What Is a Floating Charge vs. a Fixed Charge?

A floating charge is a type of security interest provided to lenders when a company obtains a loan. This arrangement allows a business to secure financing using its assets as collateral. Understanding this concept helps businesses leverage their assets for operational needs or expansion.

Defining a Floating Charge

A floating charge is a security interest granted over a fluctuating pool or class of a company’s assets, rather than over specific, individually identified assets. These assets change in quantity and value during normal business operations. Examples include inventory, accounts receivable, and cash, which are continuously acquired, used, and sold.

A floating charge’s “floating” nature means the borrower retains the ability to deal with these assets freely without needing the lender’s explicit consent for each transaction. This flexibility allows the business to continue trading, selling, and replacing its stock or collecting and replenishing its receivables. The charge hovers over the entire class of assets, attaching to them collectively as they exist at any given time. This approach is useful for companies that rely on dynamic assets to generate revenue and manage daily operations.

How a Floating Charge Operates

A floating charge remains dormant over individual assets until it “crystallizes” or converts into a fixed charge. Crystallization means the charge stops “floating” and instead attaches to the specific assets that are part of the secured pool at that exact moment. Once crystallized, the borrower’s freedom to deal with those assets without the lender’s permission ceases.

Common events that can trigger crystallization include a borrower defaulting on the loan agreement, the company entering liquidation or winding-up proceedings, or the lender appointing a receiver to manage the company’s assets. Additionally, the cessation of business operations can also cause a floating charge to crystallize. The terms outlining these triggers are detailed within the loan agreement or debenture that establishes the charge.

Floating Charge Versus Fixed Charge

A fixed charge is a security interest taken over specific, identifiable assets, differing from a floating charge. These assets are static and do not change frequently, such as land, buildings, or machinery. With a fixed charge, the borrower cannot sell, transfer, or otherwise deal with the secured asset without obtaining the lender’s prior consent.

The key distinctions between these two types of charges lie in the nature of the assets covered and the level of control the borrower maintains over them. While a floating charge covers a changing class of assets, allowing business flexibility, a fixed charge attaches to specific assets from the outset, restricting their disposal. Businesses often utilize floating charges for financing needs tied to circulating capital, while fixed charges are more suitable for securing loans against long-term, tangible assets.