Limited recourse

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Of a contract, that the obligor’s obligations under it are limited to a defined pool of assets. You see this a lot in repackagings, securitisations and other structured transactions involving espievies.

In a nutshell

Security and limited recourse are fundamental structural aspects of contracts with Special purpose vehicles and investment funds. They look significant but, in fact, aren’t. They are boilerplate. So, if you are feeling especially ornery, and have the urge to challenge these provisions, do yourself and everyone else on the deal a favour: don’t. In the immortal words of the East Enders: “Leave it Phil! Leave it! He's not worth it.”

Limited recourse and investment funds

Investment funds tend to be single corporations which and issue shares or units to investors and use the issue proceeds to buy securities investments and enter swaps, loans and other transactions with brokers. Here the brokers, being creditors, are structurally senior to the fund’s investors, who rank as equityholders. So the main reason for limiting the broker’s recourse to the SPV’s assets is to stop the broker putting the SPV into formal bankruptcy procedures once all its assets have been liquidated and distributed pari passu to creditors.

Now, why would a broker want to put an empty SPV — one which has already handed over all its worldly goods — into liquidation? Search me. Why, on the other hand, would the directors of that empty SPV, bereft as it is of worldly goods, be anxious for it not to go into liquidation? Because their livelihoods depend on it: being directors of a bankrupt company opens them to allegations or reckless trading, which may bar them from acting as directors in their jurisdiction. Since that’s their day job, it’s a bummer.

But haven’t they been, like, reckless trading? No. Remember, we are in the parallel universe of SPVs. Unlike normal commercial undertakings, SPVs run on autopilot. They are designed to give exposure, exactly, to the pools of assets and liabilities they hold. That’s the deal. Everyone trades with SPVs on that understanding.

The directors are really nominal figures: they outsource executive and trading decisions to an investment manager. Their main job is to ensure accounts are prepared and a return filed each year. They are not responsible for the trading strategy that drobve the espievie into the wall.

So all an investment fund’s limited recourse clause really needs to say is:

Our recourse against the Fund will be limited to its assets, rights and claims. Once they have been finally realised and their net proceeds applied under the agreement, the Fund will owe us no further debt and we may not take any further steps against it to recover any further sum.

Limited recourse in repackagings and for SPVs with contractually segregated pools

If the SPV has got segregated compartments in it (that is, it is issuing multiple series of securities), the limitation of a claim — what we said above for the investment funds goes hand-in-hand with a security interest over the defined pool of assets. This is to secure, and limit, the broker’s claim to the specific pool with which it is trading, leaving all the other pools unmolested should one drive itself into the wall, but keeping all claimants of those other pools away from this one too.

Limited recourse formulations

The following, rendered in the linguistic mush you can expect from securities lawyers, are the sorts of things you can expect the limited recourse provision to say without material complaint:

• Recourse limited to segregated assets: your recourse against the SPV will be strictly limited to those assets that are ring-fenced for the particular deal you are trading against. This ring-fencing might take the form of:
  • Security and limited recourse: security and contract (in an old-style repackaging with a regular LLC) — there there is a subtle trade off between security over your assets (preferring your claim against all other comers) and limitation of that claim to those secured assets; or
  • Corporate structure: by means of a specialist corporate structure providing for segregation of the corporate personality into little cells which may or may not have their own legal personality (if the SPV is a segregated portfolio company or an incorporated cell company);
• No set-off or netting between cells: Netting and set-off will be limited to the specific cell you are facing: this means if your deal goes down, others issued from the same SPV can continue unaffected — boo — and vice versa — hooray.
• Extinction (or non-existence) of outstanding debt: Following total exhaustion of all assets after enforcement, appropriation, liquidation and distribution, and realisation of all claims subsequently arising form those assets, your outstanding unpaid debt will be “extinguished”.
  • Here the intention is that you will never have legal grounds for seeking judgment, and thereafter commencing bankruptcy proceedings, for that unpaid amount once your own cell is fully unwound and its proceeds distributed.
  • Pendantry alert: some sniff at this “extinction” language, fearing it implies that there was once upon a time, until extinction, a debt for an amount which the company was theoretically unable to pay — meaning that the company was, for that anxious moment in time, technically insolvent. These people — some hail from Linklaters — prefer to say “no debt is due” than “the debt shall be extinguished”.
• A proceedings covenant: You must solemnly promise never to set to put the SPV into insolvency proceedings. If you agree to all the foregoing, you should have concluded you have no literal right to do so, so this shouldn’t tax your conscience too greatly.

See also

• Bankruptcy remoteness
• Special purpose vehicle