The pari passu principle

600 gathering and distributing the assets

pari passu is a substantive rule governing the distribution of goods and little is to be gained by asking whether a principle is, in itself, accountable or expert. Whether insolvency principles are administered accountably and expertly are matters dealt with in other chapters.

As noted in chapter 13, creditors are free, prior to winding up, to pursue whatever enforcement measures are open to them: for example, repossession of goods or judgment execution. Indeed, the race goes to the swiftest. Liquidation puts an end to the race as the liquidator is responsible for the orderly realisation of assets for the benefit of all unsecured creditors and for distributing the net proceeds pari passu.3 The pari passu principle, however, can only apply to unencumbered assets of the insolvent company that are available for distribution. If a company holds property as a bailee or trustee, that property is not part of the common pool for distribution. Similarly, goods possessed by the company under a contract of sale that reserves title to the seller until completion of payment do not form part of the pool. Where, moreover, the company has given security rights over property, this property is available for distribution only to the extent that its value exceeds the sum of the secured indebtedness.4

Corporate insolvency law is faced here with two important challenges: how to stipulate which assets will be available for distribution and whether exceptions should be made to the pari passu rule when distributing those available assets. This chapter focuses on the latter issue and chapter 15 considers the construction of the insolvent company’s estate for distribution.

At this point, the discussion of insolvency law rationales that was contained in chapter 2 should be recalled. Different visions of corporate insolvency law will produce different approaches to the distribution and

3Steps taken to protect the residual estate from leakage can thus be seen as underpinning the pari passu distribution of that estate – the view taken in Re Tain Construction [2003] 1 WLR 2791, [2004] BCC 11, a judicial view described as ‘highly unfortunate and misguided’, an ‘irredeemable mistake’ and a ‘total misunderstanding’ by Look Chan Ho (‘Pari Passu Distribution and Post-petition Disposition: A Rationalisation of Re Tain Construction’ (21 November 2005, SSRN)), who prefers to see preservation of the estate as sustaining the order of priority of distribution. In defence of the court it can be argued that, whatever exceptions to pari passu are allowed (e.g. preferential status), to allow degradation of the residual estate would be to allow bypassing of the pari passu mode of distribution applicable to that estate.

4On the limits to pari passu see F. Oditah, ‘Assets and the Treatment of Claims in Insolvency’ (1992) 108 LQR 459 at 468–76; Mokal, ‘Priority as Pathology’, pp. 585–90; pp. 667–9 below.

construction of the insolvency estate. If corporate insolvency law is seen as centrally concerned to maximise the assets available for distribution to creditors,5 creditors’ rights in a liquidation will be treated as governed by prior non-insolvency entitlements. What has been bargained for in advance will dictate priorities in a subsequent liquidation. If, on the other hand, insolvency law is seen as having a redistributional role – one that allows prior private bargains to be adjusted in the public interest or in pursuit of democratically established policies – creditors’ rights in a liquidation will be influenced by a range of factors other than rights established outside insolvency and departures from the strong version of pari passu will be more readily contemplated.6

As indicated in chapter 2, the approach taken in this book rejects the narrow ‘creditor wealth maximising’ vision of corporate insolvency law and sees insolvency law as properly concerned with redistributional and public interest aspects as well as with respect for private bargains and property. This implies, first, that exceptions to pari passu may be entertained on their public interest merits and, second, that in constructing the estate of the insolvent company that is available for distribution, it may be legitimate to restrict the extent to which private bargaining will be allowed to circumvent the principles of collectivity and pari passu distribution.

Before considering whether certain exceptions to pari passu can be justified on efficiency or on fairness grounds, the rationale for pari passu should be noted. In terms of efficiency, the case for pari passu is that within a mandatory, collective regime it conduces to an orderly means of dealing with unsecured creditor claims.

Legal costs and delays are said to be kept low by a simple pari passu rule because, in the absence of any legislative direction to differentiate

5 See T. H. Jackson, The Logic and Limits of Bankruptcy Law (Harvard University Press, Cambridge, Mass., 1986); D. G. Baird and T. Jackson, ‘Corporate Reorganisations and the Treatment of Diverse Ownership Interests: A Comment on Adequate Protection of Secured Creditors in Bankruptcy’ (1984) 51 U Chic. L Rev. 97; D. G. Baird, ‘Loss

Distribution, Forum Shop ping and Ba nkruptcy: A Reply to Warren’ ( 1 987 ) 5 4 L Rev. 815. Arguably the pari passu principle, stricto sensu, with collectivity mimics the

notional ‘creditors’ bargain’ posited by Jackson. See also the discussion in S. S. Cantlie, ‘Preferred Priority in Bankruptcy’ in J. Ziegel (ed.), Current Developments in International and Comparative Corporate Insolvency Law (Clarendon Press, Oxford, 1994).

6See, for example, E. Warren, ‘Bankruptcy Policy’ (1987) 54 U Chic. L Rev. 775; Warren, ‘Bankruptcy Policymaking in an Imperfect World’ (1993) 92 Mich. L Rev. 336.