Pari Passu: What Ranking Equally Means for a Lender

The Latin means with equal step. In credit, claims that rank pari passu are in the same class: if the pool will not pay them all, each is cut by the same percentage. Insolvency law supplies that default for ordinary unsecured creditors, after costs and preferential claims. In England and Wales, debts other than preferential debts rank equally in an administration or a court winding-up and abate in equal proportions. Australia's Corporations Act says debts proved in a winding up rank equally and are paid proportionately, except as the Act otherwise provides. New Zealand's Companies Act pays liquidation costs and preferential employee and Inland Revenue claims first, then all other unsecured creditors. Secured creditors sit outside that order and look first to their security, although preferential claims can reach some charged assets: floating-charge assets in the UK, circulating assets in Australia, and receivables and stock in New Zealand.

A facility agreement adds two things. One is the ranking undertaking, in which the borrower represents that this debt stands no lower than its other unsecured and unsubordinated debts, apart from those the law prefers. The other operates among the lenders in a club or syndicated facility, where shares are fixed by commitment and payments are divided in those shares.

The hard part is what counts as recovered. A lender holding the borrower's deposit account may be able to set off its loan against the balance on the day of default. Many syndicated agreements therefore carry a sharing clause: a lender that receives more than its proportion pays the excess to the agent for distribution among the lenders, and is treated as still owed what it handed over. Whether the clause reaches every kind of recovery depends on the drafting. So does whether it can be changed: majority lenders are often barred from altering it without every lender's consent, though not in every agreement.

On a land or personal property register, one security interest normally goes first. Lenders who want equal ranking over the same assets usually have a security trustee hold one set of security for all of them, or agree the equal rank in a deed of priority.

A maker of warehouse racking, constructed for this page like every figure in it, borrows US$20m under one facility: Bank A holds US$12m and Bank B US$8m. A security trustee holds the security for both, the agreement ranks them pari passu, and it has a sharing clause. The company defaults. Bank B, which also runs the operating account, sets off US$2m of credit balances against its loan. The security later realises US$14m after costs. In US$m:

The clause moves US$0.27m from Bank B to Bank A, and both finish at 80 cents. Without it, holding the account would have been worth 5.5 cents in the dollar. The US$4m not yet recovered remains owed. Suppose US$1m is left for unsecured creditors after the liquidator's costs and preferential claims, and trade creditors claim US$6m. The banks claim for their shortfall beside them:

Ranking equally has given the banks and the trade creditors the same 10 cents, on very different sums. The figures are the example's, and none is offered as a typical recovery.

Pari passu and pro rata are often used as if they meant the same thing. One is a rank and the other a method of division. Creditors who rank pari passu are usually paid pro rata, but a class ranking behind another can also divide its recoveries pro rata among its own members. It would be pro rata without being pari passu with the class ahead of it.

A negative pledge is drafted beside the ranking undertaking because each covers what the other leaves open. The undertaking deals with rank among unsecured creditors in an insolvency, and on the reading commonly taken under English law it does not stop the borrower paying another creditor early. Nor does it stop the borrower granting security, which would put a new creditor ahead altogether. The negative pledge addresses that. Subordination runs the other way: one creditor agrees to rank behind.

DEFINED IN ONE PARAGRAPH → · ONE SET OF SECURITY FOR ALL LENDERS → · THE RECOVERY WATERFALL, WORKED →

On a single-lender file the undertaking is usually boilerplate, and the real protection is the security. It starts to matter as the structure grows. A credit paper on a club facility asks who else is in the class: the term lenders, the revolver, the overdraft bank, the hedge provider. Whether a swap close-out shares equally with the loans is negotiated, and so is whether an overdraft ranks beside the term debt in full or only up to a cap. Each creditor admitted to the class reduces the cents in the dollar for the others without changing the ranking at all.

It matters again in a restructuring. Lenders ranking equally can disagree about what to do, the size of each share decides who can carry a vote, and the sharing clause decides whether one lender could do better by acting alone. A credit officer reading an equal-ranking structure looks past the phrase to those mechanics, because the phrase gives each lender a place in the queue and the rest of the document decides whether the queue holds.