Pari Passu is a Latin term that roughly translates to “in equal step” and is frequently used in lending agreements and bankruptcy proceedings. Given the specific context of intercreditor agreements amid corporate insolvencies, claims stated to be “pari passu” are treated equally in terms of priority of recoveries.
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The pari passu clause is a legal provision proclaiming that certain parties, such as specific classes of claim holders in an intercreditor agreement, will receive equal treatment.
The term is most prevalent in corporate insolvencies, in which the debtor—i.e. the distressed company—has filed for bankruptcy protection and will soon undergo an in-court reorganization (Chapter 11) or liquidation (Chapter 7).
In either outcome, the absolute priority rule (APR) must be abided by per the Bankruptcy Code. The APR determines the pecking order by which creditor claims and recoveries are distributed.
By virtue of possessing a lien on the debtor’s assets, senior secured creditors must be paid in full and receive full recovery before the claims held by lower-priority creditor classes can be paid.
As such, senior secured lenders like banks with a lien on the debtor’s collateral are not “pari passu” with unsecured lenders.
That said, the pari passu clause is generally more relevant to lower priority claim holders, such as lenders of unsecured loans and bonds, because of the lower recovery rates.
The classification of claims is based on shared commonalities and interests. Once the claims are classified into groups, the ranking (and treatment of the consolidated claims) is determined by the Court and then applied to each distinct class, rather than to individual claims.
For example, unsecured creditors in the reorganization (or liquidation proceeding) are treated as being on “equal footing” and the recovery proceeds are distributed on a pro rata basis. If creditors receive recoveries on a pro-rata basis, then their recoveries are in direct proportion to the original amount the debtor owes to the creditor.
In 2001, Argentina defaulted on its foreign bonds and underwent a debt reorganization.
However, holdout bondholders led by NML Capital—a subsidiary of Elliott Management—rejected the swap and continued to argue in Court that their claims were due repayment in full, despite the fact that the majority of other creditors were on board.
As part of the reorganization, Argentina had swapped most of the defaulted bonds for new bonds, which it would then service per usual.
The more pressing matter was that the holdout bondholders, like NML Capital, kept their defaulted bonds and sued Argentina in the U.S. Court system on the basis that Argentina’s defaulted bonds had a pari passu clause. NML Capital had purchased a significant amount of Argentine bonds around the time that the country defaulted.
In short, servicing the interest on the newly exchanged bonds while the holdout creditors were still not paid in full was a violation of their own contractual agreement, i.e. “equal ranking”. Thus, Argentina could not pay interest on the newly swapped bonds without first paying off the defaulted bonds held by the holdout bonds.
District Judge Thomas Griesa ruled in favor of the holdout creditors and ordered Argentina to pay the plaintiffs, stating that the new creditors were favored over the holdout creditors. In particular, the pari passu clause in the contract prohibited two items:
In response, Argentina refused to comply to the Court orders and avoided the plaintiffs, which they called “vultures”. Later on, Argentina filed a petition to appeal the decision in the Supreme Court, which was eventually granted.
In Republic of Argentina v. NML Capital, Ltd., the Supreme Court affirmed the decision, yet Argentina continued its refusal to abide by the Court’s ruling until 2016 when a settlement was finally reached with its bondholders.
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