Pari Passu Clause
Definition
A pari passu clause is a covenant included in loan agreements and other debt instruments. This clause ensures that the borrower treats the loan in question equally with other specified debts, meaning no creditor receives preferential treatment over another regarding claims on the borrower’s assets. This clause is crucial in maintaining fairness among creditors, particularly in instances of default or bankruptcy.
Detailed Explanation
In Latin, pari passu means “with equal step.” In financial terms, it mandates that all creditors under the specified debts have the same legal ranking and, thus, any repayments or claims on the borrower’s assets will be distributed proportionally and simultaneously without priority.
When a company or an entity includes a pari passu clause in its lending agreements, it gives assurance to each creditor that they will not be subordinate to future (or existing) debts. This clause provides a level of security to creditors, particularly when assessing their risk exposure.
Examples
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Corporate Loans: A company borrows $10 million from Bank A and $15 million from Bank B with pari passu clauses in both agreements. In the event of liquidation, each bank would be entitled to repayments on an equal footing relative to their claims.
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Government Bonds: Suppose a government issues multiple bonds with pari passu clauses. If the government defaults, the bondholders would receive payments proportionally without any bondholder being prioritized over others.
Frequently Asked Questions
What happens if a pari passu clause is violated?
If a borrower violates a pari passu clause by not treating all creditors equally, it can lead to legal action from the disadvantaged creditors. The borrower may be required to pay damages or be forced into bankruptcy, depending on the jurisdiction and severity of the breach.
Are pari passu clauses common in all loan agreements?
While commonly found in corporate loans and complex debt structures, pari passu clauses might not be present in smaller or more straightforward lending arrangements.
How does a pari passu clause differ from a subordination agreement?
A subordination agreement specifies that one debt is ranked below another in priority of repayment. In contrast, a pari passu clause ensures equal ranking among specified debts without prioritization.
Can existing debts be affected by pari passu clauses?
Yes, existing debts can be impacted if they fall under the purview of new pari passu clauses. Creditors would need to review any new debt agreements to understand the implications fully.
Related Terms
- Covenant: An agreement or promise within a contract that stipulates certain actions or restrictions.
- Subordination Agreement: An arrangement whereby one debt is ranked below another for repayment priority.
- Cross-Default Clause: A provision that puts a borrower in default if the borrower defaults on another related debt obligation.
- Intercreditor Agreement: An agreement between two or more creditors outlining their rights and obligations in relation to the borrower and each other.
Online References
Suggested Books for Further Studies
- “Credit Risk Management: How to Avoid Lending Disasters and Maximize Earnings” by Joetta Colquitt
- “Corporate Finance” by Jonathan Berk and Peter DeMarzo
- “The Law of Debt Restructuring” by Francisco Javier Léon Sanz
- “Debt, Defaults, Disinflation, and Demographics” by Richard Marston
Accounting Basics: “Pari Passu Clause” Fundamentals Quiz
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