What are Secured Creditors?

When a company faces financial difficulties and cannot pay its debts, not all creditors are treated equally. There’s a hierarchy of creditors that determines who gets paid first. At the top of this hierarchy are secured creditors.

Understanding this hierarchy is crucial for anyone involved in business finance, as it affects the chances of recovering debts during insolvency.

What is a Secured Creditor?

A secured creditor is an entity that has a legal right to claim specific assets of a company if the company fails to repay its debt. In the event of a liquidation, secured creditors are prioritised and repaid before other creditors.

There are two main types of secured creditors: those with fixed charges and those with floating charges.

• Fixed Charge: A secured creditor with a fixed charge has a lien on specific assets of the company, such as property or equipment.
• Floating Charge: A secured creditor with a floating charge has a claim over a more general set of assets, which can change over time, like inventory or accounts receivable.

Both types of charges must be registered with Companies House, the UK’s official register of businesses. This registration is detailed in a document known as a debenture, which outlines the terms and conditions of the security.

Depending on the terms outlined in the debenture, some secured creditors, particularly those with qualified floating charges, have the authority to appoint an administrator, further illustrating their significant standing in the financial hierarchy of a company’s creditors.

>>Read our full article on What are Fixed and Floating Charges?

Examples

• Banks
• Lenders with a charge over assets
• invoice factoring company with a lien over assets

What is a Fixed Charge?

A fixed charge is a type of security held by secured creditors over specific, tangible assets of a company, such as property, vehicles, or machinery. In the event of liquidation, these assets can be sold, and the proceeds, after deducting any costs like liquidator’s fees, are used to repay the creditor.

Alternatively, secured creditors have the right to sell the secured assets themselves, but must hand over any excess funds to the liquidator.

Assets under a fixed charge cannot be sold or disposed of without the creditor’s consent, providing them with a significant level of security. This arrangement allows secured creditors, which include banks, asset-based lenders, and finance companies, to offer loans at more favourable rates due to the reduced risk. The presence of a fixed charge ensures that they have a priority claim over the assets and are more likely to recover their investment.

What is a Floating Charge?

A floating charge is a dynamic form of security used by creditors, characteristically covering the company’s assets that are not tied to a fixed charge, such as inventory, work in progress, and some vehicles. This charge ‘floats’ over these assets, allowing the business to trade or sell them in the normal course of operations, offering flexibility not available under a fixed charge.

However, upon the occurrence of specific events, like a default on payment or the company entering liquidation, the floating charge ‘crystallises’ and becomes fixed on the assets it covers. At this point, the company can no longer freely sell or trade those assets. The conditions that trigger crystallisation are usually specified in the loan agreement.

While floating charges provide creditors with a broad security interest over a company’s assets, recovering funds under a floating charge can be more challenging than with fixed charges. In the hierarchy of creditor repayment, floating charge creditors rank below secured and preferential creditors.

What is the Difference Between a Secured and Unsecured Creditor?

A secured creditor has a legal claim to specific company assets as collateral for the debt owed to them. If the company fails to repay the debt, secured creditors can seize these assets to recover their funds. In contrast, an unsecured creditor does not have any claim to the company’s assets and stands behind secured creditors in the priority for repayment, making recovery of funds less certain if the company becomes insolvent.

Article sources

All Company Debt insolvency content is written by our licensed insolvency practitioners.

The primary sources for this article are listed below, including the relevant laws, and acts which provide their legal basis.

1. Insolvency Act 1986 (Legislation)