what is floating charge?
A floating charge, also known as a floating lien, is a security interest or lien over a group of non-constant assets that may change in quantity and value.
Companies will use floating charges as a means of securing a loan. Typically, a loan might be secured by fixed assets such as property or equipment. However, with a floating charge, the underlying assets are usually current assets or short-term assets that can change in value.
- A floating charge is a charge taken on non-constant assets of a corporation or a limited liability partnership as a security for indebtedness.
- Floating charges support companies by allowing them to use current assets to finance business operations.
- When a company fails to repay the security interest or enters liquidation, the floating charge converts to a fixed charge, after which the company is not allowed to use or sell the asset.
Floating charges allow business owners to access capital secured with dynamic or circulating assets. The assets backing the floating charge are short-term current assets, usually consumed by a company within one year.
The floating charge is secured by the current assets while allowing the company to use those assets to run its business operations. A floating charge on assets provides you with much more freedom than a fixed charge because you don’t need to seek approval from your lender before transferring, selling, or disposing of the assets.
Floating charge examples include stock, inventory, trade debtors, and so on. For lenders, fixed charges are preferable to floating charges because the value of the security isn’t likely to change. However, as it isn’t possible to attach fixed charges to every company asset, floating charges sometimes need to be used instead.
Crystallization of Floating Charges
Crystallization is the process by which a floating charge converts into a fixed charge. If a company fails to repay the loan or enters liquidation, the floating charge becomes crystallized or frozen into a fixed charge. With a fixed charge, the assets become fixed by the lender so the company cannot use the assets or sell them.
Crystallization can also happen if a company ends operations or if the borrower and lender go to court and the court appoints a receiver. Once crystallized, the now-fixed rate security cannot be sold, and the lender may take possession of it.
Typically, fixed charges are secured by tangible assets, such as buildings or equipment. For example, if a company takes out a mortgage on a building, the mortgage is a fixed charge, and the business cannot sell, transfer or dispose of the underlying asset—the building—until it repays the loan or meets other conditions outlined in the mortgage contract.
What’s the difference between a floating charge and a fixed charge?
As you can see, there are a couple of fundamental differences between floating charges and fixed charges. We’ve outlined some of the differences above, but to recap:
- Fixed charges apply to specific assets, whereas floating charges apply to all current assets
- Assets covered by fixed charges cannot be sold, unlike assets covered by floating charges
Aside from these, there’s one key difference between floating charges and fixed charges. Essentially, fixed charges have priority over floating charges in insolvency (meaning that they’ll be repaid first if the borrower can’t adhere to the terms of the agreement). In fact, floating charge holders are required to wait until fixed charge holders and preferential creditors have received their money before they can begin to recoup their debts.
Floating charges and debentures
It’s important to note that the status of your debt as falling under fixed charges or floating charges should be outlined in the debenture (a document confirming that the loan has been secured against a company’s assets, which is then registered at Companies House).