One of the key purposes of insolvency law is to provide for the fair and equal distribution of that person or company’s assets among their creditors. This purpose is encapsulated in the pari passu principle.
Pari passu is Latin for ‘with an equal step’. The principle arose out of equity, a body of law developed in the English Court of Chancery. Equity has always been concerned with the conscience of the individuals brought before it, and it is out of this context that the principle of pari passu arose. The English interpretation of the pari passu rule gives it the meaning, ‘on equal footing, proportionately’. In insolvency law, the pari passu principle ensures that the assets of a person in bankruptcy or a company in insolvency are equally distributed between creditors. The principle applies to both personal and corporate insolvency and is considered to be fundamental to both regimes.
For individuals, the principle is stated in section 108 of the Bankruptcy Act:
‘Except as otherwise provided by this Act, all debts proved in a bankruptcy rank equally and, if the proceeds of the property of the bankrupt are insufficient to meet them in full, they shall be paid proportionately’.
For businesses, the principle is stated in section 555 of the Corporations Act:
‘Except as otherwise provided by this Law, all debts and claims proved in a winding up rank equally and, if the property of the company is insufficient to meet them in full, they shall be paid proportionately.’
Whilst the principle states that all funds should be distributed equally and rateably, there are some exceptions. Firstly, the law recognises that pre-existing contractual and proprietary rights should be recognised and protected. For example, secured creditors can recover their claims out of the proceeds of property over which they have security. In this way, the PPSA and other secured protections disrupt the traditional operation of the pari passu principle. After secured creditors have had their debts repaid, the remaining creditors will have the collected asset value distributed among them equally and proportionally, according to the pari passu principle.
The second exception is provided through statute. Section 556 of the Corporations Act and section 109 of the Bankruptcy Act allow for priority payments to be made to certain groups (e.g. employees) before unsecured creditors. Again, this significantly reduces the funds available for distribution amongst creditors, which somewhat undermines the fundamental operation of the principle.
Furthermore, it is arguable that the principle is no longer economically efficient. Pari passu does not function with allocative efficiency or innovation as primary objectives. This is because rateable distribution will not be of much assistance when there are no assets or money to distribute, a fundamental contradiction within Australian insolvency law. As such, although the principle remains important in the functioning of insolvency, its application is not as innovative, efficient or fair as desired and a case could be argued for the implementation of a more pro-business, economically minded principle than that provided by pari passu.
To summarise, the actual operation of the pari passu principle has reduced as a result of the increasing prevalence of secured interests and the introduction of priority payments. There are also questions about the utility of the principle when there is no money left to distribute to unsecured creditors. Nonetheless, it remains an extremely important aspect of insolvency and bankruptcy law.