What is a floating charge? How it works and why lenders use it

How a floating charge differs from a fixed charge

A fixed charge attaches to a specific, identifiable asset from the moment of creation. The company cannot deal with that asset — sell it, charge it again, or substitute it — without the lender's consent. A floating charge, by contrast, describes a category of assets ("all book debts", "all stock in trade") rather than individual items, and the company continues to use, sell, and replace those assets in the ordinary course of business.

The floating quality is what makes this form of security commercially practical for working-capital lending. A business that needed its lender's permission to sell each item of stock or collect each invoice could not function. The floating charge allows the lender to take security over an entire asset class while the business trades normally.

Crystallisation: when the charge fixes

Crystallisation occurs on the happening of a specified event and causes the floating charge to become a fixed charge over the assets in the class at that moment. Common crystallisation triggers include: appointment of a receiver or administrator, commencement of winding up, the company ceasing to carry on business, or an automatic crystallisation event if the debenture includes one (such as a missed payment).

Once crystallised, the company loses the ability to deal with the assets without the charge holder's consent, just as with a fixed charge from the outset. The lender then has priority over those assets subject to the rules on preferential creditors and the Prescribed Part.

The Prescribed Part and unsecured creditors

The Insolvency Act 1986 (as amended by the Enterprise Act 2002) requires that a portion of the net property subject to a floating charge be ring-fenced for the company's unsecured creditors — the "Prescribed Part". The amount is calculated as a percentage of the net floating charge property, subject to a cap. This means floating charge holders do not receive all of the proceeds from those assets: a slice goes to unsecured creditors regardless of the charge.

Lenders take this into account when pricing floating charge facilities, which is part of why working-capital lending against debtors may carry a higher margin than lending secured by a first fixed charge over land. The practical cap on the Prescribed Part means the impact on the lender is bounded, but it is a real feature of the security structure that directors should understand.

Automatic crystallisation clauses

Some debentures contain automatic crystallisation provisions that purport to crystallise the floating charge on a specified event without any overt act by the lender — for example, on a company ceasing to carry on business. The legal effectiveness of automatic crystallisation in English law is settled in most circumstances, though third parties dealing with the company in good faith and without notice may have defences if they acquire assets between the crystallisation event and any public notification.

Directors should be aware that an automatic crystallisation clause can lock down assets with no warning if a trigger event occurs. Understanding which events in your debenture trigger automatic crystallisation — and ensuring you do not inadvertently trip a trigger — requires a careful read of the security document with your solicitor.