What Is Pari-Passu?

What Is Pari-Passu?

Pari-passu is a Latin phrase meaning "equal footing" that describes situations where two or more assets, securities, creditors, or obligations are equally managed without preference.

An example of pari-passu occurs during bankruptcy proceedings: When the court reaches a verdict, the court regards all creditors equally, and the trustee will repay them the same fractional amount as other creditors, and at the same time.

Pari-passu may describe certain clauses within a variety of financial vehicles, such as loans and bonds, which are debt instruments issued by companies to raise cash. Often, these clauses are in place to ensure the associated financial product functions as equal to all similar others.

How Pari-Passu Works

In finance, the term pari-passu can refer to loans, bonds, or classes of shares that have equal rights of payment or equal seniority. Pari-passu can describe any instance where two or more items can claim equal rights as the other.

Equity Shares

Within the marketplace, all new equity shares (called a secondary offering) have equal rights with existing shares or those that were previously issued. In that sense, the shares are pari-passu. Pari-passu can apply to common stock shares, for example, so that each shareholder has equal rights to claims for dividends, voting rights, and the liquidation of assets.

Creditors

However, pari-passu does not apply to creditors such as banks. If a company has debt or loans outstanding, there's a pecking order in which certain creditors are repaid first in the event of bankruptcy and liquidation of the company's assets.

As a result, pari-passu would not apply to creditors and shareholders since the creditors would be paid before the shareholders. So while shareholders and creditors are not pari-passu, these creditors, when compared to other creditors, are.

Assets and Securities

Pari-passu is also used to describe securities, such as stocks. Preferred stock has a higher priority over common stock, meaning that the holders of preferred shares receive the first payout if a company is dissolved. Stocks are considered pari-passu if they rank equally with preferred stock for dividends and liquidation.

Wills and Trusts

Wills and trusts can assign a pari-passu distribution where all the named parties share the assets equally. In other words, each of the named beneficiaries would get the same amount.

Similar Products

Often, identical items will be pari-passu, coming with the same benefits and costs as the other items with which they are grouped. In other situations, items may only be pari-passu in one or only certain aspects. For example, two competitors may offer two functionally identical widgets for the same price with superficial differences such as color. These widgets are functionally pari-passu but may be aesthetically different.

Pari-Passu and Unsecured Debts

Since an asset backs secured debts, they are often not fully equal to the other obligations held by the borrower. Since there is no asset supporting unsecured debts, there are greater instances of borrower default or bankruptcy. Further, a provider of unsecured financing may enact clauses that prevent a borrower from taking part in certain activities, such as the promising of assets for another debt to keep a position with regard to repayment.

A parity bond refers to two or more bond issues with equal rights of payment or equal seniority to one another. In other words, a parity bond is an issued bond with the same rights to a claim as any other bonds that have already been issued. For example, unsecured bonds have equal rights in that coupons may be claimed without any particular bond having priority over another. Therefore, unsecured bonds would be referred to as parity bonds with each other. Similarly, secured bonds are parity bonds with other secured bonds.

Pari-Passu vs. Pro Rata

Pro rata is another Latin term that means "in proportion." Usually, this term is used in situations where two parties have an unequal stake in a business or enterprise. If Party A has an 80% stake in a certain company and Party B has a 20% stake, a pro-rata division of profits would return 80% of the gains to A and 20% to B.

Counterintuitively, some pari-passu obligations might result in a pro-rata division of benefits. This is because the only way to ensure an equal footing is by dividing the asset in proportion to each party's contribution.

For example, consider a case of default where one creditor is owed $10,000, and another is owed $5,000. However, the debtor only has $6,000 in assets. If the debts are held pari-passu, the only equitable division is for the first creditor to receive $4,000 and the other to receive $2,000. By using a pro rata distribution, both creditors face proportionately equal losses.

Example of Pari-Passu

Parity bonds have equal rights to the coupon or nominal yield. In fixed-income investments, the coupon is the annual interest rate paid on a bond. Consider a $1,000 bond with a 7% coupon rate. The bond will pay $70 per year. If new bonds with a 5% coupon are issued as parity bonds, the new bonds will pay $50 per year, but bondholders will have equal rights to the coupon.

A parity bond stands in contrast to a junior lien or a senior lien bond. A junior lien bond, also called a subordinate bond, has a subordinate claim to pledged revenue as compared to a senior lien bond, which is also called a first lien bond. Unsecured debts are subordinate bonds compared to secured debts.

The Bottom Line

Pari-Passu means "equal footing," and in finance, it means two or more parties that are treated the same in regard to a financial claim or contract. This term can apply to many different areas of finance. This includes things like shares, loans, or bonds with equal seniority or payment rights.