How insolvency affects debentures and floating charges

Debentures and floating charges in insolvency

Debentures and floating charges offer protection to lenders if a company faces insolvency. In the insolvency liquidation process, a defined hierarchy dictates the order of repayment for creditors. Those with debentures or floating charges have precedence over unsecured creditors, increasing their chances of receiving payment.

 

What are the debentures and floating charges when your company is insolvent?

A debenture is a document outlining loan terms, ensuring clarity and security for lenders in case of the borrowing company’s insolvency. Adding a floating charge to the debenture provides additional advantages, allowing the holder to have higher priority in repayment compared to unsecured creditors.

Directors gain protection when lending personal funds through floating charges. Due to the reluctance of high street banks to lend and the burdensome application process, it’s common for directors to invest in their own company, benefiting from the advantages provided by floating charges.

Directors gain flexibility and security by specifying loan terms in a debenture, particularly useful if their company faces insolvency and struggles to regain profitability.

 

How do floating charges work?

A floating charge can cover all company assets or specific asset classes, allowing flexibility for normal business operations, including movement or sale. In insolvency, the floating charge ‘crystallises.’

When the floating charge transforms into a fixed charge, the asset requires lender permission for company dealings. In some cases, the lender might initiate administration without court involvement, especially if the floating charge encompasses a significant portion of company assets.

 

Exploring when you register a debenture

A debenture records the agreed terms between the lender and borrower, filed with the Registrar of Companies at Companies House. Registration is recommended either when the loan is initiated or within 21 days.

The agreement outlines lending terms, covering:

• Total amount
• Fixed repayment date or ‘on demand’
• Interest rate (fixed or variable based on bank rates)
• Repayment amount and frequency
• Charges secured on the loan
•  

The debenture holder has the right to receive loan interest payments ahead of any dividends from company profits. Additionally, they can appoint an administrator when the company faces insolvency.

Failure to register the debenture and floating charge with Companies House may lead the administrator/liquidator to disregard the charge, treating the holder as an unsecured creditor.

It’s important to highlight that all charges must be documented in the company’s Register of Charges, which should be kept at the registered office.

 

Which assets can be linked to a floating charge?

A floating charge can be placed on different asset classes, such as:

• Cash
• Work-in-progress
• Fixtures and fittings
• Stock
• Raw materials
•  

The adaptable nature of a floating charge allows unrestricted use of these assets when the company is solvent. Action to recover money by the lender only occurs when the company faces insolvency.

Floating charge holders enjoy the perk of selecting their preferred administrator or, in certain instances, an administrative receiver, once the charge crystallises. In the presence of both a fixed charge and a floating charge on the same asset, the fixed charge takes precedence in repayment.

 

Read More: 

• Understanding insolvency and liability for Personal Service Companies
• What is a Restructuring Plan
• How to liquidate a company
• Who can petition to wind up my company
• What is wrongful trading in company insolvency

 

What is the order of priority for repayment in insolvency?

The legal order of priority is as follows: 

1. Fixed charge holders

2. Expenses of the liquidator

3. Preferential creditors (typically employees owed wages and holiday pay)

4. The ‘prescribed part’ allocated for unsecured creditors

5. Creditors with a debenture featuring a floating charge

6. Unsecured creditors, including HMRC, suppliers, and other trade creditors 

7. Shareholders

Floating charges provide a versatile security option for lenders and borrowers alike. Vanguard Insolvency can provide expert guidance on key considerations for floating charge holders, debenture formulation, and the registration process at Companies House.