Pari Passu principle

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What is the Pari Passu Principle?

April 7, 2022         Fatima Raza

The Pari Passu principle holds that any creditors in an insolvency process will equally share any assets that are available, proportionally to the debt owed to them. It is an important aspect of insolvency law, specifically where a company faces financial issues which could lead to becoming insolvent.

This term is increasingly popular in the lending and credit area and is also often found in loan agreements. It is a financing agreement where it equally ranks unsecured creditors in the case of insolvency such as liquidation and voluntary administration.

What does Pari Passu mean?

The English interpretation of the Latin term pari passu means “on equal footing, proportionately.” Pari passu is when a business faces financial issues which can lead to insolvency. If a business’ debts are pari passu then all unsecured creditors are ranked equally.

When creditors are ranked equally it means that there is no preferential treatment and the proceeds are distributed equally. The business will then sell their assets and each creditor will receive an equal share of what is owed.

It is important to remember that the debts are of course first prioritised to secured creditors, then after they have been repaid the remaining assets are distributed to the unsecured creditors equally and proportionately.

Who Does a Pari Passu clause apply to?

The Parri passu principle only applies to unsecured creditors and not secured creditors.

A creditor applies to an individual who the business owes money to, there are two different types of creditors:

  1. Secured creditor– Has acquired security interest in the business’s assets.
  2. Unsecured creditor– Has not acquired security interest in the business’s assets.

Where can Pari Passu occur?

This clause can also occur in:

  1. Lending- multiple creditors can attain a secured loan with equal claims on asset.
  2. Bankruptcy- creditors receive equal portions of liquidations.
  3. Asset management- assets or securities to be managed with equal preference.
  4. Debt covenants- debt instruments like bonds in which companies issue bonds to raise capital through debt financing. Parri passu would be used to guarantee each bond is equal.

Pari Passu clause in loan agreements

In loan agreements the clause is usually presented as either an undertaking or a representation and warranty. 

  • Undertaking- ranking remains the same in the future.
  • Representation and warranty– debt owed ranks equally with other creditors debt.

Why is the Pari Passau principle important for the lender and the borrower?

Lender

When a creditor plans to make a loan to a company it is necessary for them to know whether there are senior creditors that rank ahead. This allows them to decide whether they go through with the loan or not. If a company does not provide such information and the creditor goes through with the loan, it is possible for the creditor to make the company repay the loan back.

Borrower

A company does not want to restrict the borrower’s future borrowings therefore they must make sure that the clauses are correct. 

Signs a business is in financial trouble 

Financial issues/difficulty may include:

  • Dishonoured payments
  • Unpaid/overdue taxes and superannuation
  • Late payment of invoices
  • Bills aren’t being paid on time
  • Cash flow problems

Key takeaway

It is important as a creditor to understand where you stand and whether the parri passu principle applies to you or not. You should seek legal advice to ensure you are aware of your situation and the rights attached. Reach out to the open legal team for legal advice via the contact page or by calling 1300 337 997.

About Fatima Raza

Fatima is a legal intern at Openlegal and is currently in her third year studying Law and Media and communications at Macquarie University. Her interests are commercial, property and international law.