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 is functioning as an equal to all similar others.
- Pari-passu is a Latin phrase meaning "equal footing."
- In finance, "equal footing" means that two or more parties to a financial contract or claim are all treated the same.
- Pari-passu is common in bankruptcy proceedings as well as debts such as parity bonds in which each party gets the same amount.
- Wills and trusts can also assign an in pari-passu distribution where all the named parties share the assets equally.
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.
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.
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.
Wills and Trusts
Wills and trusts can assign an in 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.
Often, identical items will be pari-passu, coming with the same benefits and costs of 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 equal rights to a claim as other bonds already 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 usually comes into play when dealing with unsecured debt obligations.
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.