Legal Definitions - limitation on indebtedness

A limitation on indebtedness, often referred to as a debt limitation, is a legal or contractual restriction that sets a maximum amount of debt an entity can incur. This cap is established to prevent excessive borrowing, maintain financial stability, and protect the interests of creditors, taxpayers, or stakeholders by ensuring that the entity does not take on more financial obligations than it can reasonably manage.

• Example 1: Municipal Government Bonds

  A state law mandates that no city within its borders can issue general obligation bonds if the total outstanding principal of such bonds would exceed 5% of the city's total assessed property value. This means a city with an assessed property value of $1 billion could not issue more than $50 million in general obligation bonds. This is a limitation on indebtedness because it legally restricts the maximum amount of debt the city can take on, protecting its financial health and its taxpayers from excessive future liabilities.

• Example 2: Corporate Loan Covenants

  When a bank lends money to a manufacturing company, the loan agreement includes a clause stating that the company's total debt-to-equity ratio must not exceed 2:1 at any point during the loan term. If the company's equity is $50 million, its total debt cannot surpass $100 million. This contractual provision acts as a limitation on indebtedness, ensuring the company maintains a healthy financial structure and doesn't over-leverage itself, thereby reducing the risk for the lending bank.

• Example 3: State Constitutional Provisions

  A particular state's constitution includes an amendment that prohibits the state government from incurring debt for capital projects (like building new highways or schools) that exceeds 1.5% of the state's total annual revenue, unless approved by a supermajority vote in a statewide referendum. This constitutional clause serves as a powerful limitation on indebtedness, preventing the state legislature from unilaterally accumulating large amounts of debt and ensuring fiscal prudence by requiring broad public consent for significant borrowing.