22nd November 2021
When a company borrows money to purchase a fixed asset such as land, a building, or piece of machinery, the lender will require security in the form of a fixed charge. This protects them from the risk of non-payment, and allows repossession and sale of the item if the borrower enters insolvency and is liquidated.
This arrangement is similar to a mortgage on a domestic property, whereby the borrower does not fully own their home until the loan is repaid, and the lender has the right to repossess the property on default.
A similar example is when a company enters into an invoice factoring arrangement – the factoring company ‘buys’ the value of sales invoices, lends money back to the business, but takes a fixed charge on the sales ledger.
Terms and conditions of the charge should be set out within a debenture, a document which needs to be registered with Companies House within 21 days before it becomes valid. It is also possible that the charge will have to be registered in other ways, such as with Land Registry if land or property is involved.
The same requirement to register a debenture applies to floating charges. In fact, banks sometimes take a fixed charge over specific hard assets, as well as a floating charge over general classes of asset, so the entire asset base of a company is included within a single debenture.
So how do floating charges differ from fixed charges?
Floating charges work in a similar way to fixed charges, but are attached to an asset class rather than a single asset. The assets in question could be stock, cash, or work-in-progress for example, the main significance being that they can be used by the company in the normal course of trade.
When a company defaults or liquidation commences, the floating charge ‘crystallises’ into a fixed charge on the associated assets. Depending when the charge was created, the charge-holder may then be able to appoint their own administrative receiver or administrator to deal with the assets if liquidation occurs.
A floating charge can be seen to be more flexible than a fixed charge, but once it has crystallised, the company can no longer use the associated assets in the course of trade, and they are effectively frozen.
Both types of charge protect the lender should a business fail, as charge-holders have priority over unsecured creditors in a liquidation distribution. The terms and conditions of a floating charge agreement will specify the conditions under which crystallisation occurs – generally default on a loan repayment, and automatically on company liquidation.
As we mentioned earlier, the document that links a lender’s right to certain assets via a charge, and a company’s agreement to the arrangement, is a debenture. It sets out the terms and conditions of the security charge, such as when it crystallises. Its registration also ensures that other lenders cannot take precedence without a Deed of Priority.
If new lenders wish to create their own additional charge on company assets, they will need to liaise with one another to establish the order of priority payment, should default or liquidation occur.
A Deed of Priority sets out this ranking of loans and repayments, so in the event of the company being unable to fulfil the terms of any borrowing, it is clear which lender takes priority over the others.
Under the Insolvency Act 1986, there is a specific hierarchy for repayment in an insolvency situation:
The ‘prescribed part’ is an amount set aside for the benefit of unsecured creditors, from the realisation of assets with a floating charge created after 15th September 2003. As you can see, fixed charge-holders are paid first.
Secured creditors with a floating charge rank below preferential creditors, which is why lenders will try to maximise the proportion of a loan that is covered by a fixed charge.
Security charges are a complex area of business, but essentially, fixed and floating charges allow the lender to sell an asset if a company fails to meet the agreed terms of borrowing.
If you need more information about security charges, Real Business Rescue can provide professional guidance and support. We will ensure you understand the implications of attaching a charge to your company’s assets, and offer a free same-day consultation in complete confidence. With 100 offices across the UK, you’re never far away from expert and confidential advice.