What is Pari-Passu?

Pari-passu is like splitting a pizza evenly with friends . . .

Sometimes, one person is hungrier than the others, but other times, everyone wants the same number of slices. When everyone agrees that everyone has equal rights to the pie, they’re entering a pari-passu agreement — everyone is on equal footing. However, this doesn’t necessarily mean they get the same number of slices. If Bob pays more than Jill, he will get more slices. That’s because Bob paid more, not because of his seniority. If Jack comes along and eats half the pie uninvited, Bob and Jill will split the remaining slices proportionally between them based on how much they paid. Similarly, when several parties enter a pari-passu agreement, it means that each of them has an equal rank and stake in it.

Pari-passu is a Latin phrase usually translated as “on equal footing.” It’s commonly used with debt obligations and bankruptcy proceedings. But it can also be used in other financial arrangements, and how it’s used depends on the context. In general, pari-passu clauses are used to specify that several parties have equal rights of payment and rank.

In banking, pari-passu is typically used in the context of unsecured debt, which are bonds or loans not backed by collateral. For example, if a lender provides an unsecured loan to a business, it may include a pari-passu clause in the contract. If the borrower goes bankrupt, the lender will have equal rights of payment and rank as all the other borrower’s unsecured creditors. This clause prevents other lenders from swooping in and claiming seniority just because they issued a loan earlier. Instead, once the business liquidates its assets, the funds will be disbursed proportionally to all creditors who rank pari-passu based on their initial investment (pro-rata) and at the same time.

In real estate, the term has a similar meaning, especially with commercial real estate (CRE) when discussing waterfall distributions (aka the order in which payments and profits from an investment property are distributed among investors). In this context, pari-passu is often used in conjunction with the term pro-rata, but the words have slightly different meanings. Pro-rata refers to proportionally distributing profits and obligations, and pari-passu refers to the rank and seniority of the obligations — i.e., that they are “on equal footing.”

Think about it like this: Imagine you loan your friend $50, and your friend’s cousin lends him $100. Your friend promises to pay you back, but he ends up going broke and only has $75 to repay both of you. So who gets paid? Does your friend’s cousin get the entire $75, leaving you in the dust? Or do you split the remaining funds proportionally?

If you loaned your friend the money on a pari-passu basis, you’re entitled to receive pro-rata (proportional) payment based on your initial investment. In this example, that would mean you’d receive $25, and your friend’s cousin would receive $50. You are entitled to this pro-rata payment precisely because you entered into the agreement on a pari-passu basis.

Pari-passu is an agreement to share obligations or profits equally among all parties in an agreement. In a typical pari-passu agreement, there will be a pari-passu clause in a contract, such as a loan agreement or bond covenants.

Once the agreement is entered, all parties legally have the same rights, rank, and seniority involving the assets or obligations in question. For example, if a corporation issues bonds on a pari-passu basis, then every bondholder has an equal right to payment. By issuing the bonds on a pari-passu basis, the corporation makes it clear that there is no priority given to bondholders who purchased bonds at an earlier time.

Pari-passu and pro-rata are typically used in conjunction when referring to commercial real estate investments. However, while they complement each other, they don’t mean the same thing.

Pro-rata is a Latin term that means “in proportion.” It refers to the proportional distribution of obligations and profits, usually in a real estate agreement. For example, if one investor paid for 90% of a property and another paid for 10%, the obligations and profits would be distributed proportionally to each of them.

Pari-passu, on the other hand, refers to how investors are ranked. It means that both investors rank equally. Neither takes seniority over the other, and they are both entitled to pro-rata payment based on their initial investment.

In short, the difference between the two terms is that pari-passu refers to the relationship between investors, and pro-rata refers to how funds are distributed between them.

A joint pari-passu charge means that multiple lenders rank pari-passu (equally) with each other regarding a loan or debt obligation.

Let’s say Ron is a business owner who wants to take out a $100,000 business loan. Ron approaches several banks, but no single bank will agree to lend him the entire $100,000. Instead, he receives separate $25,000 loans from four different banks.

These loans are unsecured, so each lender wants to protect themselves. To do so, they put a joint pari-passu charge on the debtor, Ron. This means that all the lenders (creditors) involved have equal rank and seniority regarding Ron’s debt obligations — they rank pari-passu.

Now, if Ron’s business goes bankrupt and he liquidates all its assets, the money will be distributed equally among the creditors. If his liquidated assets total $40,000, each creditor will receive $10,000.

A pari-passu corporate action occurs when a company makes a decision that affects its shareholders on a pari-passu basis.

Let’s break it down a bit. A corporate action is any action that a company carries out that affects its shareholders, such as issuing bonds, paying dividends, issuing stocks, etc. When a corporate action occurs on a pari-passu basis, it means that all the shareholders have equal rights to whatever is under consideration in the action.

For example, when a corporation issues bonds, that’s a corporate action. If they issue bonds on a pari-passu basis, that means that all bondholders have equal rights to that debt obligation. One bondholder can’t claim seniority over another just because they purchased their bonds a few days earlier. Instead, every bondholder has equal rank and will be paid at the same time.

A pari-passu clause in a loan agreement is typically used for unsecured debt (loans that aren’t secured by collateral, such as a house or car). The pari-passu clause states that the loan issuer will have equal rights to repayment as all the borrower’s other creditors.

In essence, this means that if the borrower goes bankrupt and liquidates their assets, the lender can collect the money they’re owed at the same time as other creditors. If the liquidated assets don’t cover all the money the debtor owes to creditors, the money will be split pro-rata (proportionally based on their initial investment) amongst the creditors.

This provides some degree of protection to unsecured debtors. Even if, after liquidating their assets, a debtor can’t pay off all their debt obligations, creditors won’t have to worry that they’ll be left entirely empty-handed while another creditor gets their loan back in full. At the very least, all creditors with pari-passu loans will get a piece of the liquidated-asset pie.

In 1983, Peru sold sovereign debt instruments that were guaranteed by two of its national banks. Unfortunately, Peru eventually defaulted on this debt. As a result, a deal was established to exchange the debt for Brady Bonds, a type of bond denominated in U.S. dollars that was mainly issued by Latin American countries.

Most of the creditors agreed to exchange the Peruvian debt for the Brady Bonds. However, one fund, Elliot Associates, refused. While the restructuring of the debt was taking place, the firm purchased $20.7M in face value of Peru’s debt for only $11.4M. The firm then took legal action to enforce the payment of the debt at face value.

Thanks to some legal ingenuity, Elliot Associates won the case. When Peru was about to make payments to European holders of its Brady Bonds, the firm went to court to block the payment. Because of a pari-passu clause in the 1983 Peruvian debt issuance, Elliot Associates was able to convince the European courts that they had equal rights to pro-rata (proportional) payment as all other foreign creditors. Eventually, Elliot Associates was paid the full amount, thanks to the pari-passu clause.