A pari passu clause is often found in loan agreements. It ranks all unsecured creditors equally in the event of insolvency. Read more about what this means for repayments to creditors when a business faces financial trouble.
Who Does Pari Passu Mean?
Pari passu is a Latin term which means “on equal footing” or “equal ranking”.
The pari passu clause is relevant when a business faces financial difficulty or insolvency.
A business becomes insolvent when they owe more money than they hold and they are unable to pay their debts. (Read more about when a business becomes insolvent here. Read about the temporary changes to Australia’s insolvency laws to help businesses cope with COVID here.)
If the business’s debts are pari passu, all unsecured creditors rank equally. That is to say, that an insolvent business will sell its assets and repay each creditor in the same amount, or an amount in proportion to the debts owed to each creditor.
As a result, the assets of the business are distributed equally to each creditor and there is no preferential treatment to any creditor.
Who Does a Pari Passu Clause Apply to?
Pari passu clauses are only relevant to unsecured creditors.
If a business owes you money, you are a creditor. As a creditor, you might be owed money for providing a loan to the business, supplying goods or services that have not yet been paid for. Employees are also considered creditors if they are owed unpaid wages or outstanding superannuation payments.
There are 2 different types of creditors:
- A secured creditor
- An unsecured creditor.
The main difference is that a secured creditor has a ‘security’ interest in the business’s assets, whilst an unsecured creditor does not. You can search here to see if you or anyone else holds a security interest in the business’s assets.
Find out the difference between secured and unsecured creditors here.
Which Creditors Get Paid Out First?
When a company enters into liquidation, a liquidator is appointed to collect and sell the company’s assets. The liquidator will distribute the money from selling off the assets to pay debts in the following order:
- costs of liquidation,
- secured creditors,
- priority creditors including employees,
- unsecured creditors.
Click here to see the list of priority creditors in s 556 of the Corporations Act 2001 (Cth).
This means that only after the secured creditors have had their debts repaid, the remaining assets will be distributed among the unsecured creditors equally and proportionally.
If a company pays back the debt to one creditor over others, the liquidator may make an unfair preference claim. Click here to read more about unfair preference claims.
Signs a Business is in Financial Trouble and What You Can Do
Signs of financial difficulty can include:
- Late payment of invoices
- Unpaid or overdue taxes and superannuation
- Dishonoured payments
As a creditor, it can be difficult to navigate the complexity of insolvency. If you are owed money by a business and suspect financial trouble, it is important to know where you stand. You may like to seek legal advice to ensure you are aware of your rights and options.
