The Principle of 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 any display of preference. An example of pari-passu occurs during bankruptcy proceedings when a verdict is reached: all creditors can be regarded equally and will be repaid at the same time and at the same fractional amount as all other creditors.

The principle of pari passu is often said to constitute a fundamental rule of corporate insolvency, which holds in a winding up situations where creditors shall share rateably in the common pool of asset available for residual distribution and receive a share in proportion to the size of their admitted claims. In fact of liquidation the assets may be taken to include all property which belonged to the company on its winding up situation.

The principle in itself carries certain characteristics namely, that its application as a mandatory rule is largely confined to liquidation; it cannot be excluded by contract and it can only apply to unencumbered assets of the insolvent company that are available for distribution. 

The rationale for the principle has been described in terms of ‘efficiency’ and ‘fairness’. Generally the aim behind the use of the parri passu is to ensure fairness, in Re Airbase(UK) Ltdhas eroded significantly and remains only as a theoretical doctrine. Equal treatment rarely occurs because the principle does not affect the rights of the certain people, firstly, creditors who have an right, such as secured creditors, which has been cleared from Re Portbase(Clothing) Ltd. Second, those whose claims are able to be classified as the expenses of winding up are paid before other creditors, finally certain unsecured creditors who are entitled to preferential treatment.

Whereas the limitation to the principle of pari passu argued that it is operates in an uncertain manner due to the multiplicity of the potential exceptions and bypassing devices, as there is lack of statutory clarification on the law relating to the exception and bypasses, i.e claims for tort victim provider of professional services who might be benefit from the common law. If we looking at the question of fairness it has been argued that that the principle of the pari passu has nothing to do with fairness, as fairness may not always result from treating two creditors equally, i,e a creditors who is able to diversify its risk such as a bank, in comparison to a creditor who is unable to do so such as employee.

Let us turn to consider the main alternatives to pari passu in distribution of the residual estates: a first alternative is debts ranked chronologically, whereby those debts established at an earlier date would accordingly be paid first on the basis of first come first served. However such regime does not address the exception and bypassing issues in additions to the fact that it may dissuade potential creditors from lending, if they know that they will rank low in the distributional order.

The second alternatives is debts ranked ethically, it would be possible to pay unsecured creditors according to their needs, this repayments system would organised on the basis of ethical order. A disadvantage of these alternatives is the high level of creditor uncertainty as predicting position in the payment queue will be nearly impossible. The effect of this would be bringing huge inefficiencies.

The third alternatives is debts ranked on size, where it might be argue that small creditors should be paid at a higher rate of return than those ordinary unsecured creditors who have loaned larger amount. The reason beyond for doing so is small creditors would be more vulnerable and deserve high level of protection. A criticism of this option is that it is difficult to correlate the size of the loan with the vulnerability of the creditor. i.e. some small creditors may be more risk reliant that the larger creditor.

By considering the above, whereas fairness and efficiency are sought in the distribution of the residual estate, and the case for collective approach which is offered by pari passu is the strong one.   It has also been argued, however, that concerns for the fair and efficient treatment of creditors may be served by looking beyond questions of residue distribution.      

The further discussion need to be consider whether the pari passu principle in fact the exception make the principle unduly complex and uncertain or the exceptions complement the ‘efficiency’ and ‘fairness’ justification of the principle.

On the separate note Professor Goode opinioned that the treatment of secured creditors, suppliers of goods under reservation of title clauses and “creditors for whom the (debtor) company holds assets on trust” all are not to be considered true exceptions to the pari passu principle, since such assets do not belong to the company and thus do not fall to be distributed among creditors on any basis. There are a number of true exceptions to the pari passu principle, fall broadly into five categories which can be identified by the statue.  

First exception is set-off which are wider in effect than those available outside insolvency. It applies whenever there have been mutual credit, mutual debit or other mutual dealing, before the onset of liquidation, between the debtors any of its creditors. The cross claims need not impeach the debt owed to the insolvent, so long as the requirement of mutuality is satisfied. The right of set off on insolvency represents a major incursion into the pari passu principle.  

Second exception is where statues provides that their claims are to be treated as part of the expenses of liquidation are therefore given to the “pre- preferential” status and that are to be paid, not proved. In addition, utility suppliers “may make it a condition of the giving of the supply that the liquidator personally guarantees the payment of any charges in respect of the supply”

Third exception is constituted by pre- liquidation creditors who can compel payment by virtue of their ability to inflict certain types of harm on the insolvent estate. This category covers payments to avoid forfeiture of a lease, distress or termination of a contract. In general creditors whose continued co operation is desired by the liquidator may be able to extract payments in respect of pre-insolvency debts.  

Forth exception is deferred claims; a claim may be deferred by statue, which is placed priority below the claims of other creditors. Thus section 215(4) of the Insolvency Act 1986 provides that where a court makes a declaration under section 213 or 214 of IA 1986 in relation to a person who is a creditors of the company may direct the whole or any part of any debt owed by the company to that person and any interest there on shall rank in priority after all other debts owed by the company and after the interest on those debts.   

However, an exception to the paru parsu principle the contractual misapplication of which might have led to a more “equal” distribution--is as mandatory as any other part of the liquidation regime. Whether that would lead to an increase or decrease in the “equality” of distribution is simply irrelevant. It is submitted that the British Eagle decision is deeply unsatisfactory. The pari passu principle actually stands more for its hollowness than its hallowedness. Though, it is arguable that in Ex parte Barter; Ex parte Black  is another interesting decision cited in support of the pari passu principle, it also noted that the same point can be made again and again and where cases cited in support of the “equality” principle. To support the principle as a part of a significantly “unequal” insolvency regime, or more frequently to show nothing except the law's intolerance towards attempts to gain immunity from the collective liquidation system in unacceptable or unfamiliar ways. In view of all this, the pari passu principle could not possibly be necessary for there to be an orderly liquidation.

It concluded that the pari passu principle is so strong that the burden of proving efficiency rests upon those who support secured credit, or is freedom of contract paramount so that the burden falls upon those who oppose security?” 

Therefore in respect assertions the principle is all-pervasive in the liquidation regime which is underlies some of the best-known avoidance provisions of that regime, or that it provides the only alternative to an undesirable free-for-all to stand rebutted as based on a fallacy. They must all be abandoned. The argument come to end here that it necessary to keep  pari passu principle to ensure the fairness in liquidation.