Fixed and floating charges are two types of security interests that a creditor can take over a borrower’s assets to secure a loan. A fixed charge is a security interest taken over a specific asset or group of assets.
The creditor has a priority claim over those assets and the borrower cannot dispose of or sell those assets without the creditor’s consent until the debt is fully repaid.
Examples of assets that can be subject to a fixed charge include land, buildings, and machinery. If the borrower defaults on the loan, the creditor can seize and sell the assets covered by the fixed charge to recover the debt owed.
On the other hand, a floating charge is a security interest taken over a group of assets that change in quantity and value over time. The borrower can continue to use and sell the assets covered by a floating charge without the creditor’s consent until an event of default occurs. When an event of default happens, the floating charge “crystallizes,” meaning that it converts into a fixed charge and the creditor gains priority over those assets.
Examples of assets that can be subject to a floating charge include inventory, accounts receivable, and intellectual property. Floating charges are often used in business finance to provide flexibility to the borrower’s cash flow while also providing security to the creditor.
What is a fixed charge?
A fixed charge is a type of security interest that provides a creditor with a priority claim over a specific asset or group of assets of the borrower. The creditor takes a fixed charge over the asset(s) as a form of collateral to secure a loan or debt. The borrower cannot dispose of or sell the asset(s) without the creditor’s consent until the debt is fully repaid.
This type of charge is “fixed” because the asset(s) subject to the charge remains the same until the debt is repaid, and the creditor maintains a fixed priority claim over the asset(s). Examples of assets that can be subject to a fixed charge include real estate, machinery, vehicles, or any other valuable asset. If the borrower defaults on the loan or debt, the creditor has the right to take possession of and sell the asset(s) covered by the fixed charge to recover the debt owed.
What is a fixed charge over assets?
A fixed charge over assets is a type of security interest that a creditor takes over a specific asset or group of assets of the borrower as collateral to secure a loan or debt. The asset(s) that are subject to the charge remain fixed until the debt is fully repaid, and the creditor maintains a priority claim over the asset(s). The borrower cannot dispose of or sell the asset(s) without the creditor’s consent until the debt is fully repaid.
The fixed charge provides the creditor with a greater degree of security than a floating charge because the creditor has the right to take possession of and sell the asset(s) covered by the fixed charge in the event of the borrower’s default. Examples of assets that can be subject to a fixed charge include land, buildings, machinery, or any other valuable asset. The terms of a fixed charge will be set out in a legal agreement between the creditor and the borrower, outlining the details of the charge and the rights and obligations of both parties.
Fixed charge examples
Fixed charges are over substantial and physical assets. Examples include:
- Mortgage payments
- Rent deposits
- Chattels and leases
- Bill of sale
- Factored book debts
It’s important to note that a fixed charge repayment ranks before that of a floating charge repayment in company insolvency.
What is a floating charge?
A floating charge is a type of security interest that a creditor takes over a group of assets of the borrower as collateral to secure a loan or debt. Unlike a fixed charge, a floating charge is not attached to a specific asset or group of assets but rather “floats” over a group of assets that are subject to change in quantity and value over time. The borrower can continue to use and sell the assets covered by a floating charge without the creditor’s consent until an event of default occurs.
When an event of default happens, the floating charge “crystallizes,” meaning that it converts into a fixed charge, and the creditor gains priority over those assets. Examples of assets that can be subject to a floating charge include inventory, accounts receivable, and intellectual property. Floating charges are commonly used in business finance to provide flexibility to the borrower’s cash flow while also providing security to the creditor.
The terms of a floating charge will be set out in a legal agreement between the creditor and the borrower, outlining the details of the charge and the rights and obligations of both parties.
What is a default of a floating charge?
A default of a floating charge occurs when the borrower fails to repay the loan or debt secured by the floating charge or fails to meet other obligations outlined in the legal agreement. When an event of default happens, the floating charge “crystallizes,” meaning that it converts into a fixed charge, and the creditor gains priority over those assets.
At this point, the borrower cannot dispose of or sell the assets covered by the floating charge without the creditor’s consent. The creditor may take possession of and sell the assets covered by the fixed charge to recover the debt owed. It is important for borrowers to understand the terms of their loan agreement and to make payments on time to avoid defaulting on a floating charge or any other type of security interest.
Similarly, creditors must ensure that their legal agreements are structured in a way that protects their interests in the event of a default.
Floating charge examples
So, a floating charge can be held over the following:
- Stock, finished or raw material
- Work in progress
- Unfactored debtors
- Fixtures and fittings
- Cash
- Vehicles or assets not subject to fixed charges
But the lender does rank behind some other creditors like wages, and the “prescribed part creditors”. This is where things begin to get complicated.
What is the main difference between fixed and floating charges?
The main differences between fixed and floating charges are:
Fixed Charges:
- A security interest taken over a specific asset or group of assets
- The creditor has a priority claim over those assets, and the borrower cannot dispose of or sell those assets without the creditor’s consent until the debt is fully repaid
- Examples of assets that can be subject to a fixed charge include land, buildings, and machinery
- If the borrower defaults on the loan, the creditor can seize and sell the assets covered by the fixed charge to recover the debt owed
Floating Charges:
- A security interest taken over a group of assets that change in quantity and value over time
- The borrower can continue to use and sell the assets covered by a floating charge without the creditor’s consent until an event of default occurs
- Examples of assets that can be subject to a floating charge include inventory, accounts receivable, and intellectual property
- When an event of default happens, the floating charge “crystallizes,” meaning that it converts into a fixed charge, and the creditor gains priority over those assets
What is Meant by ‘Crystallisation’ of Floating Charges?
Crystallisation of floating charges refers to the process by which a floating charge held over the assets of a company becomes fixed and attaches to specific assets. When a floating charge is created, it covers a class of assets that are subject to change over time, such as inventory or accounts receivable.
When certain events occur, such as the appointment of a receiver or the occurrence of a default, the floating charge “crystallises” and becomes fixed, attaching to specific assets that are then held for the benefit of the charge holder. Once a floating charge crystallises, it cannot be used to secure new borrowings, and the charge holder’s claim becomes more senior to other unsecured creditors.
What happens if a company becomes insolvent?
If a company becomes insolvent and has both fixed and floating charges in place, the creditor with the fixed charge takes priority over the assets covered by that charge, while the creditor with the floating charge has priority over the remaining assets. The assets covered by the floating charge will only be available to the creditor with the floating charge after the fixed charge has been satisfied.
In other words, the creditor with the fixed charge is first in line to recover their debt, and the creditor with the floating charge is second in line. Any remaining assets will be available to unsecured creditors, such as trade creditors and employees. The process of distributing assets to creditors in an insolvency is complex, and it is important for creditors to seek legal advice to ensure that their interests are protected.
Frequently asked questions
An example of a floating charge is when a bank provides a loan to a company and takes a floating charge over the company's inventory and accounts receivable. The borrower can continue to use and sell the inventory and collect the accounts receivable until an event of default occurs, at which point the floating charge will 'crystallize' into a fixed charge, and the bank will have priority over those assets.
An example of a fixed charge is when a mortgage is taken out on a property. The mortgage creates a fixed charge over the property, and the lender has priority over the property until the loan is repaid in full. The borrower cannot sell the property without the lender's consent until the mortgage is discharged. What is a floating charge example?
What is an example of fixed charge?
Conclusion
Understanding what a fixed and floating charge are in business is crucial for both borrowers and lenders. For borrowers, it is important to understand the terms of their loan agreement, including any security interests that the creditor may take over their assets. This understanding helps the borrower to manage their assets effectively and to avoid defaulting on the loan, which could result in the loss of those assets. For lenders, understanding the different types of security interests available and their respective benefits and drawbacks is critical to ensuring that their interests are protected in the event of a default.
This understanding helps the lender to make informed decisions about the types of security interests to take, the amount of credit to extend, and the terms of the loan agreement. In addition, understanding fixed and floating charges is important in the context of insolvency and bankruptcy, as it affects the order in which creditors are paid out of the company’s assets. Overall, understanding fixed and floating charges is essential to making informed decisions and managing risk in the context of business finance.
With over three decades of experience in the business and turnaround sector, Steve Jones is one of the founders of Business Insolvency Helpline. With specialist knowledge of Insolvency, Liquidations, Administration, Pre-packs, CVA, MVL, Restructuring Advice and Company investment.