When a company borrows money from a lender, it’s not unusual for the lender to ask for some sort of security for the debt. This is to protect the lender’s position because they can then sell the asset they have been given for security if the loan cannot be repaid. Most business owners are pretty familiar with this concept - after all, it is the same thing that homeowners do when taking out a mortgage.
But when it comes to business loan security, things are a bit more confusing because there are two different types of charge that are used to give lenders security: fixed and floating charges. So, what is the difference between a fixed and floating charge? Read on to find out…
Fixed charge versus floating charge
Depending on the type of borrowing, lenders can register either a fixed or floating charge. Both fixed and floating charge holders are classed as secure lenders, however, fixed charge lenders have a higher position in the queue than a floating charge for the repayment of the debt should the borrowing company become insolvent.
What is a fixed charge?
If a loan or debt is subject to a fixed charge, it means that the borrowing is secured against a substantial and physical asset such as land, property, vehicles or machinery. When a lender has a fixed charge, it pretty much has full control over the asset. This means that if the business wants to sell, transfer or dispose of the asset, they need to get the permission of the lender first or pay off the remaining debt.
If the business doesn’t keep to the repayment terms of the loan agreement, the lender will take charge of the assets and sell it so that they can regain the money they are owed. A good example is a mortgage: when you take out a mortgage, you cannot own the house outright until the mortgage is paid off. You also can’t sell it without the lender’s permission - and if you don’t keep up with repayments, the house could be repossessed.
In business, a common example is often seen in factoring or invoice discounting facilities where the finance provider will buy a business’s outstanding invoices and then lend money against them. The invoices will then effectively belong to the loan provider, not the company.
What is a floating charge?
As the name suggests, this type of charges ‘floats’ over the assets, but the company is free to use them in the course of their trading. A floating charge applies to assets with a quantity or value that can change. Good examples of this are stock, debtors, raw material, work in progress, fixtures and fittings, vehicles and moveable machinery.
With floating charges, businesses have much more control because they can sell, transfer or dispose of the assets without approval from the lender or having to repay the debt first. Due to this, a floating charge will typically encompass both current and future assets to take into account those which are sold and acquired.
From the lender’s point of view, a floating charge is riskier, but it’s not possible to attach a fixed charge to every type of company asset, which is why floating charges are also used. Floating charges allow the lender to recover some money if the assets are sold, but the lender does rank behind some other creditors if the borrowing company becomes insolvent.
An overview of the differences
So, the major differences between a fixed and floating charge can be summed up as:
- A fixed charge applies to a specifically identifiable asset, whereas a floating charge is dynamic in nature
- An asset covered by a fixed charge cannot be sold or transferred without the lender’s permission, whereas a floating charge can be sold, transferred or disposed of unless it crystallises and becomes fixed (more on that below!)
- A fixed charge is given preference over a floating charge in insolvency
Can a floating charge become a fixed charge?
Floating charges only become fixed - a process known as ‘crystallisation’ - if the company runs into financial difficulty, enters liquidation or fails to keep up with repayments. This is known as a trigger event, and the company will then no longer be able to dispose of any assets covered by the charge.
What is a debenture?
A debenture is a document that sets out the fixed and floating charges as well as the attached terms and conditions. It sets out the amount borrowed, interest, when it needs to be repaid and the charges securing the loan.
When it is signed by the company, the lender will send a form to Companies House to register the charge. If property is involved, the charge will also be registered with Land Registry. This prevents others from getting security against the assets in question and provides security for the lender should the company fall into insolvency.
What happens if the business becomes insolvent?
If the business enters insolvency, there is a designated order that determines which creditors will be repaid from the sale of the company assets first. Both fixed and floating charge holders are classed as secured lenders, which means they will take priority of unsecured creditors.
Fixed charge holders are first in line for payment, whereas floating charge holders must wait until preferential creditors such as employees and the acting insolvency practitioner have been paid. By this point, however, there may not be enough to repay the debt in full.
Is your business struggling to make loan repayments?
If your company is facing financial difficulty, it’s important to seek expert advice as soon as possible. McAlister & Co are one of the most in-demand licensed insolvency practitioners in the UK, providing expert advice about the different options available.
We can help you:
- Deal with your creditors
- Deal with staff and unpaid wages
- Enable you to safely close a company and restart
- Give you the breathing space you need to make informed choices
The sooner you act, the better - so contact McAlister & Co today for friendly, confidential advice.