When businesses borrow from lenders, the lenders (like banks or other financial institutions) will often ask for security for the debt. There are two main types of charges: floating charges and fixed charges. But what’s the difference? Find out everything you need to know about floating charge on assets with our simple guide. First off, we’ll clarify the meaning of a fixed charge.
Fixed charge definition
A fixed charge is when a debt is secured against a substantial, identifiable asset, such as land, machinery, vehicles, etc. If the business isn’t able to stick to the terms of the agreement, then the lender will take control of these assets to recoup the money that it’s owed. If a lender has a fixed charge, they’ll also have a high level of control over the asset. In fact, the business won’t be able to sell, dispose, or transfer the asset unless they have permission from the lender.
There are many examples of fixed charges, including mortgages, bank loans, invoice factoring, and leases.
Floating charge definition
A floating charge (also referred to as a floating lien) is when a debt is secured against a group of non-constant assets, i.e., assets that may change in value and quantity. 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.
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.
How do floating charges “crystallize” into fixed charges?
In most cases, floating charges simply “float” above your business’s changing assets. However, there are a couple of scenarios where a floating charge can become a fixed charge:
The business will cease to exist at some point in the future
The business is about to be shut down
The business appoints the receiver
The business defaults on their repayments, and the lender takes steps to recover their debt
After a floating charge has crystallized, it can’t be sold, and the lender can take possession of it.
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).
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