Floating Charge

Meaning of Floating Charge

A floating charge is a type of security that a creditor undertakes on entire business’s assets, in respect of a particular debt. Floating charge allows a business to borrow even when it does not own a particular asset like premises, which can act as a security. Under floating charge, a business can borrow against its assets like plant and machinery, stock in trade, vehicles, etc.

One of the main reason why floating charge came into existence was to allow businesses to buy and sell business inputs and stocks without affecting their day-to-day operations. They can obtain funding by keeping a charge on their inventories as collateral without interrupting their business operations.

After understanding what is floating charge, let us understand the characteristics of the same.

Characteristics of Floating Charge

Some of the characteristics of a floating charge are:

  • Floating charge allows unrestricted use of the asset held as security.
  • It is a cover against all the assets of the business. As and when the value of the assets change, the value of the charge also changes.
  • In case of floating charge, the borrower is not required to obtain the consent of the lender. The company can buy or sell the charged asset freely in the normal course of business.

Floating Charge

Advantages of Floating Charge

Floating charge is very beneficial. Let us see some of the benefits of floating charge.

  • Floating charge can be created even when the company does not have any fixed asset.
  • It offers a lot of freedom to the business owners.
  • The business is free to deal with the asset as if it was never secured. Business does not need any permission or consent from the lender before buying or selling the asset.
  • A floating charge holder is always better protected than an unsecured creditor.
  • In case of liquidation of the company, the floating charge holder can appoint an administrative receiver who will ensure maximum return to them.

Difference Between Floating Charge and Fixed Charge

Floating charge is different from the fixed charge. The fixed charge is attached to one or more assets while a floating charge is attached to all the company’s assets both present and future, which the company uses in the ordinary course of business.

In simple words, the fixed charge can be against tangible assets like equipment, building or intangible assets like patents, trademark. It is a mortgage against a particular asset. Like for example, if a business obtains a loan on the fixed charge basis by mortgaging its building, then, in that case, the business cannot sell or dispose off this building until it repays the entire loan.

On the other hand, a floating charge is created against a current asset, the value, and size of which keeps on fluctuating. It does not affect the ability of the business to use the underlying asset in the normal business operations. The business can sell, transfer or dispose off these assets as and when required. For example, if a business obtains a loan on floating charge basis against its inventory, then it can sell or dispose it off in the normal course of business without obtaining any consent from the lender. As and when the inventory gets sold or repurchased, the float value shifts. Hence, it is called floating charge.

Below are few points of differences between fixed and floating charge.

Fixed Charge Floating Charge
It is created on a particular asset. It is created on the entire company’s property.
A business cannot deal in the asset subject to fixed charge. A business can sell or dispose off any asset under floating charge.
In no case, a fixed charge can become a floating charge. In case of certain events, a floating charge may become a fixed charge.

When Does a Floating Charge Become Fixed?

The floating charge becomes fixed charge only when the company goes into liquidation or ceases to trade or fails to meet the terms of payment i.e. non-repayment of the loan undertaken. In such cases, the floating charge gets converted into fixed charge. The process of conversion of a floating charge security into fixed charge security is termed as Crystallization.

Once the security is crystallized, it cannot be sold or disposed off by the borrower. In addition, the lender obtains the right to take the possession of the crystallized security.

Conclusion

Floating charge allows flexibility to the receiver and is less of a hindrance for the lender. Overall, there are several good reasons that prove floating charge as a great option for banks and other lenders.

References:

https://www.investopedia.com/terms/f/floating_charge.asp

http://www.companylawclub.co.uk/fixed-and-floating-charges

http://www.rebuildnow.com.au/what-are-fixed-and-floating-charges/

Last updated on : November 28th, 2017
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