Pari Passu Meaning, Examples, Basis, Uses, How it Works?

By providing a fair and predictable mechanism for the distribution of assets, it enhances trust and cooperation among lenders, ultimately contributing to a more stable and efficient financial system. This is contrary to situations where some creditors may have a priority claim, often referred to as a senior or preferential charge, which allows them to be paid in full before others receive any payment. The pari passu rule allows equal distribution of assets among parties specified in a will or trust.

When companies issue bonds to raise capital, the clause assures that each bond is equal. With common voting shares, each share is equal in the sense that they hold a voting right and are equal in case of a liquidation. With preferred shares, each share is equal in the sense that they each hold an equal preference with dividend distributions and a preference (ahead of common shares) in the case of a liquidation.

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This term can apply to many different areas of finance, including shares, loans, or bonds with equal seniority or payment rights. Pari-passu is a Latin phrase used in contract law that describes situations where two or more assets, securities, creditors, or obligations are equally managed without preference. The term is most commonly found in reference to elements of bankruptcies, loans, and bonds. The Pari-Passu Charge provides an equivalent right to the share of specified assets of a borrowing company to all the lenders under the arrangements. In the event of default of repayment from the borrower, the joint lenders may decide to dispose of the security held by them to recover their dues.

She has extensive experience drafting and negotiating NDAs, commercial agreements, and legal documents in the areas of M&A, SaaS, and AI. Her global perspective is complemented by hands-on internships, corporate counsel roles, and mentoring initiatives. Pari-passu can be applied to a myriad of financial instruments or contractual relationships. Though there are multiple classes of equities, within each class, the pari-passu principle holds.

A legal charge executed against a property equating to the value of the Lenders. Normally it refers to money, and a rate of Interest is charged whilst the debt remains outstanding. With a first charge residential mortgage, people will be borrowing money to purchase their home. A second charge mortgage in comparison is an additional mortgage taken out on the same property. This means that they have an equal claim to the proceeds from the sale or liquidation of the assets.

• Pari-passu can apply to common stock shares, for example, so that each shareholder has equal rights to claims for dividends, voting rights, and the liquidation of assets.
• For example, if a company becomes bankrupt, liquidates its assets, or has outstanding loans or debts, its creditors must be paid first.
• If such information about creditors has not been revealed or disclosed before they borrow a loan from the creditors, then the company has to repay the loan when asked by the creditors.
• Where a pari passu clause is contained in a loan agreement, it states the wording that all creditors will rank pari passu with each other and any other unsecured payment obligations of the issuer.
• As investors navigate complex financial agreements, a deep understanding of the pari passu concept is imperative for making informed investment decisions that align with their financial goals.

Bankruptcy and Creditor Rights

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. 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.

Hierarchy of Debt

Companies issue bonds as a part of debt financing to raise capital; pari-passu would be implemented in bonds to ensure that each bond is equal. A second charge mortgage is a secured loan that uses the capital (or equity) in your home as collateral. In other words, it’s based on the difference between the value of the property and the amount you owe on your first mortgage.

What does pari passu mean in bankruptcy law?

This structure can lead to unequal creditor protection, as junior creditors may receive minimal or no repayment in the event of insolvency. The choice between pari passu and subordination agreements profoundly impacts creditor rights, as it determines the order and proportion of repayment. Effective creditor protection and debt collection rely on a well-structured agreement that balances the interests of all parties involved. By understanding the implications of pari passu and subordination agreements, creditors can better navigate debt collection and safeguard their rights in the event of insolvency. In the context of investment strategies, pari passu clauses play a pivotal part in protecting investors’ interests.

Importance in Loan Agreements

It implies that when a business or a person will liquidate its assets, all unsecured creditors will be repaid equally or proportionally to each individual creditor’s debt. A second charge mortgage allows you to use any equity you have in your home as security against another loan. When multiple banks finance to a single borrower under consortium arrangement or multiple banking, there are certain common assets, on which all the lenders share charge. Suppose SBI, BOI and PNB have financed working capital of Rs.25 crore, Rs.50 Crores and 100 Crores each to M/s ABC Ltd.

In a pari passu hierarchy, all creditors have equal priority, and repayment is distributed proportionally. Subordination agreements, on the other hand, establish a ranked priority, where junior creditors yield to senior creditors. Senior-subordinate relationships pari passu charge meaning involve a tiered structure, where senior creditors are paid in full before junior creditors receive any repayment.

In the event of default of repayment from the borrower, the joint lenders may decide to dispose-off the security held by them in order to recover their dues. Ultimately, the pari passu clause is indispensable in maintaining fairness and ethical standards in debt restructuring, certifying that all creditors are treated fairly and without bias. By upholding these principles, the pari passu clause promotes a stable and efficient credit market, where creditors can rely on fair treatment and equal opportunities for debt recovery.

• For example, if a company issues bonds with a pari passu clause, all bondholders must receive payments proportionally if the company faces liquidation.
• With preferred shares, each share is equal in the sense that they each hold an equal preference with dividend distributions and a preference (ahead of common shares) in the case of a liquidation.
• Wills and trusts can assign a pari-passu distribution where all the named parties share the assets equally.
• Pari-passu can describe any instance where two or more items can claim equal rights as the other.

Assets and Securities

Thus pari passu charge means, having equivalent charge/ rights or say charge-holders have equal rights over the asset on which pari-passu charge is created. This means that if the company faces financial trouble and can only repay part of the debt, all bondholders will receive the same percentage of repayment—none will be paid in full while others get nothing. In the domain of corporate finance, the pari passu clause has far-reaching implications for debt structuring, influencing the terms of bank financing and the provisions of credit agreements.

When a company borrows money or takes a loan from a creditor, the creditors would like to know if there are any other creditors in line with those creditors or ranked above them. If such information about creditors has not been revealed or disclosed before they borrow a loan from the creditors, then the company has to repay the loan when asked by the creditors. Sometimes, it is also named in other words like ‘ranking equally’, ‘with equal force’, ‘hand in hand’, or ‘moving together’. Raveena is a seasoned International IP Counsel with a unique blend of engineering and legal acumen, specializing in Intellectual Property, Technology Law, and Corporate Transactions.