What Are Fixed or Floating Charges?

As a company director, navigating the complexities of corporate finance is an integral part of your role. Key to this understanding is the concept of fixed and floating charges – two distinct forms of security often used by companies to secure loans from banks or other lenders.

Understanding the nature and implications of these charges is not only vital for effective financial management but also imperative in the event of insolvency or liquidation. However, distinguishing between these two types of charges can be challenging. Not to mention the legal complexities and implications that come into play should a company face financial distress.

In this article, we will delve into the fundamentals of fixed and floating charges, their differences, and the importance of each in the context of insolvency and legal cases. Whether you’re looking to secure a loan, manage your company’s finances, or navigate through difficult financial circumstances, this article will offer an informative guide to understanding and managing fixed and floating charges.

So, let’s embark on this journey of understanding the ins and outs of fixed and floating charges, a critical component in the finance toolkit of every company director.

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Definition and Explanation of Fixed and Floating Charges

When a company borrows money from a lender such as a bank, it is common for the lender to require some form of security for the loan. This is where fixed and floating charges come into play. They are mechanisms that give lenders a legal right over a company’s assets if the company cannot repay its debts.

Fixed Charge

A fixed charge is tied to a specific, identifiable asset or group of assets, such as land, buildings, machinery, or vehicles. The company can’t sell or dispose of these assets without the approval of the charge holder, usually the lender, as they have a ‘fixed’ interest in the assets. In essence, a fixed charge provides a lender with the security of a specific asset, if the company is unable to repay its debt.

For example, let’s say a company has a loan secured with a fixed charge over a piece of machinery. The company cannot sell that machinery without the consent of the lender. If the company were to default on its loan, the lender can take possession of the machinery to recoup the debt.

Floating Charge

On the other hand, a floating charge ‘floats’ over the general pool of assets of a company. These assets typically include stock, debtor books, or cash, which change in the normal course of business. As such, the company can use and trade these assets freely. However, upon certain events (like company insolvency), the floating charge can ‘crystallise’ and convert into a fixed charge over the assets it covers at that point in time.

For instance, a floating charge could be held over a company’s stock. While the charge is floating, the company can sell, replace, and deal with the stock as it sees fit. However, if the company fails to repay the loan, the floating charge crystallises into a fixed charge, and the lender can seize the stock to repay the debt.

Understanding these charges is crucial as they not only impact a company’s ability to use its assets but also determine the priority of debt repayment, especially in situations like insolvency or liquidation. In the following sections, we will delve deeper into the differences between these charges and their implications.

Comparison and Distinction Between Fixed and Floating Charges

When discussing fixed and floating charges, it’s important to highlight their key differences in terms of assets covered, control, security, and implications for both the company and the charge holder.

Assets Covered

As previously stated, fixed charges are linked to specific, identifiable assets like property, land, or machinery. Floating charges, however, are broader and apply to a pool of ever-changing, non-specific assets such as stock or the debtor book.

Control

A fixed charge restricts a company’s control over the asset. Under this charge, the company cannot dispose of or change the nature of the asset without the approval of the charge holder. In contrast, a floating charge allows a company to freely use, trade, or dispose of assets in the normal course of business, until the charge crystallises.

Security

From the lender’s perspective, a fixed charge offers more security. If a company defaults, the lender has a direct claim to the specific asset under the fixed charge. In contrast, the assets under a floating charge are less certain and can be disposed of by the company until the charge crystallises.

Implications for Company and Charge Holder

Fixed charges are usually ranked first for repayment in an event of insolvency, ahead of floating charges and unsecured creditors. This is beneficial for the charge holders as they get priority over others in asset recovery. For companies, fixed charges might limit their operational flexibility as they can’t freely deal with the assets without the lender’s approval.

Conversely, floating charges provide companies with greater flexibility, allowing them to use and trade their assets freely. However, for the charge holder, they might rank lower in the ‘pecking order’ during insolvency.

Consider an example of a company with both types of charges. It has a fixed charge on its office building and a floating charge on its stock. In normal operations, the company can sell and replenish its stock freely, but can’t sell the office building without the consent of the fixed charge holder. If the company faces insolvency, the fixed charge holder has the first claim on the office building, while the floating charge holder can only claim what’s left after fixed charge holders and preferential creditors have been paid.

These distinctions are critical for company directors to understand, as they impact how the company can use its assets, how it repays its debts, and the security offered to lenders. In the next section, we’ll delve into the legal implications of these charges.

Importance and Implications of Fixed and Floating Charges in Insolvency and Legal Cases

Fixed and floating charges carry significant implications during insolvency and legal proceedings, affecting the priority of repayment, the company’s dealings with creditors, and the engagement with insolvency practitioners.

Impact on Insolvency and Liquidation

The existence of fixed and floating charges greatly influences the outcome of insolvency and liquidation processes. As previously noted, fixed charge holders are prioritised for repayment. They have a direct claim over the specific asset(s) charged, even before preferential creditors. Following this, preferential creditors – typically staff owed wages – are paid, and then the floating charge holders from the ‘prescribed part’. The ‘prescribed part’ is a portion of the company’s net property set aside to repay unsecured creditors. Only after these creditors have been paid, any leftover assets are distributed among unsecured creditors, who unfortunately, often receive nothing or a negligible amount.

Legal Implications and Requirements

In the UK, under the Companies Act 2006, both fixed and floating charges created by a company must be registered at Companies House within 21 days of their creation, or they will be void against the liquidator and creditors. The registration process requires a specific document known as an MR01 form, accompanied by a certified copy of the charge deed.

Additionally, the insolvency law, specifically the Insolvency Act 1986, determines the priority of repayment during insolvency or liquidation proceedings. It also outlines conditions under which a floating charge might crystallise, turning it into a fixed charge.

Dealings with Creditors and Insolvency Practitioners

Understanding these charges also impacts the company’s dealings with creditors and insolvency practitioners. For example, in a Creditor’s Voluntary Liquidation scenario, the insolvency practitioner’s role includes the identification of all company assets and their respective charge holders. The practitioner must then follow the legal priority for repayment when distributing assets.

Furthermore, in the case of an administrative receiver being appointed by the holder of a floating charge (a right typically reserved for floating charges created before 15 September 2003), the receiver’s primary duty is towards the appointing charge holder, even though they also have a general duty to all creditors.

In essence, having an awareness of the nature of fixed and floating charges, and their implications in insolvency, can prove vital for company directors in managing business finances and dealing with creditors.

In the next section, we’ll address some frequently asked questions about fixed and floating charges to further deepen your understanding.

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FAQ Section

Here are some common questions that company directors often have about fixed and floating charges:

Remember, the answers provided here are for general informational purposes. It is recommended to seek professional advice tailored to your specific circumstances when dealing with fixed and floating charges.

Conclusion

Understanding fixed and floating charges is of utmost importance for company directors in managing the financial landscape of their businesses. In summary, fixed charges are tied to specific assets, limiting a company’s control over them, while floating charges cover a pool of assets that can be freely used until they crystallise.

These charges have significant implications, especially during insolvency and liquidation proceedings. Fixed charge holders are prioritised for repayment, while floating charge holders rank lower in the order of distribution. Registering fixed and floating charges with Companies House is a legal requirement to ensure their validity.

By comprehending the nature and implications of fixed and floating charges, company directors can make informed financial decisions, negotiate loan agreements, and understand the rights and priorities of lenders and charge holders. This knowledge enables better financial management and engagement with insolvency practitioners when dealing with challenging situations.

If you find your company in need of assistance with a Creditor Voluntary Liquidation, Company Doctor is here to help. Based in Leeds, we offer nationwide support and specialise in guiding businesses through the process. Reach out to us for professional advice and guidance tailored to your specific circumstances. Our number is 0800 169 1536

In conclusion, fixed and floating charges form an essential part of a company’s financial framework. Company directors who grasp their intricacies and implications gain an advantage in managing assets, negotiating loans, and navigating financial difficulties. Stay informed, seek professional advice when needed, and ensure your company’s financial stability through a thorough understanding of fixed and floating charges.

References

The primary sources for this article are listed below.

Companies Act 2006 (legislation.gov.uk)

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