As an insolvency practitioner, I have seen many small limited companies struggle to repay loans, leading to the enforcement of charges. One aspect of charges that can cause confusion is the distinction between fixed and floating charges. In this article, I will explain what a charge is, what a fixed charge is, and what a floating charge is, as well as provide examples of the types of assets that might be subject to each type of charge.
Firstly, what is a charge?
A charge is a form of security that a lender takes over a borrower’s assets to protect themselves if the borrower fails to repay the loan. The lender does not take actual possession or ownership of the assets but obtains rights over them. The charge is documented by an agreement between the lender and borrower, which identifies the assets subject to the charge, the nature of the charge, and the circumstances in which the charge can be enforced.
A fixed charge is often seen as better security for the lender than a floating charge. This is because realisations from fixed charge assets are paid first to those with the benefit of a fixed charge over those with a floating charge in the event of the borrower’s insolvency. However, creating a true fixed charge is not always straightforward. Fixed charges are most commonly created where the asset is easily identifiable, and the lender can control any dealing with that asset during the loan’s life. This control is usually achieved in the charging instrument by specifying that the borrower cannot sell, transfer, or dispose of the relevant fixed charge assets without the lender’s consent. A lender with a fixed charge will typically have the right to restrict the borrower from selling the assets without their consent, sell the assets themselves or via an insolvency practitioner if the borrower is in default, and claim any proceeds arising from the sale in priority to other creditors.
A floating charge ‘floats’ above a changing pool of assets over time unless and until a ‘crystallisation event’ occurs, at which time the charge crystallises and is elevated from a floating into a fixed charge. A floating charge allows the borrower to continue dealing with the assets in the ordinary course of business without the lender’s consent, for example, to sell those assets in the ordinary course of business. A company will generally want to give a floating charge over assets that it needs to use and sell in the day-to-day operation of its business, such as stock in trade. However, realisations from floating charge assets are subject to a deduction for the ‘prescribed part’, which is set aside for the benefit of unsecured creditors on insolvency, and the preferred creditors, putting the charge-holder quite low down in the order of repayment.
When banks lend to companies, they often take security over all the company’s assets by way of a combination of both fixed and floating charges under an all-encompassing security document known as a debenture. This way, the lender can maximise its potential recourse options if the borrowing company enters insolvency proceedings during the loan’s life.
Now let’s look at some examples of the types of assets that might be subject to a fixed or floating charge. Freehold and leasehold property, book debts, large immoveable plant and machinery, goodwill and intellectual property are examples of assets that may be subject to a fixed charge. The lender can control any dealing with these assets during the loan’s life. On the other hand, assets subject to a floating charge are those that the company needs to use and sell in the day-to-day operation of its business, such as stock in trade, motor vehicles, smaller items of machinery etc.
In conclusion, when a lender advances a loan to a company, they may take security in the form of a charge over the company’s assets. A charge creates an equitable interest but without a transfer of property. A fixed charge is often seen as better security for the lender than a floating charge, but creating a true fixed charge can be difficult, and it’s the insolvency practitioner who sometimes has to decide whether an item is subject to the floating, as opposed to the fixed, charge.