The Pari Passu Clause in Sovereign Debt Instruments

Abstract

The pari passu clause found in most cross-border lending instruments contains the borrower's promise to ensure that the obligation will always rank equally in right of payment with all of the borrower's other unsubordinated debts. The international financial markets have long understood the clause to protect a lender against the risk of legal subordination in favor of another creditor (something that can't happen under U.S. law without the lender's consent, but that can occur involuntarily under the laws of some other countries). In 2000, however, a new interpretation of the pari passu clause was advanced by a judgment creditor of a sovereign borrower as a purported legal basis for preventing the sovereign from paying its other creditors without making a ratable payment to the judgment creditor. If this "ratable payment" interpretation of the clause is correct (and it has now been advanced in a number of other lawsuits against both sovereign and corporate borrowers), it would significantly change the patterns of international finance. The authors argue that the ratable payment theory of the pari passu clause is a fallacy. They trace the origin of the clause back to its usage in nineteenth century credit instruments and then follow its evolution into the standard cross-border credit agreements used today.

Keywords: pari passu, sovereign debt, contracts

JEL Classification: F34, K12, K22, K33, N20, N21 ,N22, N23, N24, N40