A.CRE

Springing Recourse

A form of loan guarantee only enforceable by a lender when certain default or credit events occur (e.g. if a borrower violates operating covenants, does not meet net worth requirements, files for voluntary bankruptcy, etc.). In springing recourse or springing liability, when such adverse events occur, the borrower’s guarantor (i.e. principal) becomes partially or fully liable for the loan obligation regardless of whether the loan is non-recourse or not.

Putting ‘Springing Recourse’ in Context

Scenario Overview

Northern Horizon Development, a real estate development firm specializing in opportunistic investments, is spearheading the redevelopment of Glacier Point Shopping Plaza, a 45,000-square-foot neighborhood shopping center in Anchorage, Alaska. The plaza, originally constructed in 1985, had experienced significant tenant attrition in recent years, with its anchor tenant, a local grocer, vacating the property. Northern Horizon sees an opportunity to reposition the asset by upgrading the facade, reconfiguring tenant spaces, and securing a lease with a national retailer as the new anchor tenant.

Loan Structure

To finance the project, Northern Horizon Development secures a $12 million bridge loan from Arctic Bank, a regional lender. The loan is structured as a 24-month interest-only, non-recourse loan with an option to extend for an additional 12 months. However, as is typical with redevelopment projects, Arctic Bank insists on a “springing recourse” provision in the loan agreement.

What Triggers the Springing Recourse?

While the loan is technically non-recourse (meaning the lender can only seize the property in the event of default, not pursue the developer’s personal assets), the springing recourse clause outlines specific conditions under which the liability “springs” to Northern Horizon Development’s managing partner, Jack Weston, who is the personal guarantor. The specific triggers in this loan agreement include:

  • Filing for Bankruptcy: If Northern Horizon Development files for voluntary bankruptcy, the springing recourse provision activates, making Jack Weston personally liable for the full $12 million loan balance.
  • Fraud or Misrepresentation: If the lender discovers that Northern Horizon Development falsified financial information or misrepresented lease commitments, the full recourse obligation springs into effect.
  • Failure to Meet a Minimum Debt Service Coverage Ratio (DSCR): The loan agreement requires Glacier Point Shopping Plaza to maintain a DSCR of at least 1.25x. If the project’s income drops below this threshold for two consecutive quarters, the springing recourse clause activates, making Jack Weston personally responsible for 25% of the outstanding loan balance.

How the Springing Recourse Might Play Out

In the first year of the redevelopment project, everything goes according to plan. The facade improvements are completed on schedule, and a lease agreement is signed with Mountain Outfitters, a major outdoor retail chain, as the anchor tenant. However, in year two, unexpected delays in tenant build-outs for two smaller inline tenants result in a temporary reduction in rental revenue. As a result, the debt service coverage ratio drops below 1.25x for two consecutive quarters.

Per the loan agreement, the springing recourse clause is triggered. Unlike full recourse, where Jack Weston would be personally responsible for the entire $12 million, the provision only holds him responsible for 25% of the loan balance, or $3 million. If Northern Horizon Development fails to restore the DSCR to 1.25x or better within the next quarter, Arctic Bank could pursue Jack Weston’s personal assets for up to $3 million. This sudden liability forces Jack to contribute additional equity to the project and negotiate with the bank to avoid the consequences of the recourse trigger.

Key Takeaways

This scenario highlights how “springing recourse” can convert a non-recourse loan into a partially recourse obligation under specific adverse conditions. Developers often accept these provisions as part of risk-sharing arrangements with lenders. However, understanding the specific triggers (like DSCR thresholds, bankruptcy filings, or fraud) is crucial for developers to avoid personal liability. For Northern Horizon Development, proper forecasting and operational oversight could have prevented the DSCR breach that ultimately exposed Jack Weston to personal liability.

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