What it means
Ranking is the quiet engine of credit. When a borrower cannot pay everybody, the order in which claims are settled decides who recovers in full, who recovers part and who recovers nothing, and pari-passu describes claims sitting at the same level of that order.
A pari-passu clause in a loan agreement is usually a promise rather than a description. The borrower undertakes that the new lender's debt will rank at least equally with its other unsecured borrowings, so the borrower cannot later quietly promote a newer lender above an existing one.
Lenders care because ranking, not the interest rate, determines what they actually get back if things go wrong. Equal ranking does not mean equal amounts.
Each claim in the class receives the same proportion of its face value, so a $2,000,000 claim recovers four times as many dollars as a $500,000 claim while both recover the same percentage. The phrase also appears well outside lending.
Shares issued in a new funding round are often described as ranking pari-passu with existing ordinary shares on dividends and voting, and two classes of preference share may rank pari-passu with each other while sitting ahead of ordinary shares on a sale. The nuance most people miss is that pari-passu says nothing about security.
A secured lender holding a charge over specific assets is paid out of those assets first, so a group of unsecured creditors ranking pari-passu with one another is still sharing only whatever is left once the secured and preferential claims have been settled.
In practice
Real-world examples.
Example
A manufacturer takes a $10,000,000 term loan and the agreement includes a pari-passu covenant. Two years later it wants a second facility from a different bank, and the new bank asks for security over the factory. The existing lender must consent, because granting that security would push its own claim below the newcomer's.
Example
A venture-backed analytics company raises a Series B. The new preference shares are drafted to rank pari-passu with the Series A preference shares on a sale, so if the exit proceeds are thin both rounds share the pot in proportion rather than the later investor being paid first.
Example
A government issues a new bond that states it will rank pari-passu with all its other unsecured external debt. Bond investors treat that wording as a core protection, because it stops the issuer paying a favoured group of holders ahead of the rest in a restructuring.
Formula
Calculation
Pari-passu distribution uses a simple proportional split:
Recovery rate = Funds available to the class / Total claims in the class
Payment to a claim = Claim amount x Recovery rate
A wholesale distributor is wound up. After the secured bank and preferential employee claims are settled, $3,000,000 remains for the unsecured creditors, whose claims total $12,000,000 and all rank pari-passu. The recovery rate is $3,000,000 / $12,000,000 = 0.25, or 25%. A packaging supplier owed $800,000 therefore receives $800,000 x 0.25 = $200,000, a bondholder owed $2,000,000 receives $500,000, and a small logistics firm owed $40,000 receives $10,000. Every creditor loses exactly 75% of its claim, which is the whole point of ranking on equal footing.Case study
Seen in the real world.
Northwind Ceramics is a fictional, illustrative tile manufacturer used here to show how equal ranking plays out. It borrowed $6,000,000 from a bank on an unsecured basis, with a pari-passu clause, and later took a further $4,000,000 from a specialist lender that was quietly granted a fixed charge over the kiln equipment.
When Northwind failed, the equipment sold for $3,600,000 and went almost entirely to the secured specialist lender. The original bank found itself in the unsecured pool alongside trade suppliers, sharing $1,500,000 against claims of $7,500,000, a recovery of 20%. Its $6,000,000 claim returned $1,200,000.
The illustrative point is not that pari-passu failed, but that it only ever governs claims within the same class. The bank's clause had been breached by the later charge, and the resulting dispute took longer and cost more than simply monitoring the covenant would have done.
Watch out
Common mistakes.
- Reading pari-passu as a guarantee of being paid in full, when it only guarantees the same percentage recovery as everyone else in the class.
- Assuming pari-passu ranking beats security, when a secured creditor is paid from its charged assets before the unsecured pool is shared at all.
- Signing a pari-passu covenant and then never monitoring it, so later borrowings quietly change the ranking without anyone noticing until a default.
Questions
People also ask.
Does pari-passu mean creditors receive identical dollar amounts?
No, they receive the same proportion of what they are owed, so larger claims receive larger payments but suffer the same percentage shortfall.
Can shares rank pari-passu with each other?
Yes, share classes are frequently described as ranking pari-passu on dividends, voting or exit proceeds, meaning they are treated on identical terms for that particular right.
Is pari-passu the opposite of subordinated?
Broadly yes, since subordinated debt sits deliberately below other claims while pari-passu debt sits level with them.
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