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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, how the term is used in the context of a loan agreement and its importance.

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.

In a legal context, pari passu means to be “equal in right of payment”. You can commonly find this phrase in several legal agreements, including matters relating to finance. 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 relate 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 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 be equal in rank with the other obligations of a Company that is owing money to creditors. 

You can typically find a pari passu clause in two ways in a loan agreement:

  • as a representation and warranty (so that the debt owed under the loan agreement 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.

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 not sufficient to repay the creditor. This is because specific classes of creditors will prioritise other creditors, such as employees and costs of the liquidator. In that case, the creditor becomes an unsecured creditor and will want to rank equally with other unsecured creditors.

Why 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 several creditors pro-rata (this means proportionally), in equal rank, and at the same time. 

Additionally, a business becomes insolvent when they owe more money than they hold and cannot pay their debts when due. If the business’s debts are pari passu, all unsecured creditors will rank equally. This means that an insolvent business will sell its assets and repay each creditor in equal amounts, or an amount in proportion to the debts owed to each individual creditor. As a result, the business assets are distributed equally 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 with everyone else who has lent the company money.

Key Takeaways

Whether you are a borrower or a lender, 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 that they will rank equally with anyone else who has lent a business money. For more information on how the pari passu clause works or advice regarding your loan agreement, contact LegalVision’s banking and finance lawyers on 1300 544 755 or fill out the form on this page.

Frequently Asked Questions

What does “pari passu” mean?

Pari passu is a Latin phrase, meaning “on equal footing”. Similar translations include “ranking equally”, “hand-in-hand”, and “with equal force”.

Why is a pari passu clause important for a lender?

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 all lenders will rank pari passu or equal with each other and with any other unsecured payment obligations of the issuer. A pari passu clause protects a lender against the involuntary subordination of its loan.

Why is a pari passu clause important for a borrower?

For borrowers, a pari passu provision is rarely controversial. 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. At the very least, both sides should agree that the new loan should rank equally with the borrower’s other debts.

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