A-Z of banking and finance: F is for fixed and floating charges

Banks often take security for the loans they advance – doing so gives them some additional protection if a borrower fails to repay the loan when due. Where the borrower is a company, that security can take the form of a mortgage, a security assignment, a pledge, lien, or a charge. In this short article, we explain what a charge is and the differences between a fixed and floating charge.

But firstly, what is a charge?

A lender will rarely want to take actual possession or ownership of a borrower’s assets, due to the potential liabilities and/or practicalities involved. Instead, a lender will often look to take security by obtaining rights over a company’s assets in the form of a charge. A charge creates an equitable interest but without a transfer of property.

A charge is typically documented by way of an agreement between the chargee (lender) and the chargor (borrower). This agreement will identify which assets are subject to the charge, the nature of the charge (whether fixed or floating) and in what circumstances the charge can be enforced. Enforcing a charge will often involve the appointment of a receiver or administrator (depending upon the nature of the charge), who may realise the charged assets by selling them to one or more third parties and apply the sale proceeds to satisfy the debt owed to the chargee.

What is a fixed charge?

From a lender’s perspective, taking a fixed charge is often seen as a better form of security than a floating charge, as realisations from fixed charge assets will (after discharging an insolvency practitioner’s costs in realising those assets) be paid first to those with the benefit of a fixed charge over those assets upon a company’s insolvency.

However, taking a true fixed charge is easier said than done. Many charges are labelled as fixed when in practice what is created is actually a floating charge because the lender lacks sufficient control over the asset in question. Fixed charges are most commonly created where the relevant asset is easily identifiable, and the lender can control any dealing with that asset during the life of a loan. This control is often achieved in the charging instrument itself by specifying that the chargor cannot sell, transfer, or otherwise dispose of the relevant fixed charge assets without the lender’s consent.

A lender with a fixed charge will typically have the right to do the following:

• Restrict the company from selling the fixed charged assets without the lender’s consent
• Sell the assets (either itself or via an insolvency practitioner) and use the proceeds to discharge the loan if the company is in default
• Claim any proceeds arising upon the sale of the fixed charged assets in priority to other creditors of the company

However, control is the key requirement to create a fixed charge. By way of example, a lender will often look to take security over a company’s bank accounts by way of a fixed charge. But if the company can continue to access and withdraw sums from the relevant accounts whilst the loan is outstanding without the lender’s permission, then what is in fact created is more likely to be a floating charge.

A fixed charge ranks ahead of a floating charge in the order of repayment (priority) on a company’s insolvency.

What is a floating charge?

A floating charge "floats" above a changing pool of assets over time unless and until a so-called "crystallisation event" occurs, at which time the charge crystallises and is elevated from a floating into a fixed charge. A key benefit of a floating charge from a security provider’s perspective is that it can continue to deal with the floating charge assets in the ordinary course of its business without having to obtain the lender’s consent, for example, to sell those assets. For this reason, a company will generally want to give a floating charge over assets that it needs to use and sell in the day-to-day operation of its business (such as stock in trade).

A floating charge ranks behind a fixed charge in the order of repayment (priority) on the insolvency of a company. Realisations made from floating charge assets are also subject to a deduction for the "prescribed part", which is set aside for the benefit of unsecured creditors on insolvency.

If a floating charge constitutes what is known as a qualifying floating charge (i.e., one which extends to the whole or substantially the whole of a company’s property and assets and which is expressly stated to be a qualifying floating charge within the meaning of the Insolvency Act 1986), then the lender will be able to appoint an administrator to take control of the relevant company’s business and assets upon enforcement of that charge. This provides an additional restructuring option for a lender if the business that it lends to goes south. For this reason, when banks lend to companies, they often take security over all of a relevant company’s assets by way of a combination of both fixed and floating charges under an all-encompassing security document known as a debenture. In this way, a lender is likely to maximise its potential recourse options in the event that the borrowing company enters insolvency proceedings during the life of the loan.

When types of assets should you expect to see subject to a fixed or floating charge?

Below are some examples of the types of assets that might be caught by fixed or floating security.