Pari Passu Meaning Examples Basis Uses How It Works

Pari-Passu Meaning

Pari passu is a Latin term meaning “an equal footing” and is commonly applied in bankruptcyBankruptcyBankruptcy refers to the legal procedure of declaring an individual or a business as bankrupt.read more, liquidationLiquidationLiquidation is the process of winding up a business or a segment of the business by selling off its assets. The amount realized by this is used to pay off the creditors and all other liabilities of the business in a specific order.read more, inheritance, and insolvencyInsolvencyInsolvency is when the company fails to fulfill its financial obligations like debt repayment or inability to pay off the current liabilities. Such financial distress usually occurs when the entity runs into a loss or cannot generate sufficient cash flow.read more. These are the scenarios wherein different parties claim equal rights and a proportionate share of the asset allocation. With this clause in place, the designated entities do not have to bear the good and bad sides of the contract.

Key Takeaways

Pari Passu is a clause in a financial agreement that ensures that assets, property, securities, and debt obligations are managed and distributed equally among creditors.It refers to an unbiased right of payment within a financial instrument, such as a loan, bond, or share class, subject to the clause. The creditors are paid on a pro-rata basis, without regard to seniority, and all at once.It is frequently used in bankruptcy, liquidation, inheritance, and insolvency cases where multiple parties claim equal rights and a proportionate share of the assets.The concept finds applicability in bankruptcy, asset management, lending, wills and trusts, and debt covenants.

How Pari Passu Works?

Pari Passu agreement signifies the equal or unbiased right of payment under a specified clause within a financial instrumentFinancial InstrumentFinancial instruments are certain contracts or documents that act as financial assets such as debentures and bonds, receivables, cash deposits, bank balances, swaps, cap, futures, shares, bills of exchange, forwards, FRA or forward rate agreement, etc. to one organization and as a liability to another organization and are solely taken into use for trading purposes.read more, such as loan, bondBondBonds refer to the debt instruments issued by governments or corporations to acquire investors’ funds for a certain period.read more, or share classShare ClassShare class is the company’s bifurcation of its shares into different classes on the basis of their voting rights, privileges, ownership restrictions. For example dividing the common stock into class A shares having the most privileged voting rights and class B shares which have less voting rights.read more. As soon as the interested parties enter the contract, the pari passu clause would give every stakeholderStakeholderA stakeholder in business refers to anyone, including a person, group, organization, government, or any other entity with a direct or indirect interest in its operations, actions, and outcomes.read more equal right over liquidation, dividendsDividendsDividends refer to the portion of business earnings paid to the shareholders as gratitude for investing in the company’s equity.read more, and voting. That is why the company clarifies that no priority would be given to any specific set of people involved in the deal while issuing the agreement.

The clause is applicable in any situation where two or more parties have equal rights over an asset, property, or debtDebtDebt is the practice of borrowing a tangible item, primarily money by an individual, business, or government, from another person, financial institution, or state.read more obligation. The creditorsCreditorsA creditor refers to a party involving an individual, institution, or the government that extends credit or lends goods, property, services, or money to another party known as a debtor. The credit made through a legal contract guarantees repayment within a specified period as mutually agreed upon by both parties. read more receive the payment on a pro-rata basis, i.e., in proportion to their investment, without seniority and at the same time.

The clause is put in the financing agreement to ensure parties get access to the company’s financial products, which could include anything from a bond to an obligation. It is common in bankruptcy, liquidation, and insolvency proceedings.

This clause also safeguards unsecured creditors’ rights to assets held by the company. It implies that equitiesEquitiesEquity refers to investor’s ownership of a company representing the amount they would receive after liquidating assets and paying off the liabilities and debts. It is the difference between the assets and liabilities shown on a company’s balance sheet.read more must be distributed evenly and without preference among them. However, it is critical to remember the debts owed to each creditor while dividing their portion. The court of law always rules in favor of equal pay to the insolvent company’s creditors in proportion to the debt they still owe.

Pari Passu Examples

Let us consider the following pari passu examples to understand the concept better:

Example #1

Suppose company A is about to go bankrupt and that it has five stakeholders who have been with it through all of its ups and downs. The corporation has $1 million in assets and securities. ShareholdersShareholdersA shareholder is an individual or an institution that owns one or more shares of stock in a public or a private corporation and, therefore, are the legal owners of the company. The ownership percentage depends on the number of shares they hold against the company’s total shares.read more will receive assets worth $200,000 each, according to the provision.

Example #2

SunStream Bancorp provided a $100 million acquisition facility to cannabis business Jushi Holdings. It will enable the company to boost its financial flexibility, fund acquisitions, and expand in existing and emerging markets. This facility was secured over the company’s specific assets and on a pari-passu basis.

Pari Passu vs Pro Rata

Pro-rata and pari passu are two important principles in commercial real estate transactions. However, even though they are used in asset distribution simultaneously, they have different meanings.

The former means “in proportion.” It implies paying obligations and profits to stakeholders in proportion to the amount of money they invest and the debt they owe.

The latter means “on an equal footing.” It refers to the equal distribution of payment among creditors depending on their initial investment in assets or obligations.

For example, if one investor makes 80% of the initial investment and the other two make 10% each, their share proportions will be distributed in the same way.

Uses of Pari Passu

The Pari Passu principle is applicable in different niches, including:

#1 – Bankruptcy

Pari passu agreement protects the initial investments made by shareholders when a company goes bankrupt. The clause allows equal distribution of assets among investors in proportion to their initial investment and debt. However, it does not find applicability in cases where banks are creditors.

If a firm becomes bankrupt, liquidates its assets, or has outstanding loans or debts, it must repay its creditors first. In such cases, the court treats all creditors equally in its decision. In other words, the lack of equality in the right to payment nullifies the provision in such situations.

#2 – Asset Management

The pari passu clause is useful in asset managementAsset ManagementAsset management is a method of managing funds and investing in both traditional and specialized products in order to generate returns consistent with the investor’s risk tolerance. read more. It helps in managing assets or securities of creditors equally.

#3 – Lending

It is applicable in lending and credit scenarios, as stated in the loan agreement. As a result, creditors can get secured loansSecured LoansSecured loans refer to the type of loans approved and received against a guarantee or collateral. If they fail to do so, the lending institution acquires the collateral to compensate for the amount that the borrowers were allowed.read more with equal claims on assets.

#4 – Debt Covenants

The concept holds significance in debt covenantsDebt CovenantsDebt covenants are formal agreements between different parties like creditors, suppliers, vendors, shareholders, investors, and a company, establishing limits for financial ratios such as leverage ratios, working capital ratios, and dividend payout ratios, which a debtor must refrain from breaching.read more. When companies issue bonds to raise capital, the clause assures that each bond is equal.

#5 – Wills & Trusts

The pari passu rule allows equal distribution of assets among parties specified in a will or trust.