What are Fixed and Floating Charges: Examples and FAQs

Securing finance for a business is no easy feat. Securing financing for a business can be challenging. Lenders often require collateral in exchange for a loan to reduce the risk of default. The type of charge applied to the collateral, either fixed or floating, depends on the asset used as collateral. A fixed charge is applied to tangible assets, and a floating charge is applied to intangible assets.

Meaning of fixed charge on assets 

When physical assets such as machinery, land, or property are used as collateral to finance a loan, then charges levied on such loans are called fixed charges. 

Fixed charges give the lender a legal right over the physical assets. If the business intends to use the said asset in any way—sell, transfer, or dispose of it—it’ll have to get the lender's permission or repay the loan. If the business cannot repay the loan or disagrees with reasonable repayment terms, the lender will take charge of these assets and sell them to recoup the money.

Fixed charges give lenders a higher position in the creditors' queue than floating charges. This means if the company heads to the gates of insolvency, lenders will get their money first, followed by other creditors.

Fixed Charge Example

Some of the most common examples of fixed charges are as follows:

• Bank loans
• Leases and rentals
• Mortgages
• Rent deposits

 However, lenders cannot attach a fixed charge to every company property. In such cases, floating charges are used.

Meaning of Floating Charge on Assets 

 When tangible assets, such as stocks or machinery, are used as collateral to finance a loan, charges levied on such a loan are called floating charges. These are called floating because the assets mentioned above can change over time as the external and internal environment change and assets move. For example, stock prices change constantly, and machinery can be moved from one place to another.

Unlike fixed charges, floating charges are said to give more freedom to the business than fixed charges. The business can sell, transfer, or dispose of the said assets without asking the lender or seeking approval. Moreover, the value of floating assets changes all the time, which exposes the lender. 

To limit the lender’s vulnerability, floating charges become fixed if the business defaults on the repayment terms. This is called the crystallisation of floating charges. This phenomenon occurs in the following conditions:

• The company appoints an insolvency practitioner
• The company is about to be wound up
• The company might cease to exist

Floating Charge Example

Some of the most common examples of floating charges are as follows:

• Cash
• Stock
• Inventory
• Furniture, fittings, fixtures
• Machinery and plant

Difference Between Fixed Charge vs Floating Charge

The difference between a fixed charge and a floating charge is as follows:

Fixed Charge vs Floating Charge During Insolvency 

 What becomes of fixed and floating charges when it becomes apparent the company is in no shape to continue operations and repay the loans? In such cases, different creditors and stakeholders are given precedence that is followed when the remaining money is repaid.

 For example, secured creditors are repaid before unsecured creditors. Fixed and floating charges come under the secure category; therefore, they take precedence and are paid first. However, floating charge holders must wait until the fixed charges are paid.

FAQs on Fixed and Floating charges

What is a fixed debenture?

A fixed debenture or fixed-charge debenture is a loan issued against specific assets with a fixed interest rate. The companies sign off assets to the creditor as collateral, which also restricts the said assets.

What is a floating debenture?

A floating debenture is another kind of loan that requires the borrower to sign off an entire class of assets over to the creditor as collateral, for example, the entire inventory. However, this doesn’t give the collateral any control over the asset because the value and quantity of such assets fluctuate.

What is the deed of priority?

A deed of priority is a legal agreement that defines the terms between various lenders. A business might want to take loans from multiple creditors, and a deed of priority ensures how the realisation of assets would be dealt with should one lender’s security compete with another. This is referred to in case of insolvency.