Legal Definitions - debt limitation

A debt limitation refers to a maximum amount of money that an individual, business, or government entity is legally or contractually permitted to borrow or owe. It acts as a cap on the total outstanding debt, preventing the entity from taking on more financial obligations than a specified threshold.

• Individual Example: When an individual applies for a credit card, the issuing bank assesses their income, credit history, and existing financial obligations. Based on this evaluation, the bank might approve the card but set a maximum credit limit of $10,000. This means the cardholder cannot charge more than $10,000 to that card at any given time, regardless of their spending habits.

  Explanation: This illustrates a debt limitation because the bank has placed a clear ceiling on the amount of debt the individual can incur through that specific credit product, acting as a safeguard against over-borrowing.

• Business Example: A startup technology company seeks a venture capital investment. As part of the investment agreement, the venture capitalists include a covenant stating that the company's total long-term debt (excluding the VC investment itself) cannot exceed 50% of its equity. If the company needs to borrow more money in the future, it must ensure it stays within this ratio, or it will be in breach of its agreement with the investors.

  Explanation: This demonstrates a debt limitation as a contractual restriction imposed on the business, setting a specific cap on its ability to take on additional debt relative to its ownership value, thereby protecting the investors' interests.

• Government Example: A county government is considering issuing bonds to finance the construction of a new hospital. However, state law mandates that no county's total outstanding general obligation debt can exceed 5% of the total assessed value of all taxable property within that county. The county must calculate its current debt and the projected debt from the new bonds to ensure it remains below this statutory threshold before it can proceed with the bond issuance.

  Explanation: Here, the state law imposes a legal debt limitation on the county, establishing a clear maximum amount of debt it can carry relative to its tax base, which helps ensure fiscal responsibility and prevents excessive borrowing by local governments.