Priority as Pathology: The Pari Passu Myth
Cambridge Law Journal, Vol. 60, Part 3, November 2001
34 Pages Posted: 20 Apr 2002 Last revised: 2 Jun 2009
Date Written: November 1, 2001
This paper analyses the pari passu principle of insolvency law (which provides that the creditors of a company ranked on par with each other under the general law should similarly be treated on par with each other in insolvency proceedings), and to ask how it relates to other principles available for the treatment of claims in insolvency proceedings. The discussion reveals that the principle has rather limited effect in governing distributions of the insolvent's estate. Not only do various types of secured claim fall beyond its ambit, even unsecured claims are often exempt from its application.
Nevertheless, the principle thrives both in judicial rhetoric and in academic arguments. For example, many a challenge to the different priorities accorded to different types of claim in a company's insolvency begins with an incantation of the pari passu principle. Commentators see an inherent tension between the 'two fundamental principles of credit and insolvency law', that of the freedom of contract which allows one to bargain for priority, and the mandatory pari passu principle. The pari passu principle is said to be 'the foremost principle in the law of insolvency around the world'. It is thought to be 'all-pervasive', and its effect is to 'strike down all agreements which have as their object or result the unfair preference of a particular creditor by removal from the estate on winding up of an asset that would otherwise have been available for the general body of creditors.' The principle is said to be supported both by the need for an orderly liquidation of insolvents' estates, and by requirements of fairness. So it is not surprising that its invocation as the starting point for, say, the debate on the priority of secured or preferential claims, weights the argument in a particular way. Since the pari passu principle has been recognised so widely and for so long as vital, and since it serves such desirable aims as orderliness in liquidation and fairness to all creditors, any deviation from it must be a cause for concern.
On this view, the priority (say) of secured or preferential claims is an abnormality, a pathology to be diagnosed and controlled, perhaps even 'cured'. Since 'equality' is the norm, the onus must be on those supporting differing priorities to justify their claim. To the extent that their efforts are unpersuasive, the case for priority must be considered not established, and the 'default principle' of 'equality' must prevail.
This paper seeks to overturn this order of things. It is suggested the pari passu principle does not constitute an accurate description of how the assets of insolvent companies are in fact distributed, has no role to play in ensuring an orderly winding up of such companies, does not explain or justify distinctive features of the formal insolvency regime, and has little to do with fairness in liquidation. The actual role of the principle, it is argued, is merely to provide a low-cost method for dealing with those types of claim which both Parliament and commercial parties themselves have decided should receive little or nothing in most insolvencies. The principle, long regarded as the core distributional principle in corporate liquidation, is more properly understood as a principle of non-distribution. To the extent that these arguments succeed, the initial onus of justifying their position shifts from those arguing in favour of the priority of secured credit, to those who support a more 'equal' distribution of the insolvent's estate.
Keywords: bankruptcy, liquidation, insolvency, rateable distribution, pari passu, preferential claims, English law
JEL Classification: D23, K19, K22, K39
Suggested Citation: Suggested Citation