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Pari Passu: Legal Concept Explained

Written by Santiago Poli on Dec 26, 2023

Most legal professionals would agree that understanding complex legal concepts like pari passu can be challenging.

But having a solid grasp of pari passu can make a real difference in legal matters involving bankruptcy, corporate finance, and securities.

In this post, we'll clearly define pari passu, trace its origins, explain its practical applications, and summarize key takeaways so you can confidently apply this critical legal maxim.

Introduction to Pari Passu

Pari passu is a Latin legal phrase meaning "with equal step" or "on equal footing". It is commonly used in loan agreements and other legal contracts to signify that certain groups will be treated equally.

Defining Pari Passu

The pari passu concept essentially means that certain parties will receive equal treatment. For example, a pari passu clause in a loan agreement typically indicates that all lenders will rank equally in repayment priority. No single lender gets preferential treatment.

Tracing the Origin

The pari passu principle dates back centuries in English common law. It evolved as a legal mechanism to ensure fair and equal treatment, especially regarding creditors and debt repayment. Over time, pari passu became a standard clause included in loan agreements and securities.

General Application

Today, pari passu is most often applied in debt and financing agreements. A pari passu clause signifies that all specified creditors or investors will be repaid on equal terms. This prevents certain parties from receiving preferential treatment over others in the event of insolvency or bankruptcy.

Beyond debt agreements, pari passu can apply to any situation requiring equal legal ranking or priority status. This includes areas like dividend payments, liquidation proceedings, and sometimes even court judgments.

Explanation and Application of the Maxim

In essence, pari passu guarantees equal footing and prevents preferential treatment. It ensures fairness for all parties bound by the agreement. When included in contracts like loan agreements, pari passu clauses provide critical protection to creditors and investors by legally mandating equal repayment terms. This minimizes risks in situations of distress or default.

While originating in English common law centuries ago, pari passu remains an important legal concept today. It provides the basis for equality in wide range of agreements and securities. Understanding pari passu helps legal professionals craft agreements that fairly balance different interests.

What does pari passu mean in law?

Pari passu is a Latin legal phrase meaning "with equal step" or "on equal footing." It is used to describe how certain groups of investors or creditors are entitled to receive payment or repayment.

In the legal context, a pari passu clause ensures that if a borrower has multiple creditors or classes of creditors, they will be repaid on equal terms. No creditor gets preferential treatment. All creditors have equal rights and footing to collect debts owed to them.

For example, say Company A takes out a loan from two banks - Bank 1 and Bank 2. The loan agreement contains a pari passu clause. This means:

  • Bank 1 and Bank 2 have equal rights over Company A's assets and collateral in case of default
  • Company A cannot pay back one bank ahead of the other
  • Both banks will receive principal and interest payments at the same time and same rate

Essentially, the pari passu clause prevents Company A from favoring one creditor over another. It ensures neither bank is disadvantaged. All parties are on equal footing regarding repayment priority and rights over the collateral.

This concept applies in other situations like bankruptcy, where pari passu dictates all creditors of the same class receive proportional repayment from liquidated assets. No single creditor gets paid in full until the others in that class get equal distribution.

In summary, pari passu is a legal principle upholding equal treatment of creditors in repayment, preventing preferential treatment of one over another.

What is the concept of pari passu charge?

The concept of pari passu charge refers to a provision in loan agreements that requires the borrower to give equal ranking to the claims of all lenders. This means if the borrower defaults, all lenders have an equal right to recover funds from the assets used as collateral.

Here are some key things to know about pari passu charges:

  • It is a type of security interest that gives equal rights to lenders. All lenders are treated on an equal footing in terms of priority of payment.

  • If the borrower defaults, the pari passu clause prevents the borrower from paying one lender over another. All lenders can make equal claims on the collateral assets.

  • Pari passu charges are commonly used in syndicated loans and debt securities like bonds where multiple lenders or investors are involved.

  • By giving all lenders equal ranking, it reduces the risk associated with subordinated debt. This makes the debt issuance more attractive to potential lenders.

  • The pari passu clause provides additional protection to lenders and investors by ensuring fair treatment in case of distress. This can facilitate debt financing for the borrower.

In essence, the pari passu concept levels the playing field for all lenders involved and upholds the equitable principle of equal treatment. Its inclusion in loan covenants provides balanced rights in terms of priority and recovery.

What is the pari passu rule of equity?

The pari passu principle refers to the equal treatment of creditors in insolvency proceedings. It means that all unsecured creditors must receive an equal pro rata share of any available assets, in proportion to the debts owed to them.

This important legal concept serves to protect creditors by preventing certain creditors from being paid ahead of others due to the timing of their claims or through legal maneuvering. It aims to ensure a fair distribution of assets among all creditors based on the size of their claims.

The pari passu rule has several key implications in insolvency law and debt agreements:

  • It requires that all unsecured creditors receive an equal percentage payout from available assets based on the amount they are owed. Secured creditors are paid first from their collateral.
  • No creditor gets preferential treatment or additional priority over other unsecured creditors.
  • Creditors can't make claims on certain assets ahead of other creditors or get paid before others.
  • It provides protection to creditors so one party doesn't maneuver to get paid first unfairly.
  • The timing or order of creditor claims does not impact pro rata distribution.

The pari passu principle serves an important equitable purpose in insolvency situations to facilitate orderly and fair asset distribution. Understanding this concept helps creditors evaluate risks in debt agreements and insolvency proceedings.

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What is the difference between pro rata and pari passu?

Pro rata refers to the equal distribution of something among a group, usually based on an agreed-upon formula. For example, investors in a startup may receive pro rata rights that allow them to participate in future funding rounds at the same percentage level as their initial investment.

Pari passu, on the other hand, refers to the equal ranking or priority of payment. It means that certain parties will be paid at the same time and with equal priority. This term is often used in bankruptcy proceedings to determine the priority order of creditors getting paid from remaining assets.

In short:

  • Pro rata refers to equal distribution among a group based on a formula. Investors may get pro rata rights for future startup funding rounds.

  • Pari passu refers to equal ranking or priority of payment. It determines the order in which creditors get paid in a bankruptcy.

So while the terms sound similar, pro rata relates to allocation of something like investment participation, while pari passu sets the priority for payments, like to creditors. Understanding the distinction can be important in legal and financial arrangements to ensure fair distribution or payment.

Pari Passu in Debt Financing

Pari Passu Clause in Loan Agreements

The pari passu clause is an important provision in loan agreements and debt financing contracts. It essentially means that the debt being issued ranks equally with other existing unsecured debt owed by the borrower. This prevents the borrower from giving preferential treatment to one set of lenders over another in repayment priority.

Including a pari passu clause provides assurance to lenders that their claims will be treated on an equal footing. If the borrower defaults or goes into liquidation, all pari passu creditors will be repaid pro rata based on the amount owed to them. This reduces the risk for lenders as no other unsecured creditors can jump ahead of them in the repayment queue.

From the borrower's perspective, agreeing to the pari passu clause gives them more flexibility in taking on additional debt in the future. As long as the new debt also contains the pari passu provision, it can be treated at the same level as existing unsecured debt. This makes it easier for borrowers to raise financing from multiple sources.

Types of Pari-Passu Charges

There are several types of pari passu charges that may be created on the assets of a borrower:

  • First pari passu charge: This refers to a charge that ranks equally with other existing first charges on the same asset. No other charge takes priority over it.

  • Second pari passu charge: This ranks equally with other second charges on the asset, but below any first charges in priority.

  • Pari passu floating charge: This is a floating charge that ranks equally with other floating charges attached to the same asset. It allows the asset to be dealt with until the charge crystallizes into a fixed charge.

Understanding the distinction between these types of charges is important for lenders when analyzing the level of security being offered on a loan.

What is First Pari Passu Charge

A first pari passu charge refers to a charge that ranks equally in priority with other existing first charges on the same asset being offered as collateral. It carries the highest priority and cannot be superseded by any subsequent charges on that asset.

Having a first pari passu charge gives a lender greater security on the loaned amount. In case of borrower default or insolvency, creditors with a first pari passu charge will be first in the queue to recover amounts owed using proceeds from sale of that asset. They will get preference over other junior charges.

First pari passu charge also gives the lender certain rights over dealing with the asset. Approval is needed from all first charge holders before the borrower can sell, lease or further encumber that asset. This offers better control to lenders over securing their interests.

Senior and Subordinated Debt in Pari Passu

Senior debt refers to borrowing that takes priority over other subordinated or unsecured debt owed by a borrower. It carries lower risk due to its senior status in repayment hierarchy. Subordinated debt is riskier as its entitlements are below senior debt.

Pari passu principle applies within these categories of debt, not between them. So multiple senior debts will rank pari passu among themselves only. Similarly, subordinated debts having pari passu clause will rank equally among other subordinated debt.

But in insolvency, senior debt gets repaid before subordinated debt. Pari passu does not elevate subordinated debt to the same level as senior debt. This distinction matters to creditors assessing repayment risk on different debt tranches.

Pari Passu in Corporate Finance

Pari passu is an important legal concept that impacts corporate finance arrangements, especially during bankruptcy and insolvency proceedings.

Pari Passu and Bankruptcy

When a company declares bankruptcy, pari passu dictates that all unsecured creditors will be treated equally based on the size of their claims. This prevents certain creditors from receiving preferential treatment over others. Specifically, pari passu prevents creditors from being paid if others with similar claims are not also paid proportionally.

During bankruptcy, pari passu ensures fair and equitable distribution of assets. It reduces situations where some creditors are paid in full while others with similar claims receive little or nothing.

Pari Passu in the Context of Insolvency

Pari passu also applies during insolvency. If a company lacks sufficient assets to repay all creditors, the principles of pari passu require the limited assets to be distributed proportionally among the unsecured creditors.

This prevents situations where some creditors are favored and paid early at the expense of other creditors. Pari passu brings order and consistency during insolvency.

Common vs. Preferred Shares Under Pari Passu

Pari passu treats common and preferred shareholders differently. Preferred shareholders have priority over common shareholders when it comes to asset distribution.

During insolvency or bankruptcy, preferred shareholders must be paid first. Only after preferred shareholders receive payment can common shareholders receive any distribution.

Pari passu upholds the seniority of preferred shares. It prevents situations where common shareholders are paid despite defaults to preferred shareholders.

Pari Passu Venture Capital Arrangements

In venture capital deals, pari passu often applies to liquidation preferences and dividends. Preferred shareholders typically have liquidation preferences and guaranteed dividends.

Pari passu requires that these preferred dividends and liquidation payments are made before common shareholders receive any payments. This priority treatment protects VC investors.

Pari passu clauses in funding agreements ensure VCs can exit investments with predetermined returns without dilution from common shareholders.

Pari Passu in Securities and Investment

Pari Passu and Securities Issuance

The pari passu clause in security issuances refers to the equal ranking of the securities in terms of rights and privileges. This means that if a company issues multiple classes of securities like bonds, preferred shares etc., the pari passu clause ensures that all holders of these securities have equal rights over the company's assets and earnings.

For example, if a company issues secured bonds with a pari passu clause, as well as preferred shares, the bondholders and preferred shareholders will have equal rights over the collateral in case of liquidation or bankruptcy. Neither group is subordinate to the other.

This protects investors by preventing the company from issuing more senior securities in the future that have greater rights and privileges. The pari passu clause maintains the equality of all securities holders.

Coupon Rates and Pari Passu Considerations

The coupon rate on debt securities like bonds refers to the periodic interest payments made to bondholders. Under a pari passu clause, all bonds issued by a company must have the same coupon rate if they have the same seniority and collateral.

For instance, if a company issues two tranches of secured bonds with equal priority over the same assets, they must have identical coupon rates. This upholds the equal rights of all bondholders per the pari passu principle.

Having differential coupon rates would violate pari passu, as it effectively makes one set of bonds more valuable and senior to the other. The parity between debt securities must be maintained through equivalent coupon rates.

Debt Covenants and Pari Passu

Debt covenants are legally binding terms and conditions between a company and its lenders that are designed to protect the interests of debt holders. Common covenants include limits on additional debt, maintenance of certain financial ratios, restrictions on payments to shareholders etc.

Pari passu covenants are also frequently included in debt agreements. These prevent the company from issuing any future debt that ranks higher in priority than the existing debt. It preserves equality between current and future lenders per the pari passu principle.

If the company violates any debt covenants, it constitutes an event of default that allows lenders to demand early repayment of the loan. In this way, pari passu covenants uphold equal rights and prevent subordination of lenders.

Pari passu is one of several key legal maxims that underpin securities regulations and case law precedents. By enshrining the equal treatment of security holders into law, legal maxims like pari passu aim to protect investors and promote fair markets.

For example, securities regulations often mandate equal dissemination of information to all shareholders under the pari passu principle. This prevents selective disclosure to only certain privileged shareholders, thereby upholding equality.

As such, familiarity with pari passu and other seminal legal maxims provides helpful context for interpreting and complying with securities law. Their embodied principles form the foundation of investor protection mechanisms.

Key Takeaways and Conclusion

Summary of Core Concepts

The legal concept of pari passu refers to the equal footing of creditors in bankruptcy proceedings. It means that unsecured creditors will receive payment on a pro-rata basis, according to the amount they are owed. This prevents certain creditors from receiving preferential treatment over others. Understanding pari passu is key for lenders and borrowers when negotiating loan agreements and debt instruments.

Parting Thoughts

As complex debt structures continue to evolve, the principle of pari passu maintains relevance in ensuring equitable treatment of creditors. Its interpretation will likely come under scrutiny in future test cases globally.

Meaning and Origin Explanation

Pari passu is a Latin legal term meaning "with equal step" or "on equal footing." It underscores the equal ranking of creditors in liquidation. The term has its origins in bankruptcy law, where unsecured creditors have equal seniority to receive proportional repayment based on the amount owed.

Practical Implications and Future Considerations

The practical effect of pari passu is in the distribution of assets in liquidation. By preventing preferential payments, it aims to balance interests of creditors. As new financial instruments emerge, application of pari passu will require clarity from courts.

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