Fixed and Floating Charges
Author: John A Waller, Director December 23rd,2021.
If a limited company borrows from a financial institution, the lender needs security for the loan.
Therefore, protect the lender by allowing it to take back the asset and sell the assets, which act as security should the borrower default on payment. And enter liquidation.
However, the disorder often comes with the two types of charge, fixed and floating, used to provide lenders security over the assets of a limited company.
A fixed charge applies to debts secured against a considerable and distinguishable physical asset, examples being property, land, vehicles, and plant and machinery. In the event the company cannot comply with the terms of the financing agreement, the lender as a creditor will take over the asset and try to sell it to recover the money owed.
Fixed Charge Over Company Assets?
If a lender has a fixed charge, it effectively controls the asset to which the charge applies. If the company wants to sell, transfer the company asset, it must obtain permission from the lender or pay off the remaining debt.
Notably, a fixed charge gives the lender a higher position in the repayment order than a floating charge.
Examples of Fixed Charges?
Examples of financial arrangements generally subject to a fixed charge (Secured)– also known as secured – include:
- Commercial Mortgages
- Bank loans
- Invoice factoring
A floating charge applies to assets with variable quantity and value, examples being: stock, portable plant and machinery, debtors of the company.
A floating charge allows companies to have greater flexibility than fixed charges, as they may trade with the assets and even sell them.
However, a floating charge exposes lenders to depreciation of assets, along with debtor reduction.
So it is impossible to attach a fixed charge to every company asset, which explains the use of floating charges.
The crystallisation of Floating Charges
In the following circumstances, floating charges essentially ‘float’ above changing assets and only become fixed charges, a process known as ‘crystallisation’. The Limited Company:
- Therefore, defaults on a payment prompt the lender to recover the debt.
- Faces a winding-up order;
- Has an insolvency practitioner been appointed?
- Ceases to exist.
How does a Fixed and Floating Charge differ?
Many types exist:
- A fixed fee applies to a specific identifiable asset, while a floating fee is dynamic and involves the entire company property.
- An asset subject to a fixed charge cannot be sold or transferred unless the charge holder agrees.
- However, a floating charge may be sold, transferred, or disposed of until it crystallises and becomes fixed.
- Fixed charges always prefer a floating charge incorporating UK insolvency.
What Happens in Insolvency?
Should a limited company experience an insolvency process? Then a designated order determines which creditors will be repaid from the sale of company assets first.
Both fixed and floating charge holders remain classified as secured lenders on a liquidation. So, therefore, prioritise unsecured creditors, who must wait until all other costs and creditors are paid before receiving any of the money owed.
Priority of Fixed and Floating Chargeholders?
The holders of fixed fees are first in line for repayment and receive the money owed from realising the company’s assets. They hold a fixed charge. The order for repayment in an insolvency situation, as noted in the Insolvency Act 1986, is:
- Fees of the liquidator;
- Secured creditors with a fixed charge
- Preferential creditors – company employees with unpaid wages
- Secured creditors with a floating charge
- Unsecured creditors.
Floating charge holders remain paid once fixed charge holders, preferential creditors such as employees, and pay the insolvency practitioner before any auctioning payment. But, there may not be enough money to repay debt in full. The unsecured creditor may not receive any funds,