Fixed and Floating Charges

Hmm! Where to start? When a company (and also applicable to individuals in so far as fixed charges are concerned) needs to borrow money (for an individual, that would be acquiring a mortgage to buy a property, but I’ll concentrate on companies from here on) they can maybe find a lender or group of lenders prepared to lend the company money.

But those lenders, in a commercial environment, will likely want some security so typically the company will offer to pledge the company assets as security.

Now you know from John’s lectures for the Financial Accounts paper that there are basically two types of asset – fixed and current – and these two assets have radically differing characteristics. Fixed assets are held by the company for the long term whereas the intention of the company is to realise the current assets (use up or sell) within the following 12 months.

But both types of asset have a value for the purposes of being used as security to offer lenders in exchange for the receipt of the lenders’ money. Those assets with a potentially longer life – the fixed assets – will typically be used as security for a fixed charge debenture and, again typically, the title documents to those fixed assets could well be physically handed over to the lenders,

The current assets, on the contrary, are transient in nature and will change on a daily basis. These are not suitable assets to pledge as security for a fixed charge debenture but satisfy the necessary characteristics to be used as security for a floating charge debenture – security that attaches to a specific CLASS of assets as distinct from the fixed charge that attaches to specific INDIVIDUAL assets.

Thus, whilst inventory changes in its detail on a daily basis, there will always be inventory as a company asset.

The related debentures – ie the loans – and thus also the security offered – ie the charges – don’t exist until they are artificially created. The date of creation is the date when all the paperwork is completed, signed, sealed and filed with the Registrar of Companies and details entered into the company’s own Register of Mortgages and Charges.

Now, imagine that a company approaches you and asks to borrow money from you. If you have some to lend (and it would be no good asking ME for a loan!) you would probably ask for some sort of security. If the company has already used its assets as security for earlier loans that are still outstanding, then those earlier lenders will take priority over your subsequent loan in the event that the company is unable to pay in full.

And that explains in brief, I hope, the concept of the creation and registration, and thus also the concept of prioritisation in the situation where there are two similar charges on the same assets.

But it’s not always so simple. For example, whereas there may be two separate loans over the same asset, it could be that one of those loans is secured by a fixed charge and the other by a floating charge.

Where the floating charge was created 4 years ago and extends over the ‘assets of the company including goodwill’ and now the company is seeking to use some of those fixed assets as security for a fixed charge debenture, that would result in the fixed assets being the subject of two separate charges. The normal rule says ‘earlier one has priority’ but now we’re faced with a fixed charge debenture created subsequent to the floating charge debenture. So which one has priority?

The subsequent FIXED CHARGE debenture ranks higher than the floater even though it was created after the floater.

How can a floating charge lender protect their investment? By including within the loan paper work a ‘negative pledge clause’ that requires the company, where it is proposing to create a fixed charge over property that is already pledged as security to the first lender, to notify the first lender that a fixed charge is about to be created over some property and that that fixed charge debenture will rank higher in priority that the earlier floater.

Is that OK?