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How a Non-Recourse Loan can become a Recourse Loan

TITAN LEASING

How a Non-Recourse Loan can become a Recourse Loan

Simply stated, a non-recourse loan is an arrangement where the borrower pledges collateral as security for the loan, and the lender’s only recourse in the event of default by the borrower is to foreclose on the collateral.  This protects the borrower from any personal liability in the event of default.  However, it appears that the non-recourse protection might not be absolute.

The Seventh Circuit Court of Appeals held in Wells Fargo Equipment Finance, Inc. v. Titan Leasing Inc., that a breach by the borrower as to warranties in the security agreement created personal liability for the borrower for the balance of the note.

As collateral for a loan from Wells Fargo Equipment Finance, Inc. (‘Wells Fargo”), Titan Leasing, Inc. (“Titan Leasing”) pledged a lease agreement for a locomotive between Titan Leasing and Gerdau Ameristeel (“Ameristeel”).  In the security agreement, Titan Leasing made several warranties to Wells Fargo, including that Ameristeel had acknowledged acceptance of the locomotive from Titan Leasing.

In reality, while the locomotive was in fact delivered to Ameristeel, Ameristeel was unsatisfied with the condition of the locomotive and expressly rejected it.  However under the terms of the lease agreement, “Shipment of the locomotive to Lessee” constituted both formal acceptance of the locomotive and acknowledgement that the locomotive met delivery specifications.  Relying on this language, Titan Leasing claimed that Ameristeel had acknowledged acceptance of the locomotive and therefore no warranty was breached.

The Appellate Court instead focused on the intended meaning of “acceptance” under the security agreement between Wells Fargo and Titan Leasing, rather than the language in the lease agreement.  The Appellate Court found that under the terms of the security agreement, Wells Fargo was relying on the representation that Ameristeel was in fact satisfied with the locomotive and would therefore be making lease payments under the lease. Titan Leasing knew that Ameristeel had expressly rejected the condition of the locomotive, and therefore misrepresented that warranty to Wells Fargo.  Due to that misrepresentation, the Appellate Court held that Titan Leasing had to repay Wells Fargo.

Significantly, the Court did not distinguish between an intentional misrepresentation and an innocent misrepresentation.  It can therefore be inferred that potentially any misrepresentation of a warranty could be enough for a borrower to be personally liable under a non-recourse loan.

Accordingly, when dealing with a borrower who has defaulted on a non-recourse loan, pay careful attention to the warranties that the borrower gave with respect to the collateral.  A misrepresentation by the borrower with respect to the warranties might allow you to get personal recourse against the borrower.