Fixed and floating charge

From CEOpedia | Management online

A fixed charge is a security taken by a lender on a particular debt. A floating charge is a security interest in a pool of changing assets of a company or other artificial person.

The usual form of security is charge. The charge is used to secure any transactions where the company raises its capital through the issuance of a debenture[1]. The debenture is a document that either creates a debt or recognizes it, and any document that satisfies any of these conditions is a 'debenture'[2].

Floating charge

In legal systems with the Anglo-Saxon system of law, there is such a type of encumbrance as floating charge. This concept represents the ability of the creditor to pledge a pool of assets of the debtor, whose composition is constantly changing[3]. The assets that are pledged are not clearly defined; often it is simply all existing and future assets of the debtor. Such a pool includes not only assets that exist at the moment, but also future assets.

A floating charge acts in equity and becomes a fixed charge at a "crystallization event", which is usually defined such as[4]:

  • non-performance of payment obligations of the company;
  • liquidated company;
  • any actions of the company that endanger the charged assets.

The main characteristics of floating charge[5]:

  • it may cover future assets; thus, there is no need to identify and pledge each individual asset that becomes the debtor's property;
  • the debtor may carry out transactions with assets in the ordinary course of business until the charge is crystallized;
  • needs a public registration;
  • recovery is made by appointing an administrator who can manage the business in favor of the lender, and can also sell such assets as an economic unit, which will not lead to the depreciation of assets in the event of their sale separately.

Floating charge is generally weaker than fixed charge[6]:

  • the borrower has the right to freely dispose of and control the encumbered assets in the ordinary course of business.
  • the value of the encumbered assets is uncertain prior to crystallization, which may be too late for the creditor to seize the assets and recover its outstanding debt.
  • to be valid, a floating charge must be registered. Unregistered within the prescribed time frame may invalidate the charges and put the lender in an unsecured position.
  • floating rank is lower in priority of fixed charge by creditors.
  • can be easier allocated compared to a fixed charge.
  • floating charge is not recognized in all jurisdictions.

Fixed charge

A fixed charge is generally established for certain property (e.g. land, expensive equipment, etc.). In the case of a fixed pledge, the pledger may not dispose of the pledged property without the consent of the pledgee, and the pledger must retain the property in his possession[7].

The main difference between a floating charge and a fixed one is that in case of bankruptcy, the pledgee on a fixed charge will receive satisfaction of his claims at the expense of the pledged property mainly in front of all other creditors, and the pledgee on a floating charge - after the distribution of the amount received from the sale of the pledged property in favor of a number of creditors[8].

Registration

The company is obliged to register within 30 days from the date of its creation, if this is not done, the charge will be dropped against the liquidator and any creditors of the company[9]. In this case, the accrual will not ensure the priority of the accrual and will actually be attributed to the position of the unsecured creditor. To avoid possible non-registration by the company, any person interested in the fee can register the fee before the end of the period allowed for registration. Registration is important to establish any form of priority over the company's asset[10].

Examples of Fixed and floating charge

Fixed Charge:

  • Mortgage: A mortgage is a type of fixed charge security taken by a lender when a loan is taken out against a property. The borrower agrees to pay back the loan plus interest over a set period of time, and the mortgage is a legal document that allows the lender to take possession of the property if the loan is not repaid.

Floating Charge:

  • Accounts Receivable: A floating charge is a security interest taken on a company's accounts receivable. This allows a lender to take possession of the company's receivables if the debt is not paid. The accounts receivable are constantly changing and require the lender to continuously monitor the company's accounts.
  • Inventory: A floating charge is also taken on a company's inventory. This allows the lender to take possession of the company's inventory if the debt is not paid. The inventory is constantly changing and requires the lender to continuously monitor the company's records to make sure the debt is repaid.

Advantages of Fixed and floating charge

Fixed and floating charges provide businesses with flexibility and access to capital that they may not otherwise have access to. They are also a form of security for creditors if a business defaults on its loans. Here are some advantages of both:

  • Fixed charge: The lender has a fixed security over the asset and can take possession of it if the loan is not repaid. The asset is also protected from the claims of other creditors.
  • Floating charge: Creditors have a security interest over all the company’s assets. This gives them more flexibility and allows the company to use its assets to generate revenue. It also allows the company to restructure and reorganize without the approval of the creditor.
  • Both fixed and floating charges are registered at Companies House in the UK, meaning that the lender is informed of any changes to the business. This allows them to take appropriate action if necessary.
  • Fixed charges can be used to secure multiple debts with the same asset, while a floating charge can be used to secure multiple assets with the same debt. This gives businesses more financial flexibility and can reduce the cost of borrowing.

Limitations of Fixed and floating charge

A fixed charge and a floating charge both have their own limitations.

  • Fixed charges are limited to a specific asset that is being used as collateral for the loan. This limits the lender’s ability to access other assets in the event of a default.
  • Floating charges may limit the company’s ability to access funds or assets during the period of the loan, as these assets are held as security.
  • Another limitation of both fixed and floating charges is the fact that they can be difficult to enforce due to the complexity of the legal process. This means that the lender may not be able to recover the amount of money that is owed to them.
  • Fixed and floating charges can also be subject to certain taxes or duties, which can add additional costs to the loan.
  • Lastly, fixed and floating charges can also be difficult to transfer or assign to another lender. This means that if the original lender does not want to extend the loan, the borrower may have to look for another lender who is willing to take on the loan.

Other approaches related to Fixed and floating charge

Fixed and floating charge are two of the most common approaches for securing debt. However, there are several other approaches that can be used to secure debt, including:

  • Mortgage: This is a legal agreement between a borrower and a lender, in which the borrower pledges a certain asset, such as real estate, as security for a loan. The lender holds the right to take possession of the asset if the borrower fails to repay the loan.
  • Pledge: This is an agreement in which a borrower pledges an asset to a lender as security for a loan. The pledged asset can be foreclosed upon if the borrower defaults on the loan.
  • Guarantee: This is an agreement in which a third party guarantees the repayment of a loan. The guarantor can be held liable if the borrower fails to repay the loan.
  • Hypothecation: This is an agreement in which a borrower pledges an asset as security for a loan without transferring ownership of the asset to the lender.
  • Lease: This is an agreement in which a borrower rents an asset from a lender for a fixed period of time. The lender retains ownership of the asset and can repossess it if the borrower fails to make payments.

In conclusion, fixed and floating charge are two of the most common approaches for securing debt, but there are several other approaches, such as mortgage, pledge, guarantee, hypothecation, and lease, that can also be used.

Footnotes

  1. ↑ Zhuravel M. (2015), p. 49
  2. ↑ Zhuravel M. (2015), p. 49
  3. ↑ Chin A. W. (2017), p. 9
  4. ↑ Chin A. W. (2017), p. 9
  5. ↑ Fixed and Floating Security (2011), p. 3
  6. ↑ Zhuravel M. (2015), p. 51
  7. ↑ Fixed and Floating Security (2011), p. 3
  8. ↑ Paterson S. (2016), p. 3
  9. ↑ Chin A. W. (2017), p. 10
  10. ↑ Chin A. W. (2017), p. 10


Fixed and floating charge — recommended articles
Bankers lien — True lease — Absolute assignment — Spendthrift clause — Mortgage deed — Assignment of insurance — Cash Collateral — Consent order — Ijarah

References

Author: Anastasiia Ilnytska

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