Recourse carve-outs: how a nonrecourse loan comes after you

“Nonrecourse” is the most reassuring word in commercial lending and one of the most misunderstood. It tells the borrower that if the deal fails, the lender takes the building and stops there. No one reaches your home, your other properties, or your savings. The promise is real, and it holds right up to the moment you trip a carve-out. Then the lender can come after you personally for the entire shortfall. The carve-outs are written to punish bad behavior. In the case that taught a generation of lawyers to distrust the word, the borrower’s only bad act was running out of money.

A nonrecourse loan is nonrecourse until a carve-out says it is not. The protection is the list of exceptions, not the label on the loan.

The promise: the building, and only the building

On a true nonrecourse loan the lender’s remedy on default is foreclosure and nothing more. If the sale leaves a deficiency, the borrower and any guarantor walk away from it, and the lender eats the loss it priced in at origination. This is why nonrecourse debt lives almost entirely in commercial real estate: CMBS conduit loans, agency multifamily debt, life-company loans. The borrower pays for the protection through rate and terms and expects it to mean what it says. Most of the time it does.

The carve-outs come in two strengths

Every nonrecourse loan carries a list of exceptions, the recourse carve-outs, known in the trade as bad-boy provisions. They come in two strengths, and the gap between them is the whole game.

A loss carve-out makes the borrower liable only for the lender’s actual loss from a specific act. Pocket $200,000 of insurance proceeds or divert rents after default, and the guarantor owes that amount, the harm the act caused, and no more. The nonrecourse limitation survives. One slice of liability is carved out of it.

A springing carve-out, also called a full-recourse carve-out, is a different machine. When the defined event happens, the nonrecourse limitation is voided for the whole loan. The guaranty, signed by an actual person, becomes enforceable for the entire unpaid balance, and the lender can take a deficiency judgment against that person for everything the foreclosure did not cover.

The gap is not academic. Take a $10 million loan on a property that sells for $7 million at foreclosure, a $3 million deficiency. Trip a loss carve-out by mishandling $200,000 of rent, and the guarantor owes $200,000. Trip a springing carve-out, and the same guarantor owes the full $3 million, even though the deficiency is identical. Which schedule a breach sits on, not how much harm it caused, is what decides whether the number is a nuisance or a ruin.

Two triggers spring most often, and neither is a bad act in the ordinary sense. A voluntary bankruptcy filing is the classic one: the borrower files to halt the foreclosure, and the filing itself springs full recourse, which is exactly how lenders deter it. The second is a breach of the single-purpose-entity covenants, the promises that the borrowing LLC will keep its own books and accounts, hold no other assets, take on no other debt, and never commingle its cash. Those covenants read like housekeeping. They are the tripwire.

Cherryland: insolvency became the trigger

Cherryland Mall borrowed $8.7 million on a nonrecourse CMBS loan. The property failed, the lender foreclosed, and the sale left a deficiency of about $2.1 million. Buried in the documents were two ordinary-looking covenants: the borrower would stay solvent, and it would keep its single-purpose-entity status. A Michigan appeals court read the borrower’s insolvency as a breach of those covenants, treated the covenants as recourse carve-outs, and made the loan fully recourse against the guarantor. He owed the $2.1 million out of his own pocket.

Insolvency is not a bad act. It is the market risk that nonrecourse debt exists to leave with the lender. The court admitted the outcome looked incongruent with the nature of nonrecourse debt and enforced it anyway, saying it was not its job to save the parties from their own contract. Michigan’s legislature moved within months and passed the Nonrecourse Mortgage Loan Act, which bars a post-closing solvency covenant from being used as a carve-out, and made it retroactive. That fix is Michigan law and Michigan only. In a state without its own version, a lender can still make the Cherryland argument today, and the covenant is still sitting in the loan documents.

Springing recourse is not piercing the veil

Borrowers hear that the lender can reach them personally and assume the LLC itself failed them. It usually did not. Springing recourse is a contract term. You agreed the shield would drop on a defined event, so the lender needs no finding of wrongdoing, the clause does the work on its own. Piercing the veil is a court taking the shield away because the owner abused the entity, through commingling, undercapitalization, or fraud, and it takes proof to get there. One is a bargain you signed. The other is a verdict on how you behaved. The defenses are different, and a borrower who treats a carve-out problem as a veil problem is preparing for the wrong fight.

What protects you is the list, not the word

Negotiate the schedule, not the label. The highest-value move at origination is to keep solvency and SPE-maintenance breaches out of the full-recourse bucket, recast as loss carve-outs or struck entirely. Know precisely who signs the carve-out guaranty, because that person carries personal exposure for every springing trigger, whether or not they still run the deal when it fires years later. And treat the entity’s separateness as a live discipline, not a closing chore. The single-purpose covenants the lender demands are the same covenants that become recourse triggers, so keeping the LLC genuinely separate, its own books, its own accounts, no commingled cash, is not housekeeping. It is what keeps the loan nonrecourse. The deal-level version of this fight arrives when the loan matures and the refinance comes up short or the sponsor has to sell, refinance, or hold, and this is the mechanism sitting underneath those decisions.

The word nonrecourse protects the lender’s downside. It was never the thing protecting yours. The carve-out schedule is, and it only protects the borrower who read it before signing.