Ranking of securities ‘pari passu’

The latin term ‘pari passu’ is used as terminology in legal, financial and other areas of everyday business and conveys the meaning of equal and proportionate treatment without priority.

In the event of obtaining loans from two or more financial institutions which are secured by the provision of two or more mortgages of different value, their ranking is secured pari passu.

In this way the mortgages have equal seniority, with none of them prevailing over the other, but instead, the extent of their security depends on the sum that each of them secures. If the mortgaged assets are sold at a public auction, each creditor will receive out of the proceeds thereof the sum which corresponds to their security and if a balance is left over, this will be paid to the debtor.

A similar procedure is also followed in the distribution of the assets of bankrupt persons amongst their unsecured creditors, who receive a pari passu share therein, proportionately with the size of their claim.

Shares in a public or private company have the same rights of dividend payment, as the issue of new shares which rank pari passu. Even in cases of hereditary succession through wills, the testator may devise and bequeath his assets to his heirs pari passu.

Distribution of assets of a company under liquidation

When a charge is created over the assets of a company and subsequently the company goes into liquidation, the term pari passu is used for the distribution of the assets or the proceeds from their liquidation to the creditors, i.e. the beneficiaries of the charge, proportionately to the size of their security provided that the assets or the proceeds from their liquidation are insufficient to fully pay off the claims of the creditors.

Consequently, in the event that two banks provide loans to a company, one for 100k and the other for 300k, if upon sale of the charged assets the proceeds are insufficient to repay the creditors in full, then they will be distributed between the two creditors in the analogy 1:3. The purpose of such a term is to protect the security of the creditors in the event of insolvency and distribute the assets to them proportionately.

In practice, usually the creditor providing the loan attempts to obtain priority over other unsecured creditors by signing documents containing the relevant term, as well as through the registration of the relevant security, such as a floating charge or a mortgage.

In this way the unsecured creditors remain vulnerable and exposed, since in the event of insolvency, priority will be given to the payment of the liquidation costs, then the secured creditors and only then will the unsecured creditors’ claims be satisfied, provided that enough or any money are left over for this purpose.

Bankruptcy

The term pari passu is found in legislation such as the Bankruptcy Law and specifically the treatment of unsecured creditors under article 37B (6), which states that the difference between the value of the assets covered by the security and the balance of the debt, ranks as an unsecured debt for the purpose of the bankruptcy procedure and the specific creditor obtains payments proportionally to the other unsecured creditors.

A similar provision is found in the Companies Law, article 202KZ, paragraph 10 (a), (b), which refers to guarantees and the valuation of assets encumbered with security interests.

Issuance of bonds

In the event of states and public companies obtaining lending through the issuance of bonds, such loans, as well as the corresponding coupons, are considered immediate, unconditional and unsecured obligations of the issuer, ranking pari passu with the other unsecured creditors’ claims, without priority amongst to the remaining pending unsecured obligations, present and future.

Apart from the obtaining of lending through the issuance of bonds, states and public companies can and do obtain at the same time syndicated loans and lending from organisations or investment funds, through the signing of relevant loan agreements.

For the protection of the securities received by such organisations, a negative pledge clause is usually introduced therein, through which the debtor undertakes, depending on the facts in issue, not to obtain lending from any other creditor which may in effect subdue their security as against any other present or future obligation owed to any other creditor.

Such a clause is not strictly considered as security, but an undertaking of an obligation by the debtor which effectively protects the interests of the lender. The debtor is prohibited from charging his assets for the purpose of providing security for any other loans which may affect the interests of the lender, guaranteeing in this way the existence of assets, present and future, for the repayment of the debt.

George Coucounis is a lawyer specialising in Immovable Property Law, based in Larnaca. E-mail: coucounis.law@cytanet.com.cy, tel: 24818288