What is Pari-Passu?
Pari-passu is a Latin term that means “on equal footing” or “moving together.” It’s a widely used legal term that has applications in corporate finance and personal finance that indicates fairness in the distribution of something. The term is used in equity shares, insolvency, and inheritance.
Let’s take a look at how the pari-passu principle plays out in different settings.
Pari-passu in inheritance means that all parties that inherit the estate will receive an equal portion of it. It’s best understood in contrast to the per stirpes method for distributing an inheritance.
Suppose G had 3 children A, B, and C. A has just one child, AA. B has two children, BA and BB. C has three children, CA, CB, and CC. G wants to leave his estate to his grandchildren in his will. He can do it in two ways:
- Per stirpes: Each branch of the family gets an equal portion. If the estate of G is distributed by the stirpes method, here is how it gets distributed: A’s child (AA) gets one-third of the estate of G. The children of B combined get one-third of G’s estate. This means BA and BB each receive one-sixth of G’s estate. All the children of C together receive one-third of G’s estate. This means CA, CB, and CC each receive one-ninth of G’s estate.
- Pari-passu: If G leaves the inheritance to his grandchildren to be distributed using the pari-passu method, all his grandchildren inherit one-sixth of the estate. All the grandchildren receive an equal portion without consideration to the branches of the family.
In the context of equity shares, pari-passu refers to a situation in which all the shares issued by the company have equal voting rights and equal rights to dividends. Some companies issue shares with different voting rights and different ownership weights, known as classes of shares. Facebook, for example, issues different classes of shares. Such share issuances are not pari-passu.
In terms of the debt a company owes to its creditors, there is always a pecking order. In the event of insolvency and eventual bankruptcy filing, creditors are settled first before other stakeholders are considered. Even within creditors, there is a prioritization for the distribution of funds. Secured loans have the top priority, followed by unsecured loans. Employees and vendors come into the picture only after secured and unsecured loans are satisfied. This is not pari-passu as they are not treated equally.
At the time of the loan agreement, pari-passu conditions can be included in the agreement. A pari-passu clause ensures that all the creditors will be treated equally in the event of liquidation of the company’s assets. All the creditors receive a share of the assets in a pro-rata fashion. That is, each creditor receives the share of the assets sold in proportion to the amount they’re owed.
The concept of pari-passu can be included in many different financial instruments. It’s typically included in the terms of an agreement to dictate the distribution of assets.