Secured creditors enjoy enhanced rights on insolvency. They hold either fixed or floating charges (or both). Since each form of charge has different implications for the debtor’s ability to dispose of its assets, it is essential to understand the distinction between them.
Broadly speaking, the key criteria to characterise a charge as fixed or floating is the level of control the debtor has over the asset, regardless of the terminology used to describe the charge. When this is difficult to determine, the commercial nature and practical effect of the arrangement takes precedent over the definition given to describe the transaction.
A fixed charge is a direct charge over a specific ascertainable asset or category of assets which ensures that the debtor cannot deal or dispose of the charged asset(s) without the consent of the creditor.
Land and buildings, fixed plant and machinery, intellectual property and goodwill are typical examples of assets commonly secured using a fixed charge.
Following the court decisions on fixed charges over book debts (Spectrum v National Westminster Bank ) it will be unusual for such charges to be created and they will only be possible with very careful drafting. When dealing with book debts subject to a fixed charge, the court should determine whether the creditor has control over the collection and disposition of the book debts. Where this is not the case the charge will be treated as a floating charge.
In the event of default on a secured loan fixed charge holders will have the right to repossess and sell the charged asset(s) and appoint a fixed charge receiver.
Where there is more than one secured creditor they may agree between themselves as to the order in which they will rank. If there is no agreement the following rules will apply:
- Fixed charge holders over land are paid in order of registration at the Land Registry
- Fixed charge holders over other assets are paid in order of creation
A floating charge is a charge on a (usually changing) class of the assets of a company, present and future. It gives flexibility to both debtor and creditor. The debtor is free to deal with its assets in the ordinary course of business and the creditor is protected when a “crystallising event” takes place. Crystallisation occurs automatically when:
- A winding up order is made
- The company ceases to trade
- A secured creditor takes steps to enforce its security
Cash, stock, non-fixed plant and machinery and usually non-factored book debts are examples of assets commonly secured using a floating charge.
A floating charge holder can only appoint an administrative receiver if the floating charge was created before 15 September 2003, otherwise the charge holder will only have the right to appoint an administrator, provided that the charge falls within the definition of a “Qualifying Floating Charge Holder”.
Where there is more than one floating charge the charges are paid out in the order of creation unless the lenders have entered into a deed of priority in which case they are paid out in the order set out in the deed.
On a debtor’s insolvency, the holder of a fixed charge will get paid out of the proceeds of sale of the assets subject to that fixed charge before all other creditors. A floating charge holder only gets paid out after certain payments are made to other creditors, including preferential creditors, a percentage of unsecured liabilities and expenses of administration and liquidation, which can greatly affect the amount it receives.