What is a Charge?

A charge is an equitable interest in an asset to secure a loan. It does not transfer ownership of the asset to the lender or require possession of the asset by the lender. If the loan is repaid, the charge terminates. If the loan is not repaid, the borrower has a right to enforce the charge, sell the assets, and apply the proceeds towards repayment of the loan.

In general, any existing or future asset that is identifiable and capable of being transferred can be the subject of a charge. This includes land, goods, and intangible property (such as accounts receivable, securities, goodwill, and intellectual property).

Charges can either be fixed or floating, and the status of a charge as one or the other can be critical to the lender if the borrower becomes insolvent, because it will greatly affect the lender’s priority with respect to the borrower’s other creditors.

For a charge to be fixed the lender must have control over the charged asset. This means that only assets which are definite and ascertained can be the subject of a fixed charge such as land, buildings, equipment, intellectual property rights, etc. Therefore, it is important for the effectiveness of the fixed charge that the charged assets be identified as precisely as possible and the lender be given as much control over them as possible.

In order to accomplish this, the charge document or Debenture under which a lender takes a fixed charge will typically give the lender the right to:
  • Prevent the borrower from disposing of the asset without the lender's consent
  • Sell the asset if the borrower defaults under the loan
  • Require the borrower to maintain the asset

However, keep in mind that whether a charge is fixed or floating is not a matter of the intention of the parties, but a matter of fact. Regardless of what the charge document says, if the lender does not in reality have sufficient control over the asset, the charge will be deemed to be floating. For example, if in practice the borrower is allowed to freely sell the assets without the lender's consent, the charge will be floating.

Floating charges hover above a shifting pool of assets that are not definite and ascertainable and/or are not under the control of the lender. Floating charges normally cover classes of assets belonging to the borrower which, in the ordinary course of business, change from time to time such as cash in bank, book debts and stock in trade. Unlike assets secured by a fixed charge, which are described specifically, the assets secured by a floating charge are described generically.

The most common example is a floating charge over the borrower’s inventory, which is stocked, sold, and restocked in the normal conduct of the business without the consent of the lender. This illustrates both the advantage and disadvantage of a floating charge. On the one hand, it provides the flexibility of allowing the lender to take a security interests over an evolving class of assets where a fixed charge is not possible without restricting the borrower’s ability to conduct its business. But on the other hand, it leaves open the risk that all of the assets subject to the floating charge will be sold.

However, a floating charge can convert, or crystallize, into a fixed charge if certain events occur, such as when the borrower stops conducting business or a receiver is appointed. In addition, a charge document or Debenture will typically specify other events that either automatically trigger crystallization of a charged asset or give the lender the right to do so. Once an asset has “crystallized”, the borrower’s ability to dispose of the asset becomes restricted.

The status of a charge as fixed or floating becomes most important when a borrower becomes insolvent. During insolvency proceedings, the holder of a fixed charge will get paid out of the proceeds of sale of the charged assets before all other creditors (including preferential creditors such as employees and employee pension schemes). In contrast, the holder of a floating charge will only be paid following payment of the holders of fixed charges and the preferential creditors.

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