When you are creating a will, trust, or other estate planning document, you may come across various legal terms of art. Pari passu is one phrase you may come across and which can have a significant impact on your beneficiaries. It may be particularly relevant if you want to ensure all of your beneficiaries are treated the same.
Below, we discuss pari passu, its literal definition, and how it may impact your estate plan.
What Pari Passu Means
Like many antiquated legal terms, pari passu is a Latin term. The pari passu definition literally translates to “equal footing.” This Latin phrase means that the people named in the instrument have equal rights, that no one has superior powers over others in the same class.
How Pari Passu Works
Generally, pari passu refers to the requirement of a fiduciary to equally manage assets without preference. No party has a right to a greater payout than another. Likewise, no one party has a higher financial burden related to the matter than the others. The goal of a pari passu clause is to ensure that all parties are treated equally.
One common use of pari passu clauses is in the terms of a will. A testator may want to split their estate between two or more people, such as their adult children. This clause is used when the beneficiaries are to share the assets equally. Each beneficiary will receive the same amount of money or ownership interest in an asset.
When You Might See the Latin Phrase Pari Passu
Some of the most common uses of pari passu are:
Will Distributions
In a last will and testament, the testator makes important decisions like: Who will be the executor to carry out my wishes? Who should be the guardian of my minor children? What assets should I pass through my will? How will I fairly divide my assets?
If the testator determines that they want their beneficiaries to equally share their estate, they can include a pari passu clause. The testator will name their beneficiaries, determine the assets to be divided (or the entire estate), and say they want the beneficiaries to inherit pari passu or “share and share alike.”
Trust Instructions
A trust can also use the phrase pari passu. In many cases, trust funds are used to benefit the maker of the trust during their lifetime and then go to named beneficiaries at the time of their death.
Pari passu can also be used to provide instructions to give the beneficiaries an equal amount of income the trust assets generate. If the trust asset is a business, piece of real property, or other tangible asset and the beneficiaries receive it pari passu, each beneficiary will have an equal ownership interest in the asset.
Corporate Finance
The pari passu principle can also apply to corporate finance. For example, stocks may state that they will pay out an equal dividend to each owner at their issuance. In this case, the issuer would need to provide an equal payout to each shareholder (the term “pro rata” is also used sometimes in this context). The same principle may apply to bondholders. Sovereign debt instruments may also include a pari passu clause.
Commercial Real Estate Transactions
You might also see a pari passu clause in transactions relating to the acquisition, restructuring, or development of commercial real estate. For example, a borrower may approach multiple lenders to help them purchase a real estate investment. In the loan agreement, the borrower may sign a series of covenants that provide equal rights to creditors, such as:
- Using the same repayment terms for all lenders
- Stating that all lenders will have an equal claim to the property
- Agreeing that all lenders are entitled to the right of payment
- Using the same interest rate for each lender
Bankruptcy Proceedings
The term pari passu can also be used in bankruptcy proceedings. In the event of insolvency, a person may file a liquidation bankruptcy in which all unsecured creditors will have an equal right to repayment of unsecured debt. While secured debt obligations will have a higher priority than these unsecured debts, all unsecured creditors will be on equal footing, including:
- Unsecured loans
- Unpaid medical bills
- Credit card bills
- Personal loans
- Loans from friends or family
- Student loans
Pari passu can be used in many other matters in which someone must equally manage assets without preference.
The Difference between Pari Passu and Pro Rata
While the terms pari passu and pro rata are often used together, pari passu is broader in scope. Pari Passu requires equality in all aspects: financial, rank, and seniority. In other words pari passu requires the preservation of the pre-existing relationship amongst the parties when making an equal distribution. Once the rank, seniority, or relationship is determined, then and only then can a pro rata “proportional distribution” be made. In contrast, the definition for pro rata is typically limited to the proportional distribution of a numerical sum (e.g. splitting $10,000 pro rata).
Example of Pari Passu
Here is an example of pari passu in a will:
Mary has four children: Abe, Collin, Diana, and Edith. She owns a bank account with $10,000 in it, a house valued at $500,000, a business valued at $200,000, stocks in the amount of $40,000, and a retirement account with $400,000 in it.
She states in her last will and testament that she wants her children to inherit pari passu in all of the assets of her estate and the residue of her estate. The children could liquidate everything if they wanted, in which case, they would stand to split $1,150,000, or $287,500.
Alternatively, they might decide to hold onto the stocks, live in the house together, and keep the business, so there would be no immediate payment. However, all four beneficiaries would have an equal right to these assets. They could still liquidate the bank account and roll over the retirement account into their individual retirement accounts equally, if they so choose.
Benefits of Pari Passu
A pari passu arrangement can offer many benefits, including:
- Equality – If beneficiaries split all assets pari passu, their distribution can be equal, even if they inherit various types of assets, such as stocks, bonds, real estate, intangible property, personal property, and bank accounts.
- Sharing – This arrangement can be helpful when the testator has several loved ones and they want all of them to share equally. For example, the testator may have remarried and have children from a previous marriage he wants to protect. A testatrix may want to provide for her children and grandchildren.
- Continuity – The testator may want several people to own an asset so one could not overrule the others. For example, the testator may provide their adult children to run a family business or own a home together.
Cons of Pari Passu
A pari passu arrangement is not for everyone. There may be times when using this type of clause can complicate the estate. For example, how exactly do you split a couch between three people? By cushion? Or, sometimes what is fair may not be equal. For example, you might want to provide for a child with special needs more so than a child with a successful career and financial independence.
Is Pari Passu Right for You?
Whether or not pari passu is right for you depends on your particular situation and objectives. A will or trust is a personalized document that you can create to meet your specific needs. You may want to ask yourself several questions before you put a pari passu clause in your estate planning document, such as:
- How many beneficiaries do you have?
- Who do you want to provide for?
- What is fair in your particular situation?
- Are there specific assets you want specific beneficiaries to have?
- What are the alternatives to a pari passu arrangement?
- Will having multiple beneficiaries unnecessarily complicate things?
- Do your beneficiaries get along and will they be able to get along?
- What do you want to happen to your property after your death?
- What if there is a sudden change? Would you still want your beneficiaries to inherit pari passu (like death, divorce, or disability)?
- Do you want a trustee to have discretion over how assets should be managed?
- Can a third party manage assets for the benefit of beneficiaries?
Takeaway
Pari passu and other financial terms can be confusing. However, it is up to you whether or not you want to use this type of clause. You can also seek legal advice and information about how financial terms like pari passu may affect your estate plan.