Pari Passu: Everything You Need to KnowStartup Law ResourcesVenture Capital, Financing
Pari passu is a Latin phrase lawyers use that means treating all parties the same for something. For example, when a company issues common stock the shareholders are pari passu to each other because none of them has more rights and obligations than the others. 4 min read
2. Why Is Pari Passu Important?
3. Examples of Pari Passu
4. Common Mistakes with Pari Passu
5. Frequently Asked Questions
6. How to Use Pari Passu
What Is Pari Passu?
Pari passu is a Latin phrase lawyers use that means treating all parties the same for something. For example, when a company issues common stock the shareholders are pari passu to each other because none of them has more rights and obligations than the others. Pari passu is also used in other kinds of business transactions to describe how investors, lenders, and creditors are treated.
Why Is Pari Passu Important?
Pari passu is useful because it is a shorthand way of describing situations when equal, non-preferential treatment is part of a business deal. Shares of stock (and classes of stock) can be pari passu, investors in a company can be pari passu, and creditors who receive an insolvent company's assets in a bankruptcy case can be pari passu.
Keep in mind that pari passu is not an all-or-nothing concept: in any given deal, you may find that the parties to the transaction are treated pari passu in certain situations, but not in others. Business lawyers make their living drafting complicated corporate charters, shareholders agreements, and loan documents that describe in detail when pari passu applies and when it doesn't.
Examples of Pari Passu
In a private equity deal, pari passu describes when a right or obligation associated with a class of stock or investors (for example, the right to receive dividends or the obligation to make capital contributions) applies equally to more than one category of shareholders.
By definition, common and preferred stock are not pari passu for most purposes because each class of stock carries different rights. Preferred shareholders are entitled to receive dividends from the company, for example, while common shareholders usually do not have dividend rights. That said, a company's charter or shareholders agreement sometimes makes some of the rights of the common and preferred pari passu. All shareholders may have the same right to elect people to the company's board of the directors or the same right to receive financial reports from the company's executives.
If your company borrows money from banks or investors, you will be required to treat any future lenders pari passu with your existing banks and investors. In other words, you cannot give additional or senior rights to the new lenders and investors before the old debt is paid off.
If your company files for bankruptcy, pari passu would be used to describe how a category of creditors are treated when your company's assets are divided up. For example, if all creditors are paid 20 cents on the dollar for their claims, they have pari passu status as a class.
Common Mistakes with Pari Passu
Pari passu usually doesn't apply to all circumstances that could arise between the parties in any given business deal. The details matter, so don't assume, for example, that your Class A Preferred Stock is completely pari passu with your Class B Preferred Stock without carefully reading and understanding your company's charter and shareholders agreement (or asking your lawyer to explain those details to you).
Frequently Asked Questions
Does pari passu always mean the same thing?
No, pari passu is not a fixed idea but instead is very fact sensitive. The degree to which shareholders, investors, lenders, shares, and loans are pari passu depends on the structure of the deal and how the parties want their business relationship to work when certain things happen in the future.
Is pari passu the same as the phrases "pro rata" or "most favored nation"?
No, these three legal concepts are different.
The term pro rata defines how something is paid or distributed to the parties to a deal while pari passu describes their status as a group or class. So to use those phrases in sentence, if the shares of Class A and Class B Preferred Stock are pari passu for dividends, those dividends are paid to the preferred shareholders pro rata - i.e., based on the number of shares owned by each shareholder.
Most favored language in legal documents (sometimes called "most favored nation," or "MFN") is used by the parties to maintain pari passu status for future events. If your company agrees to include an MFN clause in its bank or investor agreements, you are agreeing that any additional right or privilege granted to a future lender or investor (for example, a higher interest or dividend rate) that your existing banks or investors don't already have will be automatically extended to the existing banks and investors. All of the parties are then restored to pari passu status.
How to Use Pari Passu
Because pari passu stands for a complicated legal idea, it is useful for term sheets or letters of intent for deals. A term sheet or LOI outlines the big-picture legal and business terms before the longer legal documents set out the details. Using phrases like "pari passu" keep the preliminary documents short and to the point.
The classic place that business people use pari passu is when investors negotiate how they will get their money back from a company after they make an investment. As the company generates profits after the investments are made, the investors require the company to pay them back from that money. The required repayments from future profits are called a distribution "waterfall." In a typical waterfall, the different categories of investors are sometimes pari passu to each other, and then after they get their money back (plus a rate of return) the investors and the company's executives get to share the company's future profits on a pari passu basis.