What Is a Floating Lien and How Does It Work?

A floating lien represents a type of security interest that lenders can hold over a debtor’s assets. Unlike traditional liens that attach to specific, unchanging property, a floating lien is designed to cover a fluctuating pool of assets. This security interest allows businesses to obtain financing by pledging a general category of assets that may change in quantity and value over time. It provides a dynamic form of collateral that adapts to the ongoing operations of a business.

Understanding the Floating Lien

A floating lien “floats” over a changing class of assets, expanding to include new assets acquired by the borrower and releasing assets sold or consumed in the normal course of business. This contrasts with a fixed lien, which targets a specific asset like machinery or real estate and remains attached until the debt is satisfied. A fixed lien typically requires lender consent for disposal.

Sometimes called a floating charge, this lien provides a broad legal interest over a pool of assets, particularly relevant for businesses with dynamic asset bases such as inventory or accounts receivable. These collateral assets are not static; they can be traded, sold, or disposed of without requiring constant lender approval. This flexibility distinguishes floating liens from more rigid security interests.

How Floating Liens Operate

Floating liens cover assets that constantly change as a business operates. Examples include inventory (bought, sold, replenished) and accounts receivable (fluctuating with billing and payments). Other assets like raw materials or work-in-progress can also fall under a floating lien. The agreement describes asset categories rather than individual items.

“Attachment” is central to how a floating lien functions. Attachment occurs when the security interest legally comes into existence, binding the collateral to the debt. New assets acquired by the borrower automatically become subject to the lien, while assets sold or used are released. This automatic adjustment ensures the lender’s security interest remains comprehensive without continuous updates.

When a debtor defaults or another triggering event occurs, the floating lien “crystallizes.” Crystallization transforms the floating lien into a fixed charge, making the assets static and preventing the debtor from freely using or disposing of them. This allows the creditor to recover missed payments or sell the collateral. In bankruptcy, a floating lien immediately becomes fixed.

Why Floating Liens Are Used

Floating liens offer advantages for both lenders and borrowers in commercial financing. Businesses gain flexibility, securing financing with assets like inventory or accounts receivable without re-pledging for every transaction. This is beneficial for companies whose primary assets are current assets, allowing them to leverage ongoing operations for capital.

Lenders secure a broad range of collateral without the administrative burden of constantly monitoring specific items. The lien automatically attaches to new assets and releases old ones, simplifying collateral management. This broad coverage provides a dynamic security interest, adapting to the borrower’s evolving asset base and offering continuous protection for the loan. It enables lenders to support revolving credit facilities and other operating debt.

Establishing Legal Enforceability

To make a floating lien legally effective and enforceable against third parties, the lender must “perfect” their security interest. Perfection provides public notice of the lien, establishing the lender’s claim to the collateral. The primary method is filing a Uniform Commercial Code (UCC) financing statement, known as a UCC-1 form, with the appropriate state authority, typically the Secretary of State’s office. This filing informs other potential creditors.

The UCC-1 statement includes the debtor’s name and address, the secured party’s name and address, and a description of the collateral. This form registers the debt and security interest with the state, similar to recording a deed for real property. Filing fees vary by state, typically $10 to $100. A UCC-1 is valid for five years and must be renewed with a continuation statement to maintain its perfected status.

Filing a UCC-1 also establishes the lender’s “priority” over other creditors. Priority determines which creditor has the superior claim to the collateral in default or bankruptcy. Generally, the first creditor to properly perfect their security interest holds the highest priority claim. This public notice system mitigates risk for lenders and ensures an orderly process for resolving claims against a debtor’s assets.