An introduction to floating charges

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A floating charge is a way of taking security over a pool of assets that change regularly. It can cover assets currently held, or those that may come into the chargor’s possession in the future. The assets secured can be sold or used as part of day-to-day business so a company can continue to trade while using its assets as security.

Floating v fixed

On the other hand, a fixed charge is granted over an identifiable asset and the lender needs to be able to exercise control over that asset. It cannot be granted over assets that continually change.

Whether a charge is fixed or floating depends on the control the lender has over the secured assets. If the lender was to attempt to create a fixed charge over a bank account, but the chargor could still withdraw freely from that account, then the charge will likely be deemed a floating charge, even if the charge document states differently. If the account is blocked however, it should be capable of being charged by a fixed charge. It is not always clear what is deemed to be sufficient control for different types of asset.

Priority – why it matters

Realisations in an insolvency rank in a particular order (as per the Insolvency Act 1986 (as amended)). Money from assets subject to fixed charges will get paid out first, if there are two or more charges in place the one created first (or for certain assets that need to be registered on a specialist register such as the Land Registry, the one registered first) will rank first.

The second in line of priority will be the payment of the expenses of the insolvent estate, which will include any fees due to the administrator. Preferential creditors such as contributions to pension schemes, wages and holiday pay to employees will be paid next, followed by the ‘prescribed part’.

The prescribed part is a ring-fenced pool of realisations under the floating charge that is set-aside for unsecured creditors. This will dilute the realisations available for distribution to the floating chargeholder.

The next to receive any money on insolvency will be the holders of floating charges and then unsecured creditors. The company’s shareholders are paid last.

This is a simplified outline of priority but shows why it matters if a charge anticipated as fixed is re-designated as floating, as the realisations available to the chargeholder will be diluted by the amount payable as the prescribed part.

In addition, the ‘default’ priority is often changed by agreement between some of the creditors (particularly the secured creditors) entering into intercreditor or priority arrangements. Such agreements won’t alter the payment waterfall described above, but can alter priority within a class of creditors, e.g. floating chargeholders.

Converting a floating charge

A floating charge can convert, or ‘crystallise’, into a fixed charge if certain events occur. The document containing the floating charge, usually a debenture, will allow for the floating charge to crystallise over all of the assets subject to it, or just some of them if the lender wishes.

Following crystallisation, the chargor’s ability to deal with the affected assets will be limited and the chargeholder will be entitled to appoint a receiver and/ or sell the assets subject to the charge. Crystallisation will usually be automatic on the occurrence of certain events and, on the occurrence of others, at the choice of the lender.

It is common for the floating charge to automatically be converted into a fixed charge if steps are taken to wind-up the chargor or appoint an administrator. Many lenders will also want automatic crystallisation if the chargor grants security to someone else over the asset, ceases trading, or if another lender tries to enforce its security. These events can result in crystallisation taking place very late, once financial difficulties of the chargor have become significant enough to warrant intervention.

To give the lender more protection, security will usually contain other triggers which will result in crystallisation, commonly an event of default or any other matter giving the lender reason to be concerned about the preservation of the assets or priority of the security.

However, the extent to which crystallisation takes effect will depend on the nature of the assets and the degree of control exercised over them by the lender.

Qualifying floating charges

A floating chargeholder may also have the right to appoint an administrator, who has a wide range of powers to run the business of the chargor and manage its affairs. An administrator will try to rescue the business of the company and will have duties to act in the interests of all the creditors.

In order to be able to appoint an administrator, without the need for a court application, the lender must hold a ‘qualifying‘ floating charge. There are a number of criteria that must be met in order to hold a qualifying floating charge (as per Schedule B1, Insolvency Act 1986) including specific wording in the charge document. In addition, the floating charge must be contained in a charge or charges which, together or separately, secure ‘the whole or substantially the whole’ of the company’s property.

Without a qualifying floating charge, the administration route is still available in the same way as it is for any creditor by application to court, but this adds additional time and cost. The lender will usually want to act quickly and appoint an administrator of its choice through the out-of-court route. This is why it is important to preserve the qualifying floating charge.

The issues with releases

This need for a floating charge to cover all or substantially all of the assets in order for it to be ‘qualifying’ makes any agreement to release assets from the security risky, unless those assets are being disposed of.

If a lender agrees that another lender can take prior security over an asset, it is best to retain the security and deal with priority in a separate deed. Releasing the asset from its security could result in a lender no longer having security over ‘all or substantially all’ of the assets, which will prevent it from appointing an administrator out of court.

In addition, the Insolvency Act requires the holder of a second ranking floating charge to notify the first floating chargeholder before enforcement. If they enter into a priority arrangement, the lending parties can decide in advance how the process should be carried out.

So whilst a simple deed of release or letter of non-crystallisation might seem the best route when allowing another lender to take security over an asset, if the chargor intends to keep ownership of the asset, a priority arrangement is preferable.

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