Pari Passu Clauses And Their Importance In Complex Transactions

While American law is less than 250 years old, some of the expressions used in the U.S. legal system come from a time much older. Latin phrases, such as per stirpes, malum in se, malum prohibitum, and de facto are all still used in American law today. Another such phrase, pari passu, is used as legal terminology, and can play an important role in complex transactions.

Translated literally, pari passu means “with an equal step” or “on equal footing”. It is commonly used in law, and is defined in Black’s Law Dictionary as “proportionally; at an equal pace; without preference”. The term is most relevant in matters relating to estate planning and finance.

Pari passu is important to understand, because it can have dire effects on complex transactions that can affect how creditors are paid. An example of pari passu occurs during bankruptcy proceedings. When a verdict is reached, all creditors can be regarded equally, and will be repaid at the same time and at the same fractional amount as all other creditors.

The purpose of pari passu is to ensure that borrowers neither have nor subsequently create a class of creditors whose claims rank legally senior to the indebtedness represented by the loan agreement. New creditors are naturally concerned about whether senior creditors have a first call upon the borrower’s debt payments or, in the event of the borrower’s bankruptcy, enjoy a priority in the distribution of the borrower’s assets. A pari passu clause can help ease these concerns.

For lenders, a pari passu clause is essentially a conversation starter. Before most lenders make a loan, they will want to know of the existence of any legally superior lenders whose claims will rank higher than theirs. If a lender discovers such superior lenders after the money has been lent, the false representation will provide a basis for calling the loan. Additionally, a pari passu clause protects a lender against the involuntary subordination of its loan.

For borrowers, a pari passu provision is rarely controversial. The borrower’s principal objectives in negotiating this kind of clause are to ensure its accuracy and to limit the constraint it may impose upon the borrower’s future debt servicing behavior. At the very least, both sides should agree that the new loan should rank equally with the borrower’s other debts.

Regardless of one’s role in a transaction, a pari passu clause can be troublesome if not approached properly. At HEITNER LEGAL we can guide you through the intricacies of complex transactions and intimidating terms in contracts, like pari passu. Additionally, we can draft documents for you to help in any transactions you may be engaged in.

Resources:

http://www.lse.ac.uk/fmg/events/financialRegulation/LFR14L_Buchheit-(How-to-Negotiate-the-Pari-Passu-Representation-Clause).pdf

Black’s Law Dictionary (9th ed. 2009)

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