recourse loan or not depends on whether a particular partner has any economic risk of loss with respect to the repayment of that debt.