The term Pari-Passu is a Latin word that means “on an equal footing”. The Pari-passu charge gives an equal right to its lenders over the assets provided as collateral to secure a loan. When the borrower doesn’t fulfill the payment terms, the assets are sold and the amount received is distributed among all the lenders.
This concept is different in comparison to most of the agreements among borrowers and lenders where a hierarchy is established to repay the debt amount among all creditors. Pari passu charge deals with all the creditors equally without any priority. However, when we compare the rights of the creditors with shareholders pari passu is not applicable. So, When a company becomes bankrupt, the pair passu charge enables lenders to get a share from the sale of assets of a business propionate to the respective holding of the creditors.
How does the Pari-passu charge work?
It is an agreement among borrowers and lenders to share their profits equally among all the parties. A Pari passu charge clause can be incorporated into a loan agreement. Once a Pari passu agreement is executed, all the parties to the agreement are treated equally and there is no ranking or seniority. Like if a company issues bonds on a Pari-passu basis, it will enable all the bondholders to have equal rights of payments. The bonds are issued on a Pari-passu basis to enlighten the fact that no priority will be given to any bondholders who purchased it either at an earlier or a later date.
Pari passu clauses can be included in the agreements of loans, shares, bonds, creditors, wills. and trusts, etc. It will enable the parties to demand or claim equal rights to dividends, assets, voting rights. For example, in the case of equity shares, Pari passu is applied so that all shareholders can claim equal rights to dividends or assets of a company.
Benefits of Pari-passu
Pari-passu charge is useful to restrict the borrower of funds to create a hierarchy of its investors or creditors. Some of the merits of the Pari-passu charge are discussed below:
- All parties are treated same in Pari-passu charge.
- The Pari-passu charge helps the investor to secure his invested amount.
- Pari-passu distribution is also a suitable method used in Wills and Trusts. Here assets are distributed among parties equally based on a Pari passu principle.
- Pari-passu charge is suitable to use for unsecured debts obligations.
- The investors who are interested to minimize their risk and want to secure their funds, do prefer Pari-passu charge
A company TPL ltd. has decided to finance its new project by taking loans/investments from different financial institutions. The investment was provided to the TPL company by three parties. The total amount required from the project was $7.5 million. The details of the creditors are as follows:
Investment of party ABC = $1.5 million
Investment of party ITC= $2 million
Investment from part AHP= $4 million
Later on, terms with all these three parties were decided. The investment of party ABC was declared as Pari-passu to all other types of investment. This agreement will enable the party ABC with the same rights and privileges as that of other parties ITC and AHP. Now if the company faces bankruptcy, party ABC will have rights similar to the other two parties and receive claims in proportionate to their investment.