Permitted indebtedness: Overview, definition, and example
What is permitted indebtedness?
Permitted indebtedness refers to the types and limits of debt that a borrower is allowed to incur under the terms of a loan agreement or other financial contract. In many agreements, the borrower may be restricted from taking on certain types or amounts of debt without the lender’s approval. However, permitted indebtedness outlines the specific circumstances or types of debt that are acceptable, typically without needing additional approval from the lender. These debts are considered acceptable under the terms of the agreement because they do not pose a significant risk to the lender's interests.
Permitted indebtedness can include things like business loans, certain types of credit lines, or specific loans related to business expansion or operational needs. It is often a clause in loan agreements, bond covenants, or corporate financing contracts, helping to set boundaries on what constitutes acceptable borrowing.
Why is permitted indebtedness important?
Permitted indebtedness is important because it allows both the borrower and the lender to understand what kind of borrowing is acceptable under the loan agreement. For lenders, having clearly defined permitted indebtedness helps ensure that the borrower does not take on excessive debt that could jeopardize their ability to repay the loan. For borrowers, it provides flexibility to take on certain debts when necessary to operate or expand their business, without violating the terms of the existing loan agreements.
Having a clear definition of permitted indebtedness can also protect both parties from disputes about what debts are allowed and ensures that the borrower can still access financing if needed for business growth or operational needs.
Understanding permitted indebtedness through an example
Imagine a business that has taken out a loan from a bank to fund its operations. As part of the loan agreement, the business is restricted from taking on additional debt that could negatively impact its ability to repay the loan. However, the loan agreement includes a clause for permitted indebtedness, which allows the business to take out additional loans up to a certain amount, or for specific purposes, such as financing expansion projects or securing lines of credit for working capital.
For example, the business can incur additional debt to purchase new equipment or finance a marketing campaign, as long as the total debt does not exceed a specified limit or the additional borrowing meets the criteria outlined in the loan agreement. This gives the business the flexibility to take on new debt for growth, while still staying within the terms of the original agreement.
Example of a permitted indebtedness clause
Here’s how a permitted indebtedness clause might appear in a loan agreement:
“The Borrower shall not incur any indebtedness except for the following: (1) Existing indebtedness as of the date of this Agreement; (2) Indebtedness arising from trade credit in the ordinary course of business; (3) Additional indebtedness incurred for the purpose of financing capital expenditures, not exceeding $X in the aggregate; (4) Indebtedness approved by the Lender in writing. Any indebtedness not expressly permitted hereunder shall require prior written consent from the Lender.”
Conclusion
Permitted indebtedness is a crucial concept in loan agreements and other financial contracts, providing both borrowers and lenders with a clear understanding of what types of debt are acceptable. By setting limits and specifying conditions for additional borrowing, permitted indebtedness helps maintain a healthy financial balance, allowing the borrower to access necessary financing while protecting the lender’s interests. Understanding the terms of permitted indebtedness is vital for businesses to ensure they do not violate their loan agreements and can continue to manage debt responsibly.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.