Floating charge

3 key takeaways

• A floating charge is a security interest over a pool of assets that are constantly changing, allowing the company to manage and use these assets until the charge crystallizes.
• Upon crystallization, the floating charge becomes a fixed charge over the specific assets held by the company at that time, limiting the company’s ability to dispose of these assets.
• Floating charges provide flexibility for businesses to operate and manage their assets while providing lenders with security that can become more concrete if the borrower defaults.

What is a floating charge?

A floating charge is a form of security interest that a lender holds over the assets of a borrower. Unlike a fixed charge, which is tied to specific assets, a floating charge covers a general pool of assets that may change in quantity and value over time. These assets can include inventory, receivables, and other current assets. The company can continue to use and trade these assets in the normal course of business until an event of default or another specified event occurs, causing the floating charge to crystallize into a fixed charge over the assets held at that moment.

Characteristics of floating charges

Dynamic nature: Floating charges are not tied to specific assets. Instead, they float over a pool of assets that can change as the company buys, sells, and replaces its current assets.

Crystallization: The floating charge remains flexible until a triggering event, such as default on a loan, insolvency, or a specified event in the loan agreement. At this point, the charge crystallizes, converting into a fixed charge over the assets held at that time.

Security for lenders: Floating charges provide lenders with a form of security that can become more concrete if the borrower encounters financial difficulties, offering protection against loss.

Flexibility for businesses: Companies benefit from floating charges by maintaining the ability to manage their assets freely in the ordinary course of business, which supports operational efficiency and flexibility.

Examples of assets under floating charges

Inventory: Goods held for sale, raw materials, and work-in-progress items are often included under a floating charge since their levels and values fluctuate regularly.

Accounts receivable: Outstanding invoices and amounts owed to the company by customers can be part of the floating charge, providing a valuable asset that changes as receivables are collected and new sales occur.

Cash and cash equivalents: Cash on hand, bank balances, and other short-term liquid assets can also be included under a floating charge, supporting the company’s liquidity needs.

Advantages of floating charges

Operational flexibility: Companies can continue to use and dispose of assets covered by the floating charge in their normal business operations without needing lender approval.

Broad security: Lenders receive security over a wide range of assets, increasing the likelihood of recovering funds if the borrower defaults.

Simplified lending: Floating charges simplify the process of securing loans, as they do not require detailed lists or valuations of specific assets.

Disadvantages of floating charges

Lower priority: In the event of liquidation, floating charges typically rank lower in priority compared to fixed charges and preferential creditors. This means that lenders with floating charges may receive payment only after these higher-priority claims are settled.

Potential for reduced asset value: As the pool of assets under a floating charge can change, the value of the assets available when the charge crystallizes may be lower than anticipated, reducing the security for lenders.

Complexity in enforcement: Crystallizing and enforcing a floating charge can be more complex than dealing with a fixed charge, as it involves identifying and securing the assets at the time of the triggering event.

Crystallization of floating charges

Crystallization occurs when a specified event in the loan agreement triggers the conversion of the floating charge into a fixed charge. Common triggering events include:

• Default on loan repayments.
• Insolvency or bankruptcy of the borrower.
• Appointment of a receiver or liquidator.
• Breach of covenant terms in the loan agreement.

Upon crystallization, the lender gains a fixed charge over the specific assets that are part of the asset pool at that moment, providing a more concrete security interest.

Related topics

To further understand the concept and implications of floating charges, consider exploring these related topics:

• Fixed Charges: Security interests that are tied to specific, identifiable assets of a borrower.
• Secured vs. Unsecured Loans: The differences between loans that are backed by collateral and those that are not.
• Insolvency and Liquidation: Processes and implications of a company’s financial failure and asset liquidation.
• Receivership: The role and process of appointing a receiver to manage the assets and operations of a financially troubled company.

Floating charges offer a flexible and dynamic form of security for lenders, allowing businesses to operate efficiently while providing protection for lenders in the event of default. Exploring these related topics can provide a deeper understanding of how floating charges function within the broader context of secured lending and financial management.