Meaning
Contractual clauses ensure that a borrower treats different groups of creditors equally in terms of security and payment. When a borrower agrees to parity covenants, they promise not to grant better terms to new lenders without offering the same to the existing ones. This prevents the dilution of a creditor’s position over the life of a loan.
Rules Treatment
Rules established in the agreement mandate that any asset pledged to a new lender also secures the existing debt. Under parity covenants, if a company enters a crisis, all lenders in that class share the available assets. This ensures a level playing field for everyone at the same level of the debt stack and prevents the company from picking favorites during a period of stress.
Violations Linkage
Violations of these terms often trigger an immediate right for the lender to demand repayment. If a firm breaks its parity covenants by giving a preference to another creditor, the entire debt facility may become due.
Scope Reach
Scope of the clause is limited to the specific legal entities named in the contract. While parity covenants protect creditors at the parent company, they might not apply to the actions of a remote subsidiary. This boundary is a common point of negotiation during the initial funding.
