Understanding Pari-passu Charge: A Discussion

CA Raja: Good morning, Ajeesh. How are you doing today?

Ajeesh: Good morning, CA Raja. I'm doing well, thank you. How about you?

CA Raja: I'm good, thank you. So, I heard you've been learning about banking concepts recently. Have you come across the term "Pari Passu Charge" yet?

Ajeesh: Yes, I have heard about it, but I'm not entirely sure what it means. Can you explain it to me?

CA Raja: Sure. Pari Passu Charge refers to a type of security interest that gives all lenders an equal claim on the assets of the borrower. This means that if the borrower defaults on their loan, all lenders will be treated equally in terms of their right to recover their funds.

Ajeesh: I see. So, if there are multiple lenders who have given a loan to a borrower, and the borrower defaults, all lenders will have an equal right to recover their money.

CA Raja: Yes, that's right. The term "Pari Passu" means "on equal footing" in Latin, so this type of charge ensures that all lenders are treated equally.

Ajeesh: That makes sense. But what happens if the borrower doesn't have enough assets to cover the loans?

CA Raja: In that case, the lenders will have to share the available assets on a pro-rata basis, which means that each lender will get a proportionate share of the available assets based on the amount of their loan. This is also known as "sharing pari passu".

Ajeesh: I see. So, even if a lender has given a larger loan than the others, they will only get a proportionate share of the available assets.

CA Raja: Yes, that's correct. The idea behind Pari Passu Charge is to ensure that all lenders are treated equally and that no one lender has an unfair advantage over the others.

Ajeesh: Thanks for explaining it to me, CA Raja. Can u give me one example?

CA Raja: Sure, Ajeesh. Let me give you an example to help you understand Pari Passu Charge better.

Let's say a company wants to raise funds by taking a loan from two different banks. Bank A agrees to lend the company Rs. 5 crore, while Bank B agrees to lend Rs. 3 crore. To secure their loans, both banks take a Pari Passu Charge on the company's assets.

Now, if the company defaults on its loans, both Bank A and Bank B will have an equal right to recover their funds. This means that both banks will share the available assets on a pro-rata basis.

So, if the company's total assets are worth Rs. 6 crore, Bank A will get 5/8th (or 62.5%) of the available assets, while Bank B will get 3/8th (or 37.5%) of the available assets. This is because Bank A's loan is larger than Bank B's loan, so it will get a larger share of the available assets, but the share will still be proportionate to the amount of the loan.

Ajeesh: I think I understand it now. It ensures that all lenders have an equal right to recover their funds and that no one lender has an unfair advantage over the others.

CA Raja: That's right, Ajeesh. Pari Passu Charge is an important concept in banking because it helps to protect the interests of all lenders and ensures that they are treated fairly in case of default.