Pari passu ranking: Overview, definition, and example
What is pari passu ranking?
Pari passu ranking is a Latin term meaning "on equal footing." It refers to the equal ranking or priority of two or more financial instruments, obligations, or claims. In a financial or legal context, it means that the parties involved share the same level of priority or status, and they are entitled to an equal distribution of any assets or payments. Pari passu ranking ensures that no party has a preferential treatment over others when it comes to receiving payments or settling debts.
For example, in the case of bondholders, pari passu ranking means that all bondholders are entitled to receive payment on equal terms and in proportion to their holdings, without one bondholder being paid before the others.
Why is pari passu ranking important?
Pari passu ranking is important because it provides fairness and clarity in the distribution of assets, especially in the event of liquidation, bankruptcy, or any situation where multiple parties are entitled to receive a share of the same pool of funds or assets. It ensures that no creditor, shareholder, or bondholder has a higher priority unless specifically stated otherwise in the terms of the agreement.
For investors and creditors, understanding pari passu ranking is crucial for determining the risk and potential return on investment, as it clarifies how they will be treated in comparison to other stakeholders. For businesses, implementing pari passu ranking can help ensure equal treatment of stakeholders and minimize disputes during the distribution of assets.
Understanding pari passu ranking through an example
Imagine a company that issues two types of bonds: one for senior bondholders and one for subordinated bondholders. If the company faces financial difficulties and must liquidate, the senior bondholders may have a priority claim to assets over the subordinated bondholders. However, if both classes of bonds are issued with pari passu ranking, both senior and subordinated bondholders will have equal rights to the company's assets in the event of liquidation, with each class receiving a proportionate share.
In another example, a group of investors holds shares in a company, and these shares are classified as pari passu. In this case, if the company distributes dividends, all shareholders will receive the same dividend per share, without one group of shareholders being treated preferentially over others.
An example of a pari passu ranking clause
Here’s how a pari passu ranking clause might appear in a loan agreement or bond indenture:
“The obligations of the Borrower under this Agreement shall rank pari passu in all respects with the Borrower’s other senior unsecured debt, and no obligation shall have any priority over another except as provided herein.”
Conclusion
Pari passu ranking ensures that multiple parties or claims are treated equally in terms of priority or distribution of assets, providing fairness in financial and legal contexts. Whether in the distribution of payments among bondholders, shareholders, or creditors, pari passu ranking helps maintain equity and clarity. For businesses and stakeholders, understanding and implementing pari passu ranking provisions can prevent disputes and ensure that all parties are treated equally unless otherwise agreed upon.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.