Fixed Charge vs. Floating Charge

Attribute	Fixed Charge	Floating Charge
Priority	Higher priority over unsecured creditors	Lower priority compared to fixed charge
Asset type	Specific assets are charged	Charges over a class of assets
Creation	Created by a specific agreement	Created by a general debenture
Control	Restricts the disposal of charged assets	Allows the company to deal with assets in the ordinary course of business
Conversion	Cannot be converted into a floating charge	Can be converted into a fixed charge
Ranking	Ranks higher in priority during liquidation	Ranks lower in priority during liquidation

Introduction

When it comes to financing options, businesses have various choices to consider. Two common types of charges used in lending agreements are fixed charge and floating charge. These charges provide lenders with security over a borrower's assets in case of default. While both types of charges serve the same purpose, they differ in terms of their attributes and the assets they cover. In this article, we will explore the characteristics of fixed charge and floating charge, highlighting their similarities and differences.

Fixed Charge

A fixed charge is a type of security interest that is created over specific assets of a borrower. These assets are typically tangible and identifiable, such as land, buildings, machinery, or vehicles. The key characteristic of a fixed charge is that it attaches to specific assets, meaning the borrower cannot sell or dispose of these assets without the lender's consent. The lender has a fixed claim on the assets covered by the charge, and in case of default, they have the right to seize and sell these assets to recover their debt.

One advantage of a fixed charge is that it provides a higher level of security for lenders compared to floating charges. Since the charge is attached to specific assets, the lender's claim takes priority over other creditors, including those with floating charges. This means that if the borrower becomes insolvent, the lender with a fixed charge has a better chance of recovering their debt. Additionally, the fixed charge ensures that the borrower cannot dispose of the secured assets without the lender's permission, reducing the risk of asset depletion.

However, there are also some limitations to fixed charges. The lender's claim is limited to the specific assets covered by the charge, which means that if the borrower has other assets that are not included, the lender may not have a claim on them. Furthermore, if the borrower sells or disposes of the assets covered by the fixed charge, the lender's security interest is extinguished, and they lose their claim on those assets. This makes fixed charges less flexible compared to floating charges, which we will discuss next.

Floating Charge

A floating charge, unlike a fixed charge, is a type of security interest that covers a class of assets rather than specific assets. These assets are typically more fluid and subject to change, such as inventory, stock, or accounts receivable. The floating charge "floats" over the assets until it crystallizes, which happens when certain events occur, such as default or insolvency. Once the charge crystallizes, it becomes a fixed charge, attaching to specific assets within the class covered by the floating charge.

One of the main advantages of a floating charge is its flexibility. Unlike a fixed charge, a floating charge allows the borrower to freely deal with the assets covered by the charge without seeking the lender's consent. This means that the borrower can sell, dispose of, or replace the assets as part of their normal business operations. The lender's claim only crystallizes when specific events occur, providing the borrower with more freedom in managing their assets.

However, the flexibility of floating charges also poses some risks for lenders. Since the charge covers a class of assets, the lender's claim is not as secure as with a fixed charge. If the borrower becomes insolvent, other creditors with fixed charges or preferential claims may have priority over the lender with a floating charge. This means that the lender's recovery may be limited if there are insufficient assets to satisfy all claims. Additionally, the floating charge may not cover assets acquired after its creation, leaving the lender without security for new assets.

Comparison

Now that we have explored the attributes of fixed charge and floating charge, let's summarize their key differences and similarities:

1. Asset Coverage

A fixed charge attaches to specific assets, providing a higher level of security for lenders. In contrast, a floating charge covers a class of assets, allowing the borrower more flexibility in dealing with those assets.

2. Priority of Claims

A lender with a fixed charge has priority over other creditors, including those with floating charges, in case of default or insolvency. However, a lender with a floating charge may face a lower priority if other creditors have fixed charges or preferential claims.

3. Asset Disposal

Under a fixed charge, the borrower cannot sell or dispose of the secured assets without the lender's consent. In contrast, a floating charge allows the borrower to freely deal with the assets covered by the charge until it crystallizes.

4. Flexibility

A fixed charge provides less flexibility for the borrower, as it restricts their ability to sell or dispose of the secured assets. On the other hand, a floating charge offers more flexibility, allowing the borrower to manage the assets covered by the charge without seeking the lender's consent.

5. Risk and Security

A fixed charge provides a higher level of security for lenders, as it attaches to specific assets and limits the borrower's ability to dispose of them. In contrast, a floating charge poses higher risks for lenders, as it covers a class of assets and may not have priority over other creditors.

Conclusion

Fixed charge and floating charge are two common types of security interests used in lending agreements. While both charges serve the purpose of providing security to lenders, they differ in terms of asset coverage, priority of claims, asset disposal, flexibility, and risk. A fixed charge offers higher security and priority for lenders but limits the borrower's flexibility, while a floating charge provides more flexibility but poses higher risks for lenders. Ultimately, the choice between fixed charge and floating charge depends on the specific circumstances and preferences of the parties involved in the lending agreement.