Fixed and Floating Charge – Understanding the Differences
What is a fixed charge?
A fixed charge is attached to an identifiable asset at creation. Assets can include land, property, machinery, copyright, trademark and much more. The business does not typically sell these fixed assets, and the fixed charge is applied to protect the repayment of the company debt. The simplest way to put it into perspective is to think of a mortgage; you cannot sell your house without your lender’s permission, as you have not yet paid the debt off and own the house. With a fixed charge, the lender has full control of the company asset. Therefore, should any corporation want to sell that particular asset, they must have the lender’s approval to do so or pay off the debt.
Fixed charge examples
As previously mentioned, fixed charges are over substantial and physical assets. Examples include:
- Mortgage payments
- Rent deposits
- Chattels and leases
- Bill of sale
- Factored book debts
It’s important to note that a fixed charge repayment ranks before that of a floating charge repayment in company insolvency. You can find out more about the legislation of business insolvency with our What is Insolvency Law article.
What is a floating charge?
The term floating charge is apt, as a floating charge ‘floats’ by its very nature. While a fixed charge is attached to an asset that can be easily identified, a floating charge is a charge that floats above ever-changing assets.
The floating charge, or a security interest over a fund of changing company assets, allows for more freedom for a business, than the lender. While a fixed charge protects the lender, the floating charge gives more scope for the company to sell, transfer or dispose of their assets, without seeking approval from the bank. From the lender’s point of view, it leaves them exposed – particularly as floating charge repayments typically recoup less than the fixed charge. However, it’s impossible to attach a fixed charge on all company assets, hence the use of floating charge assets.
Floating charge examples
A floating charge differs from a fixed charge, as it refers to interest applied to company assets that are not constant, or changing. Examples of a floating charge feature:
- Stock and inventory
- Trade debtors
- Movable plant and machinery
- Furniture, fixtures and fittings with the business
Lenders may attempt to classify certain items on the above list as being subject to a fixed charge, however they will in reality only hold a floating charge over the specific company assets. Trade debtors are commonly miscategorised in this regard which can only be subjected to a fixed charge if they are factored and therefore in the control of the charge holder.
What is a debenture in relation to fixed and floating charge?
The definition of a debenture is a document that sets the terms of a loan and, thus, the types of charges – whether they are fixed or floating charges. This document sets out the amount borrowed, interest, when it needs to be repaid, charges securing the loan and insurance, etc. Debentures must be registered at companies house in order to create a valid floating charge and the lender will send that to be recorded once the company has agreed to the respective terms and conditions. A debenture provides security for the lender or bank, should the company fall into insolvency.
Default of a floating charge
If a borrower defaults on repayments to the lender, they will have discretion to issue a demand for repayment against the floating charge. This allows the bank to enforce the charge. This was previously commonly dealt with by appointing an administrative receiver, however it is much more usual for an administrator to be appointed. If the company gives notices of a liquidation or otherwise this will also generally be a default on the floating charge.
Examples of defaults on a floating charge
- Company defaults on payment to the bank
- The company give notice of intention to enter insolvency
- Breach of other terms and conditions of the loan
The fixed and floating charge differences are significant as much as the ways they can be enforced are. If you need to speak to an expert about the charges, or fear your company could be heading for the early stages of insolvency, get in touch with one of our experts to discuss your options.