Overview Of What Is A Fixed And Floating Charge
A fixed and floating charge is security when money is borrowed by a company from a lender.
The security that is sought by the lender (eg. a bank) is to attempt to safeguard against the possibility that the borrower may default on their obligations and not pay some or all of the loan back.
What Is A Fixed Charge?
A fixed charge is the form of security that a bank or lender may take to attempt to secure their position in relation to specific types of assets that tend to be “fixed” by their nature, such as land and buildings.
The nature of the security arising under a fixed charge means that the asset, subject to the terms of the agreement, becomes the lender’s asset. As a result, the Company cannot sell it without the agreement of the lender.
The most common example of a fixed charge is when an individual purchases their own property, they will borrow money from a mortgage company. A mortgage is an example of a fixed charge.
In the context of companies, aside from land and buildings, one of the most common forms of fixed charge is obtained over a company’s outstanding invoices when a factoring or invoice discounting company lends money over the same. In the same way with land and buildings, the book debts effectively become the property of the factoring company that has obtained the fixed charge.
What Is A Floating Charge?
Perhaps unsurprisingly, a floating charge is a form of security obtained by a lender when the nature of the asset changes over time in the normal course of business. This can apply to assets such as stock, work in progress, fixtures and fittings, cash at the bank, motor vehicles and so on.
What Is The Difference Between A Fixed And A Floating Charge?
The difference between a fixed charge and a floating charge is the asset over which the charge and security is granted as explained above.
Charges On Insolvency
However, the purpose of a bank or lender obtaining such security is to safeguard their position in the event of default and insolvency. The reason is that in the case of a fixed charge, the lender is in a more secure position when the assets are sold.
A floating charge holder does not have as a strong position as a fixed chargeholder, because they will rank behind other creditors for some element of the realisations. A floating chargeholder does not have the same rights over the assets as a fixed chargeholder, mainly because the assets they have taken as security over are constantly changing. In particular, they will rank behind what is known as preferential creditors in respect of wages, PAYE and VAT debts. A floating chargeholder will also rank behind the unsecured pool known as the Prescribed Part pursuant to Section 176A of the Insolvency Act 1986.
What Is A Debenture?
A debenture is an instrument or document that sets out the terms of a fixed and floating charge over a company’s assets. This has to be registered at Companies House.
What Happens In The Event Of Insolvency?
The question of what happens when a borrower defaults on a fixed or floating charge in the event of insolvency, such as Liquidation, is explored in an article referred to as “How Does A Liquidator Share The Assets? What Do The Creditors Get?”.
The position, as explained in this article, can be quite complicated in view of the various different categories of creditors that can arise i.e. from secured creditors, such as those with either a fixed or floating charge, preferential creditors such as HMRC in respect of PAYE and VAT that has been collected but not paid over and all the other creditors that rank beneath the aforementioned, known as the unsecured creditors.