Question: What is a Pari Passu in a Loan Agreement?Answer:
Pari passu is a Latin term that means ‘on equal footing’ or ‘ranking equally’. It is an important clause for creditors of a company in financial difficulty which might become insolvent.
If the company’s debts are pari passu, they are all ranked equally, so the company pays each creditor the same amount in insolvency.
The loan agreement usually frames the pari passu clause as either:
- a representation and warranty (so that the debt owed under the loan agreement ranks equally with the borrower’s other debts in insolvency); and
- an undertaking that the ranking will remain the same in the future.
The undertaking is important for unsecured loan agreements because it deals with the ranking of unsecured claims. Although, it can be useful for secured loan agreements in case the proceeds from selling the secured asset (e.g. a mortgage or asset) are not sufficient to repay the creditor. This is because specific classes of creditors will have priority over 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 a Pari Passu Clause Important For a Lender?
Before a creditor makes a loan to a company, they would want to know whether there are senior creditors which would rank ahead. If the company has not disclosed these creditors before the creditor makes the loan, the creditor can make the company repay the loan.
Why is a Pari Passu Clause Important for a Borrower?
It’s important the company ensures that the clauses are accurate and that they do not restrict the borrower’s future borrowings.