Understanding all the terms of a contract is vital to ensure you can comply with all its provisions. In reviewing your loan agreement, you may come across the phrase “pari passu”. Pari passu, while a short and seemingly simple little phrase, can be complex. It is essential to understand what it means in the context of your loan agreement. Not understanding its practical meaning can have serious legal effects on you and your business. This is especially the case in complicated transactions that can affect how you pay creditors. This article will explain the meaning of pari passu, what it means in the context of a loan agreement and why it is important.
What Does Pari Passu Mean?
Pari passu is a Latin phrase, meaning “on equal footing”. It is also sometimes translated to other similar phrases, which include “ranking equally”, “hand-in-hand”, “with equal force”, or “moving together”. As such, a pari passu refers to things that are in the same situation or things that rank equally.
You can commonly find this phrase in several legal agreements, including matters relating to finance. In a loan context, pari passu means to be “equal in right of payment”. It means that all parties or assets involved in a contract will be treated equally. Therefore, multiple parties under multiple financial agreements with one company or under one financial arrangement which relates to the same company have equal rank and rights of payment.
Pari Passu in the Context of a Loan Agreement
A pari passu clause in a loan agreement usually contains wording that states that all lenders will rank on equal footing, or pari passu, with each other and any other unsecured payment obligations of the issuer. This clause often refers to loans or bonds. It means that a specific debt will rank equally to other obligations of a company owing money to creditors. Where a loan does not contain a pari passu clause, loan amounts will be repaid in the order they were initially advanced.
You can typically find a pari passu clause in two ways in a loan agreement:
- as a representation and warranty (so the loan debt ranks equally with the borrower’s other debts in insolvency); and
- as an undertaking to the effect that the ranking will remain the same in the future (giving lenders certainty of their rights).
The undertaking is significant for unsecured loan agreements because it relates to the ranking of unsecured claims. However, it can also be helpful for secured loan agreements if the proceeds from selling the secured asset, like a mortgage or asset, are insufficient to repay the creditor. This is because specific classes of creditors will prioritise other creditors, such as employees and the costs of the liquidator. In that case, the creditor becomes an unsecured creditor and will want to rank equally with other unsecured creditors.
Continue reading this article below the formWhy is the Pari Passu Clause Important?
A pari passu clause is particularly relevant when a person or business faces financial difficulty, insolvency or files for bankruptcy. This clause indicates that the business facing financial difficulty must pay creditors pro-rata in equal rank, at the same time.
Additionally, a business becomes insolvent when it owes more money than it holds and cannot pay its debts when due. If the business’s debts are pari passu, all unsecured creditors will rank equally. This means that the insolvent business will sell its assets and repay each creditor in proportion to the debts owed. As a result, the business assets are distributed proportionally to each creditor. Ultimately, there is no preferential treatment to any creditor.
Lenders will almost always want to make sure that the loan agreement has a pari passu clause in it. This is because, in the context of a loan agreement, a pari passu clause will ensure that the lender will rank equally.
Know which key terms to negotiate when buying a business to protect your interests and gain a favourable outcome.
Key Takeaways
In summary, it is crucial to understand how a pari passu clause may affect your loan agreement. A loan agreement with a pari passu clause means that all lenders will rank pari passu or equal with each other and with any other unsecured payment obligations of the issuer. This clause is particularly useful for lenders. It ensures they will rank equally with anyone else who has lent a business money.
If you need help with a pari passu clause, our experienced banking and finance lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 1300 544 755 or visit our membership page.
Frequently Asked Questions
It is valuable for lenders to be aware of the existence of any legally superior lenders whose claims will rank higher than theirs. A loan agreement with a pari passu clause means that the borrower must ensure that all lenders will rank pari passu or equal with each other and with any other unsecured payment obligations of the borrower. A pari passu clause protects a lender against the involuntary subordination of its loan.
For borrowers, a pari passu provision is rarely controversial. However, the borrower’s principal objectives in negotiating this kind of clause are to ensure its accuracy and limit the constraint it may impose upon the borrower’s future debt servicing behaviour.
Where there is no pari passu clause in a loan agreement, bankruptcy and insolvency laws will usually dictate the order of repayment. Once the company’s assets are sold, a repayment hierarchy will be established whereby certain lenders (typically secured senior creditors) get preferential treatment and priority in repayment over other lenders.
We appreciate your feedback – your submission has been successfully received.
