What is Pari Passu?

What is pari passu?

The pari passu clause is standard in debt agreements, for both corporate and sovereign borrowers and in loan and bond borrowings. It in essence means ‘ranking equally’. It is the clause that dictates who you sit with as a lender or investor in a company’s creditor hierarchy.

Why is it important to know where you sit in a company’s creditor hierarchy?

The credit hierarchy dictates who gets paid in what order. The pari passu clause will ensure that all payments made to your position in the creditor hierarchy are made pro rata - pro rata comes into play if a company has insufficient funds to pay out on its obligations in full.

It helps define a given level of risk for a given level of return. Insolvency regimes vary by jurisdiction, but courts will follow formal processes for deciding who gets what as whatever cash and other assets are left is distributed strictly in order.

What does pari passu protect against?

Pari passu protects against preferential treatment against lenders at the same level of the creditor hierarchy.

What is the typical order of the creditor hierarchy?

A company’s capital structure is a good representation of this; secured creditors being paid off first (in order depending on the structure of a company’s secured obligations) followed by unsecured creditors in order of contractual seniority - i.e. senior unsecured first followed by subordinated and junior debt class with equity holding up the rear-guard.

Why are pari passu clauses in a sovereign debt document different from pari passu clauses in a debt document issued by a company?

Pari passu clauses in sovereign debt documentation are different by definition since governments can’t be declared bankrupt or be liquidated like companies and have their assets distributed to creditors.