What is a Floating Charge?

A floating charge is a type of ownership interest that is issued by companies or limited liability partnerships over a collection of non-constant assets. The term floating charge comes from the changing assets in the fund where the security interest is considered to “float” over the fund until the interest becomes a fixed charge. This means that the security interest is now tied to specific assets. An example of a floating charge would be inventory. It has a variable quantity and value over time and can be used as a type of collateral in a loan. The company retains an unhampered use of the inventory as long as the loan is current. However, in the event of default, the floating charge will convert into a fixed charge at the time of default and ownership interest of any present inventory will go to the lender. This effectively freezes the assets that were borrowed against so that the company cannot attempt to dispose or otherwise prevent the lender from seizing it. In practice, any assets which are not otherwise claimed by a lien or mortgage to another lender can be included in the fund that secures the loan.

Crystallization

Crystallization is the process by which a floating charge becomes a fixed charge. By definition, the owner of the floating charge agreement  cannot exercise property rights on the company’s assets before the floating charge is crystallized. The triggers for crystallization can be explicitly described in the floating charge agreement, but even without specified triggers, crystallization automatically occurs when the company begins to liquidate.

A common trigger provision included in agreements is that crystallization will automatically occur as soon as the company defaults on the loan. When the floating charge crystallizes, it becomes enforceable and is secured by whatever claimable assets belong to the company at the time.

Priority

Floating charges become fixed charges and are thus considered secured debt. These fixed charges will always be repaid before unsecured debt in the liquidation proceedings. There is, however, some conflict among which secured debt is paid first. Any mortgages or fixed charges which are secured by specific assets are always paid first. They are followed by preferential creditors, such as employees who are guaranteed a certain amount of unpaid wages and pension, and then fixed charges are paid.

Since floating charges have a lower priority, loan agreements tend to contain many fixed charges while minimizing the amount of the loan which is covered by a floating charge. This ensures the highest possible collection rate for the lender by pushing up the priority of the lender’s debt holdings. Even without fixed charge provisions, however, floating charges are still repaid before any type of unsecured debt.

It has thus been suggested that floating charges harm unsecured creditors because those unsecured creditors are therefore unlikely to see any sort of compensation during liquidation. Without a change in the statutes, this simply provides an incentive to creditors to always enter into floating charge arrangements before considering unsecured lending.

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