I am really confused as to the difference between a fixed and floating charge and what they mean to my business.
Easy to understand Guide to FIXED and FLOATING Charges!
Well it sounds easy but....
First an admission the title is a bit misleading as the whole subject of security charges is pretty complex!
We have written this guide to give a basic understanding of the types of charges and a worked example of liquidation will hopefully illustrate it for you. But you should ask us for help on your own particular circumstances.
When a company borrows money, the lender / bank usually takes some security for that debt, this is designed to protect the lenders' position and also to try and get the lenders' money back if the borrower fails.
What is a FIXED CHARGE?
The bank or lender may have provided money to acquire an asset like property, printing press, car, etc. The company cannot sell this without the lenders permission. The debt must be repaid as per the loan agreement or facility letter.
Think of a mortgage, you borrow money to buy a house, you cannot own the house outright until the debt is repaid, nor can you sell it without the lenders permission. The mortgage is a form of fixed charge.
Another example is an assignment of a company's debtor book through factoring or invoice discounting. This means the bank buys the outstanding invoices and lends money against them. The debtor book is then subject to a FIXED charge. In effect, the book debts belong to the bank or factoring company, NOT the company.
The factoring or discounting charge is the most common fixed charge, other than property.
Another fixed charge is the Goodwill payment in administration. For example, if the business fixed assets, sold by an administrator, are worth £20,000, but the buyer pays £100,000 for the business, the databases, the customers and so forth, then £80,000 is a goodwill payment. This is usually paid to the bank or lender.
What is FLOATING CHARGE?
- Stock, finished or raw material
- Work in progress
- Unfactored debtors
- Fixtures and fittings
- Vehicles or assets not subject to fixed charges
If you think about it, many of these are things that the company uses to generate business and trade, it would not be practical to stick a fixed charge over every item of stock or desks and chairs, would it?
So the floating charge allows the lender to recover some money if the assets are sold. But the lender does rank behind some other creditors like wages, and the "prescribed part creditors". This is where it gets complicated!
What is a Debenture?
This is the document that sets out the FIXED and FLOATING charges and the attached terms and conditions. When signed by the company the lender sends a form to Companies House to register that charge. This prevents other people getting security against the assets in question, unless a Deed of Priority is created (see below).
What happens if a company becomes insolvent?
This is where things get a bit more complex! Instead of theory, here is a simple example.
Suppose a software company has a debtor book of £350,000 against which Royal Bank has provided factoring facility of £250,000 and an overdraft of £20,000. The company has £50,000 of fixed assets and 15 people. It owes £100,000 to tax and trade creditors. It loses a big client and enters liquidation. The debtor book would be collected (usually by lender and directors who have provided personal guarantees). BUT debtors don't always get recovered in full, of course!
After insolvency costs, a total of £200,000 is collected in from debtors. The business is sold to a buyer for £30,000 goodwill and £25,000 for the assets like work in progress, PCs, equipment etc but not debtors. So a total of £255,000 is available.
The bank as a FIXED and FLOATING charge holder would be paid out as follows; Debtor proceeds of £200,000 go to pay fixed charge off. The Goodwill element is also a fixed charge "collection" and is paid to the bank as well. Thus the bank has a shortfall of £20,000 on the fixed charge.
There are arrears of staff salaries and holiday pay of £20,000. That is paid next, to the ex-staff from the £25,000 received for the assets. That leaves £5,000 available for the bank under the floating charge collection. It is still owed £20,000 under the fixed charge and also the overdraft of £20,000 remains.
In this very simple example the bank would lose c£40,000. The preferential (staff) creditors are paid in full and unsecured creditors get nothing.
Insolvency ranking - prefer to see a picture flowchart (click here)?
What is a Deed of Priority?
If there are a number of lenders and a number of loans a pecking (ranking) order is drawn up and the Deed lays out the order of priority if a default occurs.
What is a Deed of Postponement?
Often a director will introduce money to a company and the bank will require his loans to be frozen until their debt is serviced and or paid.
So I hope this little guide helps your understanding, suffice to say in practice is much more difficult.
When a bank sees a shortfall looming, it will want a practical solution that ensures the best recovery of its debt obviously, but with asset values falling many banks will see losses ahead.
If you want to ask questions about fixed and floating charges please email us or call Iain Campbell on 08009700539.
If you are interested in creating a fixed charge over assets or want to make a loan to a company then you may be interested in some standard templates of letters and agreements. We have agreed discounts on the Simply Docs website, please see this page for details.
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