What-are-fixed-and-floating-charges

What are fixed and floating charges?

Fixed and floating charges come into play when a business borrows money. A fixed charge involves using a specific asset as collateral, while a floating charge involves using a category of assets as collateral, rather than a single asset.

 

A guide for company directors on fixed and floating charges

When a company borrows money to acquire a fixed asset like land, a building, or machinery, the lender seeks security through a fixed charge. This serves as protection against the risk of non-payment, enabling repossession and sale of the asset if the borrower faces insolvency and undergoes liquidation.

This setup is akin to a mortgage on a residential property. The borrower doesn’t have full ownership of their home until the loan is repaid, and the lender retains the right to repossess the property in case of default.

Another instance is when a company engages in invoice factoring. In this scenario, the factoring company ‘buys’ the value of sales invoices, lends money to the business, but secures it with a fixed charge on the sales ledger.

 

Recording the terms of a security charge

The details of the charge’s terms and conditions must be outlined in a debenture, a document that must be registered with Companies House within 21 days to be valid. If the charge involves land or property, additional registration with the Land Registry may be necessary.

The obligation to register a debenture is the same for floating charges. Banks, in fact, may opt for a dual approach, taking a fixed charge on specific tangible assets and a floating charge over broader categories of assets. This way, the entire asset portfolio of a company is covered under a single debenture.

 

‘Floating’ over tradable assets

Floating charges function similarly to fixed charges but are linked to a category of assets rather than a specific one. These assets may include stock, cash, or work-in-progress, and the key distinction is that the company can utilise them in its regular business operations.

If a company defaults or enters into liquidation, the floating charge transforms into a fixed charge on the designated assets. Depending on when the charge was established, the holder may have the authority to appoint their own administrative receiver or administrator to manage the assets in the event of liquidation.

 

Protection for lenders

A floating charge is considered more adaptable than a fixed charge. However, once it has crystallised, the company loses the ability to utilise the connected assets in its regular business operations, rendering them effectively frozen.

Both charge types safeguard the lender in the event of business failure, as charge-holders take precedence over unsecured creditors during liquidation distribution. The terms and conditions outlined in a floating charge agreement determine the circumstances leading to crystallisation, typically triggered by a loan repayment default or automatically upon company liquidation.

 

Debentures and the Deed of Priority

As mentioned earlier, the document connecting a lender’s right to specific assets through a charge and the company’s agreement to the arrangement is a debenture. It outlines the terms and conditions of the security charge, including when it crystallises. Registration ensures that other lenders cannot take precedence without a Deed of Priority.

Should new lenders intend to establish an additional charge on company assets, coordination is necessary to determine the order of priority for payment in case of default or liquidation.

A Deed of Priority delineates this hierarchy of loans and repayments. In the event that the company cannot meet the terms of any borrowing, it becomes evident which lender holds precedence over the others.

Read More:

 

Where do secured creditors rank for repayment?

According to the Insolvency Act 1986, there exists a distinct hierarchy for repayment in a situation of insolvency:

  • Liquidator’s fees and expenses
  • Secured creditors with a fixed charge
  • Preferential creditors (including employees with arrears of wages and other payments), and the ‘prescribed part’
  • Secured creditors with a floating charge
  • Unsecured creditors

 

The ‘prescribed part’ is a designated sum reserved for the benefit of unsecured creditors, derived from the liquidation of assets subject to a floating charge established after 15th September 2003. As evident, payment priority is given to holders of fixed charges.

Creditors with a floating charge are positioned lower in the hierarchy compared to preferential creditors. This is why lenders strive to increase the portion of a loan covered by a fixed charge.

Security charges constitute an intricate aspect of business, yet fundamentally, both fixed and floating charges empower the lender to sell an asset if a company fails to adhere to the agreed-upon borrowing terms.

For further details on security charges, Vanguard Insolvency can furnish professional guidance and assistance. We guarantee a comprehensive understanding of the ramifications associated with attaching a charge to your company’s assets and extend a free same-day consultation in complete confidentiality. 

David Jackson MD
Senior Partner at Vanguard Insolvency Practitioners | Website

I am an insolvency professional with a distinguished career specialising in commercial insolvency, adeptly navigating Creditors Voluntary Liquidation, Company Voluntary Arrangements, and Company Administrations. With a comprehensive understanding of insolvency laws and an unwavering commitment to ethical practices.