Floating Charges And Fixed Charges: Understanding The Differences
Floating charges, fixed charges and understanding the differences between the two are important for anyone involved in running a business – especially if you’re looking to borrow capital.
Financial institutions, for example banks, will normally seek some kind of security when lending money. This security is often more tangible than simply a credit rating.
The bank requires genuine reassurance they can regain the money lent, should the loanee be unable to pay it back.
In day-to-day life, this is commonly exemplified by mortgages. Should the homeowner be unable to repay the bank, the bank can recoup the money via the property.
In this situation in business, a mortgage would be a fixed charge.
In this article we will provide an overview of floating charges and fixed charges to clarify the difference between the two.
What is a fixed charge?
By mentioning mortgages above, we’ve given a clue as to one of the most common types of fixed charge.
We tend to see fixed charges against property, land or significant parts of business infrastructure such as immovable machinery.
Fixed charges don’t necessarily need to be physical. From intellectual property and copyright, to factored debts and mortgage payments, fixed charges can represent a broad range of tangibles and intangibles.
What unifies these types of fixed charges is the control the lender has over them. Should a business want to sell a fixed asset, they will have to seek approval from the lender – or have already resolved all outstanding debts.
What is a floating charge?
It’s a common misconception that the difference between a fixed and floating charge comes down to whether they are physical. As we’ve seen above, this isn’t the case.
A floating charge is generally seen as more flexible for the borrowing business. Floating charges are dynamic – as the name suggests. The charges cover assets such as stock, movable machinery, and debtors. They can also refer to future assets acquired in the running of a business.
A business may feel more secure in borrowing money against floating charges since such assets can be managed by the business without lender approval.
Contrastingly, a lender may prefer a fixed charge option given the greater potential for the value of such floating assets to fluctuate over time.
Note: a floating charge can become fixed in certain circumstances, which we shall look at in more detail.
Understanding the differences between floating and fixed charges
Crucially, it comes down to the control of the charge holder.
The selling or transferring of a fixed charge cannot take place without the charge holder’s (the lender’s) assent. On the other hand, a floating charge can be managed as the business sees fit.
When it comes to insolvency and payment disputes, fixed charges take precedent over floating charges in order of repayment.
As we touched on above, a floating charge can become fixed – or in insolvency parlance, “crystallised”.
If a business is to be wound up, becomes insolvent or enters receivership (among other debt-related issues), a floating charge may become fixed. The lender gains control of how the asset is managed until its debts are settled or recovered.
How do fixed and floating charges relate to insolvency?
Insolvency proceedings follow a set pattern, determining the order in which creditors are reimbursed.
Creditors holding fixed and floating charges are defined as “secured lenders”.
This prioritises them over unsecured creditors (whose lending is not tied to a fixed or floating asset) who will have to wait for their reimbursement.
However, among the secured lenders, fixed charge holders will take priority over those holding floating charges.
The Insolvency Act 1986 lays out the order in which repayments take place in a company insolvency scenario.
In addition, floating and fixed charges can also occur in debentures. Read our blog for more information as to what debentures are and how they work.
Seek advice at all stages of the process
It’s worth considering carefully the type of business loan you require. Due to the nature of your business, or its current status, an unsecured option may be more appropriate.
Certainly, it is strongly recommended to take specialist advice.
At Hudson Weir, we’re highly experienced in guiding companies through the insolvency process and various procedures involved.
We will be able to clearly breakdown your obligations as a business owner when it comes to repaying creditors and help you to define the difference between floating charges and fixed charges.
If you would like to discuss your current credit situation in more detail, don’t hesitate to contact us for a no-obligation chat.
