When businesses borrow, the lender will require some kind of security as reassurance that their money can be recovered should the business in question fail to make its agreed repayments. This security is called a charge and can be ‘fixed’ or ‘floating’, depending on exactly what is being borrowed.
While all businesses will borrow at some point in their lifetime and therefore should be aware of fixed and floating charges, complexities can arise if the business finds itself in trouble. If the lender wishes to recover what was borrowed, it will be key to understand the difference between fixed and floating charges to ensure that a possible rescue plan or company liquidation is navigated legally and effectively.
What Are Fixed Charges?
Lenders can obtain security for borrowing through a fixed charge. Fixed charges are created over specific and identifiable assets of a company, such as buildings, machinery and even land. In the event that the business cannot repay the amount borrowed, the lender can then repossess the asset as collateral for the loan. The business will also need to seek permission from the lender if it wishes to sell an asset secured with a fixed charge. They may agree that the asset can be sold, providing the remaining debt is paid off first.
What Are Floating Charges?
Floating charges are the other type of security that can be held over a loan and, as the name implies, can ‘float’ or change over time. Typically this type of charge will apply to assets that change by nature such as stock, debtors and even cash. Crucially, it is not linked to a specific asset which gives companies the freedom to use and dispose of these assets while doing business.
However, lenders can make demands for repayment should they not receive payments as agreed. Failure to pay or an event like the company going into liquidation will result in the floating charge being crystalised and therefore linked or fixed to a specific asset. When this kind of event occurs, the asset(s) can no longer be used or disposed of freely and the lender can use it/them as collateral for the loan.
The Differences Between Fixed And Floating Charges
From the outset of a loan, a business should be provided with a document called a debenture which outlines the terms and amount of the loan and highlights which type of charges are held against it. Businesses should make sure they are familiar with the differences between fixed and floating charges at this stage so that they are aware of any trading restrictions and what may happen should they default on the loan.
The key differences between fixed and floating charges are:
- Asset specificity – fixed charges are attached to specific assets from the start of the loan. Floating charges will apply to a fluctuating pool of assets but can be fixed to a specific asset if the company enters into insolvency.
- Sale and disposal – assets secured with a fixed charge cannot be sold or disposed of without the consent of the lender. If a floating charge is in place, the company can operate normally and deal with the assets in the course of business.
- Priority – if the business enters into liquidation, fixed charge holders will be paid ahead of floating charge holders.
Fixed And Floating Charges In Business Rescue & Closure
If a business keeps up with all agreed repayments, it is unlikely to have to worry about the lender reclaiming the money borrowed via a fixed or floating charge. However, if the business is struggling and enters into a formal insolvency process like company administration or liquidation, the type of security held by the lender becomes very important.
Both fixed and floating charges count as secured creditors which means they are the priority for repayment when an insolvency practitioner sells and distributes assets to creditors. Fixed charges will always come ahead of floating charges but it is important to note that both still take priority over unsecured creditors. Unsecured creditors will only receive any money once the security of secured creditors has been satisfied.
If your business is struggling to pay its debts, make sure you know what kind of security is held against the loan. If you need any additional information about the types of charges that may be attached to your borrowing, do not hesitate to get in touch with the business rescue experts at Ballard Business Recovery. We can help you understand the implications of your borrowing and navigate your next steps if you are struggling to pay. Get in touch today to find out more.
