The use of charges as security for the repayment of debt is a common feature of agreements between businesses and their lenders. The current economic environment will have seriously tested the strength of existing charges while ensuring that they are increasingly common.
Many small business owners will attest to having been offered loans only if they are prepared to offer charges over business or even personal property. It is therefore of great importance that business managers recognise the types of obligations they are entering into, whether fixed or floating charges, and the potential implications that each carry.
The Basics
A charge can be taken over a variety of different assets such as bank accounts, plant and machinery and receivables. It gives a secured lender an equitable right in the charged property. This differs to a mortgage which gives a lender a legal right in the property although the effect is similar in practical terms; the lender can sell the charged assets in satisfaction of the debt.
Fixed Charges
Fixed charges give a lender security over specific, identifiable assets which the borrower cannot dispose of or deal with unless consent has been given by the lender. Fixed charges may be suited to illiquid assets such as a company's real estate. Businesses are generally less inclined to grant them over day to day assets such as inventory or bank accounts. An obligation to seek a lender's consent for day to day transactions is clearly impractical.
Floating Charges
Floating charges create an immediate interest in property but do not encumber specific identifiable assets. Commonly a company will grant its lender a floating charge over its "undertaking and assets, present and future". In this way the security is taken over a changing group of assets enabling a business to continue in the normal manner unless the floating charge is triggered by certain events, such as the appointment of a receiver. At that point the charge "crystallises" meaning it effectively becomes a fixed charge over the remaining assets of the business identifiable at that point in time.
The Lender's Perspective
From the point of view of a lender, fixed charges are generally considered more substantial than floating charges due to their prefered treatment in a liquidation process. Floating charges are usually subordinate to fixed charges, preferential creditors and liquidation expenses. They are also at risk of being set aside if they are taken to secure pre-existing debts and deductions can be made to pay unsecured creditors where the floating charge is over the "prescribed part" of any realisations.
Rollingsons has lawyers experienced in advising both lenders and borrowers regarding charges; if you need Company Law advice or would like more information please contact James Crighton via e-mail jcrighton@rollingsons.co.uk or by phone on 0207 611 4848.
