If you’re not familiar with the lending and insolvency world, the difference between Fixed and Floating Charges over business assets can be confusing. However, a recent High Court ruling in the Avanti Communications case has brought some clarity, though it also introduces more flexibility and uncertainty regarding Fixed Charges.
Let’s break down the basic characteristics of Fixed and Floating Charges:
Fixed Charges:
- When a borrower creates a Fixed Charge in favour of a lender, it immediately attaches to specific, identifiable property, granting the lender proprietary rights to those assets.
- Despite this, the borrower retains ownership and possession of the assets. However, the lender has some control over what happens to these assets, preventing the borrower from freely disposing of them.
Floating Charges:
- A Floating Charge hovers over a pool of assets that can change over time until a triggering event causes it to “crystallise.”
- Crystallisation occurs when certain events take place, such as the borrower going into liquidation, the lender taking control of the assets, or specified events listed in the security document happening.
- Before crystallisation, the borrower is free to deal with the charged assets without requiring the lender’s consent. This makes Floating Charges suitable for assets that fluctuate and circulate within a business, like stock and work in progress, and cash in current accounts.
Why does the type of charge matter? It becomes crucial to secured creditors, especially when multiple creditors hold security over a company’s assets. In formal insolvency procedures like Administration or Liquidation, Fixed charge holders have priority over Floating Charge holders. The proceeds from asset realisations are distributed in a set order of priority, with Fixed Charge debts at the top of the list.
Floating Charge holders will receive their share only after Fixed Charge debts, insolvency costs, preferential creditor claims, and the “Prescribed Part” (a ring-fenced sum to satisfy ordinary unsecured creditors) have been dealt with. Moreover, Floating Charges have a 12-month “hardening period,” which can extend to two years if taken in return for “new” funding. This means Floating Charges granted within the hardening period before insolvency can be set aside, whereas Fixed Charges are not affected.
Now, let’s look at the key points in the Avanti judgment:
- Avanti Communications’ case revealed that a Fixed Charge doesn’t necessarily require a complete prohibition on the borrower dealing with the charged assets.
- Specific exceptions to a total disposal prohibition, often negotiated by borrowers in finance documents, may still be consistent with the creation of a Fixed Charge.
How does the Avanti judgment affect future lending strategies? As always, the outcome of court decisions depends on the case’s facts. In Avanti, the assets in question were crucial to the business’s infrastructure rather than freely circulating assets, leading the court to classify them as Fixed Charges despite some degree of flexibility granted to the borrower.
The judgment also provided detailed criteria for analysing security documentation and categorising Fixed Charge assets accordingly. This will likely have significant implications for structured and asset-backed finance arrangements that utilise industry-standard forms.
The Avanti ruling brings more flexibility to funding business assets but also opens up possibilities for disputes, especially if security documentation is poorly drafted.
In conclusion, understanding the distinction between Fixed and Floating Charges is essential for directors of struggling small companies, as it can significantly impact their financial situation and relationships with creditors during insolvency procedures. For further advice or clarification on this topic, don’t hesitate to reach out to me – we’re here to help you navigate through these complexities and find the best solutions for your specific situation.[/fusion_text][/fusion_builder_column][/fusion_builder_row][/fusion_builder_container]