A floating charge is a flexible security interest that covers changing assets like inventory and receivables until specific events trigger its conversion to a fixed charge, giving lenders security while allowing businesses to trade normally.
A floating charge is a specific type of security interest that lenders take over a company's assets, particularly those that change regularly in the ordinary course of business. Unlike a fixed charge which attaches to specific, identifiable assets like property or machinery, a floating charge "floats" over a class of assets such as inventory, stock, raw materials, or accounts receivable. This means the company can continue to buy, sell, and use these assets in its daily operations without needing lender approval for each transaction.
The floating charge concept was developed to allow businesses to secure financing whilst still being able to trade normally. Imagine a manufacturer that needs to borrow money but whose main assets are raw materials that get used up and finished goods that get sold daily. A traditional mortgage over specific items wouldn't work because those specific items won't exist tomorrow. A floating charge solves this by creating security over the "pool" of assets that constantly replenishes itself.
For founders seeking equity financing or other forms of business funding, understanding floating charges is essential. Lenders often require them as part of the security package to protect their investment. The charge remains "floating" until a predetermined event occurs—known as crystallisation—at which point it becomes fixed on the specific assets the company owns at that moment.
The fundamental difference between a floating charge and a fixed charge lies in the nature of the assets secured and the company's ability to deal with them. A fixed charge attaches to specific, identifiable assets like land, buildings, or major equipment. Once a fixed charge is created, the company cannot sell or dispose of those assets without the lender's consent. In contrast, a floating charge covers assets that are constantly changing, allowing the company to use, sell, and replace them in the normal course of business.
Another key distinction is priority in insolvency. Fixed charges generally rank higher than floating charges when a company becomes insolvent. This means fixed charge holders get paid first from the sale of their specific secured assets. Floating charge holders only receive payment after all fixed charges, preferential creditors, and insolvency expenses have been satisfied from the assets covered by their charge.
Floating charges typically cover assets that a business uses and replaces regularly. The most common categories include stock and inventory, raw materials, work in progress, trade debtors (accounts receivable), cash at bank (except that subject to a fixed charge), and sometimes intellectual property like trademarks that are licensed rather than sold outright.
Importantly, assets that are essential to the company's continued operation are often excluded from floating charges or subject to restrictions. For example, a manufacturing company's specialised machinery might be subject to a fixed charge, whilst its inventory of finished goods would be covered by a floating charge. The exact assets covered will be specified in the debenture or loan agreement creating the charge.
Crystallisation is the process by which a floating charge becomes fixed on specific assets. This typically occurs when certain predetermined events happen, most commonly: the company ceases trading, goes into administration or liquidation, fails to make loan repayments (defaults on the debt), or if the company breaches the terms of the loan agreement in another significant way.
Once crystallised, the floating charge holder's rights become similar to those of a fixed charge holder. They can appoint an administrator to take control of the assets, or in some cases, appoint a receiver to sell the assets and repay the debt. The charge "fixes" on whatever assets the company owns at that moment, and the company loses the ability to deal with those assets freely.
In Ireland, a floating charge is created through a legal document called a debenture, which sets out the terms of the loan and the security being provided. The debenture must be registered with the Companies Registration Office (CRO) within 21 days of creation to be valid against the company's creditors and liquidators. This registration gives notice to the world that the lender has security over the company's assets.
Failure to register a floating charge within the 21-day period renders it void against any liquidator, administrator, or creditor of the company. This strict timeline means lenders are usually very diligent about registration. As a borrower, you should ensure any floating charge appears correctly on your company's public record at the CRO to maintain transparency with other potential creditors.
For lenders, a floating charge provides security over assets that would otherwise be difficult to secure. It allows them to lend against the value of a company's working capital—the very assets that generate revenue. This is particularly valuable for retail, manufacturing, or wholesale businesses where inventory and receivables represent significant value.
A floating charge also gives lenders considerable control if things go wrong. Once crystallised, the charge holder can appoint an administrator or receiver to take control of the business and its assets. This ability to intervene quickly can maximise recovery compared to unsecured creditors who must wait for liquidation proceedings to conclude.
For borrowing companies, the main risk of granting a floating charge is the loss of flexibility if the charge crystallises. Once crystallised, the company cannot deal with the charged assets without the lender's consent, which can severely hamper operations during financial difficulty. This can create a downward spiral where the company cannot trade its way out of trouble.
Another risk is that floating charges rank behind many other claims in insolvency. Employee wages, certain taxes, and insolvency practitioner fees typically take priority over floating charge holders. This means that even if a lender has a floating charge, they may recover little or nothing if the company fails with significant preferential debts.
Yes, certain floating charges can be challenged, particularly if created shortly before insolvency. Under Irish law, a floating charge created within 12 months of the company going into liquidation may be invalid unless the company was solvent immediately after creating the charge. This prevents companies from giving security to one creditor to the detriment of others when they know insolvency is imminent.
Floating charges can also be challenged if they are seen as unfairly prejudicing other creditors or if they were created without proper corporate authority. In extreme cases, a court might set aside a floating charge if it determines the transaction was at an undervalue or was intended to defraud creditors.
While a floating charge is "floating," it generally does not interfere with day-to-day business operations. The company can continue to buy and sell stock, collect receivables, and use cash normally. However, the debenture creating the charge will often include covenants restricting certain actions, such as selling major assets without consent or incurring additional secured debt.
Companies with floating charges should be aware that major corporate transactions might require lender approval. For example, entering into a joint venture agreement that involves transferring charged assets could trigger default provisions. Similarly, if the company faces legal action resulting in an injunction that prevents it from trading, this might constitute an event of default under the loan agreement.
When a company with a floating charge is sold, the charge typically transfers with the company to the new owner. The new owner assumes the obligation to the lender, and the floating charge continues to attach to the company's assets. However, the sale might trigger a requirement to repay the debt, depending on the terms of the loan agreement.
If the sale involves only assets rather than the entire company, the situation is more complex. The floating charge would likely crystallise upon the sale of a substantial part of the charged assets. The lender would need to consent to the asset sale and might require partial repayment of the loan from the sale proceeds. This is why transparency with lenders about major asset sales is crucial for companies with floating charges.
