The Mysterious Pari Passu Principle

If you know anything about insolvency law, you know that the pari passu principle is fundamental.

If asked to say more, you may venture that the principle requires creditors to be treated equally, meaning proportionately, in payment out from the insolvency estate. Pressed further, you may accept that this of course does not mean all creditors: those holding proprietary security in certain of the debtor’s assets need not, and indeed ought not, to be treated on par with unsecured creditors in payment from the proceeds of the encumbered assets. If particularly knowledgeable about insolvency practice, you may also say that, frequently, all of an insolvent debtor’s assets are encumbered by some combination of fixed and floating security. And if particularly knowledgeable about insolvency law, you may say that not even all unsecured creditors are subject to the pari passu principle. Certain employee claims and certain tax claims are also exempted by statute and given payment priority over other unsecured claims. And, of course, insolvency law creates special payment regimes for certain debts incurred once the debtor enters one or other insolvency proceeding.

If none of this is news to you, look again at the first sentence of this post. Do you think that the pari passu principle is fundamental to insolvency? If so, note three points. First, we have agreed that it is a principle governing distributions from the insolvency estate. Second, however, you have nodded along to an ostensibly lengthy list of debts, secured and unsecured, which, as you acknowledge, fall outwith the application of the principle. And third, all these categories of debt to which the pari passu principle does not apply are categories which insolvency law permits or, indeed, itself creates.

So, in what sense is the pari passu principle fundamental to insolvency law? To the contrary, insolvency law appears perfectly content to permit parties to arrange their affairs so as to put certain claims beyond the reach of the principle. What is more, this law itself creates numerous ways in which claims may be paid other than under the pari passu principle.

Perhaps you think all this misses the point. We have been counting categories of claims when, instead, we should perhaps be asking how much of the value in insolvency estates is distributed according to the pari passu principle. The principle would remain distributively fundamental to insolvency law if most, or much, value in most, or many, insolvency proceedings is in fact distributed pursuant to the principle, and so much the worse for the categories of debt not governed by it.

Reviewing the empirical evidence back in the early noughts, I concluded that ‘in an overwhelming majority of formal insolvency proceedings, nothing is distributed to general unsecured creditors (the only category of claimant truly subject to the pari passu rule).’ General unsecured creditors received nil in an estimated 88% of administrative receiverships, 75% of creditors’ voluntary liquidations (‘CVLs’), and 78% of compulsory liquidations. On average, they received 7% of what they were owed. See Mokal, Corporate Insolvency Law: Theory and Application (OUP, 2005, Oxford) at p. 100.

The years since have not been kind to the distributive potency of the pari passu principle. For example, Asad Khan reviews data from (in particular) over 1,000 CVLs commencing in a two-year period from December 2016 to find that ‘in 99.55% of cases (971 out [of] 1,038 CVLs), unsecured creditors received 0% of their debt,’ and that ‘unsecured creditors, despite being featured in over 92% of CVLs and representing 76% of total debts, only get repaid 1.48 pence to the pound.’ See Khan, ‘An empirical snapshot of English corporate insolvencies’ (2023) 32 International Insolvency Review 447, particularly 455 and 456.

Similarly, Jonathan Hardman and Alisdair MacPherson analyse data from over 500 insolvent liquidations (both CVLs and compulsory liquidation) in Scotland concluding in the year from 1 October 2019 to find that ‘Four hundred and five companies (80.2%) provided no return to [non-preferential] unsecured creditors at all (despite the potential availability of the prescribed part in some cases).’ See Hardman and MacPherson, ‘Small and state-funded: An empirical study of liquidations in Scotland’ (2023) 32 International Insolvency Review 420, particularly 437.

Plainly, then, the pari passu principle, considered as a principle of distribution, is not a fundamental principle of insolvency law.

Perhaps this continues to miss the point? Should we understand the pari passu principle as a weighty moral norm, which the law ought to at least seek to uphold? After all, the principle demands equality of treatment amongst creditors, and who would be against equality? On this view, the fact that the principle plays little or no role in an overwhelming majority of insolvency proceedings is a failure and a cause for regret. An analogy may be pressed with moral norms such as those requiring truth-telling and promise-keeping. Such norms are valuable both intrinsically and instrumentally, such that their widespread violation would heighten rather than diminish their fundamental role in our lives (in that the greater the violation of such a norm, the greater our unmet need for the norm to be adhered to). So, it may be said, it is with the pari passu principle.

I first considered this line of argument back in the mists of time and found it wanting. See Mokal, ‘Priority as Pathology: The Pari Passu Myth’ (2001) 60(3) Cambridge Law Journal 581, particularly 606-611. My view remains unchanged. The pari passu principle enshrines formal, ‘shallow’ equality: all unsecured creditors are supposedly equal. This version of equality is oblivious to the myriad normatively significant differences amongst claimant types which are presumptively relevant to insolvency law’s distributive role. Such differences include but are not limited to whether and to what extent a creditor (i) chooses that status, (ii) is able to influence the terms on which they become a creditor, (iii) is able to monitor and influence the debtor’s behaviour, (iv) is able to adjust the terms of the ‘loan’ in response to such behaviour, (v) is able to protect themselves through security, diversification, or similar, and (vi) is able to exit the relationship on acceptable terms and obtain repayment. It is in consideration of such factors that it is normatively right for insolvency law to (for example and ignoring the role of the National Insurance Fund) give a special statutory priority to certain claims held by creditors qua employees of the insolvent debtor. But, as noted, the pari passu principle is insensitive to all such normatively weighty factors and focuses solely on the status of a creditor as ‘unsecured.’ Therefore, the principle lacks any significant normative attraction. What is normatively attractive, to continue the example just introduced is the derogation from the pari passu principle that is represented by the existence of the statutory priority in favour of certain employee claims.

Even if I am right both empirically and normatively, however, we are left with a puzzle. References to the fundamental importance of ‘the pari passu principle’ abound in both judicial and textbook writings. Virtually all the most distinguished judges and scholars continue to insist that the principle plays one or more roles vital to insolvency law.

In a new paper, I attempt once again to solve this puzzle. I suggest that references to ‘the pari passu principle’ are ambiguous as amongst four different principles to which the terms ‘pari passu’ and ‘the pari passu principle’ are applied. Regrettably, this is a reliable recipe for confusion. Three of these principles relate to distribution of value from the insolvency estate but are very different from each other, while the fourth is a principle of conservation rather than distribution. The undifferentiated and unreflective use of the term ‘pari passu’ for one or other of these four principles leads to mistakes in both analysis and decision. This article explains the four principles, outlines the ways in which they differ, highlights the confusion resulting from not distinguishing amongst them, and argues that the term ‘pari passu’ should be restricted to only one of the four.

Riz Mokal is a Barrister at South Square, London; an Honorary Professor at the University College London; and an Honorary Research Fellow at the University of Aberdeen School of Law.

A copy of ‘The Mysterious Pari Passu Principle’ can be found in the (2024) 39(7) Butterworths Journal of International Banking and Financial Law 443-449.

A copy of the final working paper version is available on the Social Science Research Network.