When a limited company borrows money from a bank or other financial institution, it is not unusual for the lender to ask for security for the debt.
If your business has given lenders fixed and/or floating charges against some assets in your business or a floating charge over all assets, the first point to note is that the lender in question will be a secured creditor. There is a major difference between secured and unsecured creditors if your business becomes insolvent, with secured creditors having far stronger rights.
A second important implication linked to fixed and/or floating charge holders being secured creditors is that, in many cases, the documents you have signed will give the lender enhanced rights to take action against some assets of your business. even if the business is not legally insolvent at that point. So, a technical default can give fixed and/or floating charge holders the ability to act in a way which could mean your business cannot continue.
If you are starting to have financial problems and know that you have fixed or floating charges (a floating charge is often also known as a debenture) getting good, experienced advice may mean the difference between losing control of it or not. We are experienced in advising business owners in this situation and there is often room to negotiate or find ways to reduce concerns of charge holders so that they do not enforce their rights.
- What is a Fixed Charge?
- What is a Floating Charge?
What is a Fixed Charge?
If a debt is subject to a fixed charge, the borrowing will be secured against a substantial and identifiable physical asset such as land, property, vehicles, plant and machinery. If the business is unable to keep to the terms of the finance agreement, the lender as a creditor will take charge of the asset and look to sell it in order to recoup the money it is owed.
What is a Fixed Charge Over Assets?
When a lender has a fixed charge, it has strong legal rights over the asset the charge applies to. If the business wants to sell, transfer or dispose of the asset charged, it will have to get permission from the lender first or pay off the remaining debt.
It’s also important to note that a fixed charge gives the lender a higher position in the queue of creditoirs than a floating charge or undescured creditors when it comes to repayments of debts in the event of the borrower’s insolvency.
A common example of a fixed charge in practice is factoring or invoice discounting facilities. In this type of arrangement, the finance provider buys a business’ outstanding invoices and lends money against them. The debtor book is then subject to a fixed charge, which means the business invoices effectively belong to the finance provider and not the company.
What are Examples of Fixed Charges?
Examples of financial arrangements that are commonly subject to a fixed charge – also known as secured – include:
- Bank loans
- Invoice factoring arrangements
As with floating charges, these are defined in statute .
What is a Floating Charge?
A floating charge applies to assets with a quantity and value that can change periodically, such as stock, debtors and moveable plant and machinery .
It gives the business much more freedom than a fixed charge because the business can sell, transfer or dispose of those assets without seeking approval from the lender or having to repay the debt first.
From the lender’s point of view, a floating charge leaves it more exposed than a fixed charge because the value of the assets can and will change over time.
However, it’s not possible to attach a fixed charge to every company asset, which is why floating charges are used.
What is Meant by ‘Crystallisation’ of Floating Charges?
Floating charges essentially ‘float’ above changing assets and only become fixed charges, a process known as ‘crystallisation’, in the following circumstances:The company defaults on the repayment and the lender takes action to recover the debt
The company is about to be wound up
The company appoints the insolvency practitioner
The company will cease to exist in the future such as through liquidation.
What is the Difference Between a Fixed and Floating Charge?
There are a number of major differences to be aware of:
- A fixed charge applies to a specific identifiable asset, while a floating charge is dynamic in nature and generally applies to the whole of the company’s property.
- An asset covered by a fixed charge cannot be sold or transferred unless the charge holder agrees. A floating charge can be sold, transferred or disposed of until a point when it crystallises and becomes fixed.
- A fixed charge is always given preference over a floating charge in insolvency.
What Happens in Insolvency?
If a business enters insolvency, there is a designated order that determines which creditors will be repaid from company assets first.
When it comes to a liquidation, both fixed charge and floating charge holders are classed as secured lenders. That means they take priority over unsecured creditors who must wait until all other costs and creditors have been paid before they receive any of the money they are owed.
What is Meant by Priority of Fixed and Floating Chargeholders?
Fixed charge holders are first in line for repayment and receive the money they are owed from the sale of the company assets they hold a fixed charge over. Under the Insolvency Act 1986, the hierarchy for repayment in an insolvency situation is:
- The liquidator’s fees and expenses
- Secured creditors with a fixed charge
- Preferential creditors – typically employees with wage arrears
- Secured creditors with a floating charge
- Unsecured creditors.
Floating charge holders must wait until fixed charge holders, preferential creditors such as employees and the insolvency practitioner, acting as liquidator, have received the money they are owed before they are repaid. Although as can happen when a business is wound up and by that point, there may not be enough funds to repay debts in full – this is also why the unsecured creditor may receive nothing at all.