When banks or private institutions lend money, they tend to require some kind of security for the debt. This is to mitigate risk when giving out a loan, as lenders can repossess collateral assets in the event the borrower cannot repay the debt.
This is to be expected from most, if not all, borrowers, regardless of whether they are borrowing for commercial or private use. As such, most prospective borrowers have some understanding of loan security. However, what is often less understood is the charges associated with loans, namely fixed and floating charges.
In this article, we will break down these charges, giving you what you need to make an informed decision when assessing your loan options.
What is a fixed charge?
A fixed charge loan is a type of secured loan used to acquire specific assets, such as a house, a vehicle, or equipment for a company. As these assets are not owned by the borrower outright, they cannot be sold or otherwise discarded without the lender’s permission. Fixed charge loans must be repaid as per the loan agreement, which stipulates fixed repayments at regular intervals for an agreed-upon period.
Examples of fixed charges
There are several types of fixed charges. Here are some examples:
- Mortgages – When taking out a mortgage to purchase a house, you can neither sell it without the lender’s permission, nor own it outright until the debt is paid. This, in addition to the regular mortgage repayments, makes mortgages a type of fixed charge.
- Bank loans – Though a bank loan can be used to fund a wide variety of purchases, it must be repaid at regular intervals and often at a fixed rate. This regular repayment makes them a form of fixed charge.
- Vehicle/equipment loans – Many loans that are used to purchase a vehicle or equipment fall under the category of a fixed charge. Lenders must be asked for permission to sell these assets, and you won’t fully own them until the debt is paid.
What is a floating charge?
A floating charge is considerably different. While still a type of secured loan, they are much more flexible than the rigid fixed charges, affording borrowers some room for manoeuvre regarding their assets. For example, a borrower is free to sell their assets without permission from the lender under a floating charge.
Floating charges are usually applied to assets that have properties prone to change. These properties can include quantity, their value, or their condition. As such, it does not make sense to apply a fixed charge, given how easily the assets could change.
Although floating charges usually act in the background, there are events that could cause them to “crystallise.” These events are known as trigger events, referring to instances where the borrower cannot make repayments. One of the most common trigger events is a company entering liquidation. In this instance, the company will be forbidden from selling or otherwise disposing of assets under a floating charge.
Examples of floating charges
There are several types of floating charges. Here are some examples:
- Stock – The items that make up a company’s stock can change in a number of ways. A company could decide to purchase stock in lower quantities, the value of the order could increase or decrease, and many types of stock can degrade over a short space of time. As such, a floating charge is usually held over stock.
- Incomplete services – If a company takes out a loan to fund the rendering of a service, such as the refurbishment of a property, it often falls under a floating charge until it is complete. As the work is in progress, the cost is prone to change. As such, it is held under a floating charge.
- Assets not held under a fixed charge – Vehicles, equipment, and other assets often held under a fixed charge can sometimes be subject to a floating charge.
Key differences between fixed and floating charges
As you can see, there are several key differences between fixed and floating charges. The most notable, of course, is that assets held under fixed charges cannot be sold without the lender’s permission. This can be considerably restrictive for companies that aim to sell the target of a loan, which can effectively preclude them from taking out loans with fixed charges. This is not the case for a floating charge.
Another key difference is that floating charges are much more dynamic than fixed charges. The latter is often used for specific assets with rigid properties, while floating charges have a wider, more flexible application. This can be an important distinction for some businesses.
In addition to the above, there is one more key difference between the two – who gets paid first during insolvency proceedings. In the event a company goes into liquidation, fixed charges are always given priority over floating charges. Let’s continue in more detail.
What happens during the insolvency process?
If your company enters insolvency proceedings, outstanding creditors must be repaid in a certain order. This order prioritises lenders of secured loans over lenders of unsecured loans. Both fixed and floating charges are classed as secured loans. Meaning that they will be given priority when it comes to repayment. Fixed charges, however, are given preference over floating charges.
If you decide to liquidate your company, assets will be sold to raise money for repayments. Money raised through the sale of assets held under a fixed charge will go to repaying their respective loans. Due to the aforementioned hierarchy, floating charges will have to wait until all fixed charges have been paid. However, other payments must be made beforehand. Preferential creditors, such as employees, must be paid first, as does the appointed insolvency practitioner. Once those payments have been made, floating charge lenders can receive their dues.
Clarke Bell can help
If you have decided to pursue liquidation for your company, then Clarke Bell can help you through the process. We offer a range of services, including a Creditors’ Voluntary Liquidation (CVL) and a Members’ Voluntary Liquidation (MVL). Clarke Bell have earned significant experience over our 28 years of working with companies. We know we can find the best path forward for you. To find out what we can do to help, don’t hesitate to contact our experts today.