Critically Evaluate How Far the Principle of ‘Pari Passu’ Is Embodied in Insolvency Law and How Far Should It Be.

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Critically evaluate how far the principle of ‘pari passu’ is embodied in Insolvency Law and how far should it be.

It is critical to an understanding and appreciation of insolvency law to identify the principles on which the law is granted and the principles which it seeks to achieve. According to Professors Baird and Jackson, ‘insolvency law has only one function: to maximise the returns to creditors and it is not a function of insolvency law to concern itself with employment protection or the interests of the wider community.’

To take it into consideration, it is important to say that ‘pari passu’ principle is the ‘foremost principle in the law of insolvency around the world’ and it is at the very heart of the whole statutory schemes of bankruptcy and winding up. The leading authority of the ‘pari passu’ principle was received from the House of Lords decision in British Eagle International Airlines Ltd v Compagnie Nationale Air France. Vanessa Finch stated that ‘pari passu’ is ‘the normal rule in a corporate insolvency is that all creditors are treated on an equal footing - ‘pari passu’- and share in insolvency assets pro rata according to their pre-insolvency entitlements or the sums they are owed. Security avoids the effects of pari passu distribution by creating rights that have priority over the claims of unsecured creditors.’

To emphasize that, the statute itself confirms Finch’s ‘normal rule’, that all creditors of an insolvent company are to be treated ‘equally’. Basically, ‘there is a difference between treating people equal, with respect to one or another commodity or opportunity, and treating them as equals.’ To illustrate that, the problem is that a rule based on formal equality does not take into account important differences between people, even thought those differences are relevant to any consideration of rule’s fairness.

Generally, therefore, the determination of who are equals is not a concern of insolvency law. In Re Smith, Knight & Co Lord Romilly M.R. stated that ‘the Act of Parliament unquestionably says that everybody shall be paid ‘pari passu’, but that means everybody after the winding up has commenced. It does not mean that the court shall look into past transactions, and equalise all the creditors.’ The general justification for the principle is its’ economical efficiency, in the sense that it reduces strategic costs and increases the aggregate pool of assets through the collectivity of dealings.

Hence, it avoids the costs of dealing with claims on their individual merits. Indeed, Keay and Walton are of the view that the underlying aim behind the use of the equality principle is to produce fairness, so that every creditor is treated in the same way. Fairness, in the procedural and substantive senses, can also be said to be assured by the ‘pari passu’ principle as it prevents a race to enforce claims that is destined to be won by the strongest, wealthiest, and it also involves equality of treatment between unsecured creditors. In fact, it has been seen as a way of preventing an intra-class race to enforce claims and can therefore be described as bringing about equality of treatment between unsecured creditors.

However, the application of the ‘pari passu’ principal is not absolute, nor does it achieve its aim with any degree of spectacular success as noted by the Cork Report.. The ‘pari passu’ principle is rather less important than it is sometimes made out to be, and does not fulfill any of the functions often attributed to it. For reasons of policy insolvency law provides certain deviations. The principle of ‘pari passu’ distribution of assets does not apply to the rights of secured creditors, suppliers of goods under agreements reserving the title or creditors for whom the company holds assets on trust. To bear this in mind, unsecured creditors usually receive little, by the of dividend also, it is argued that what the law disallows is not evasion of the ‘pari...
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