Key takeaways
– A floating charge (floating lien) is a security interest over a changing pool of assets—usually current assets such as inventory, receivables and marketable securities—so a company can continue using those assets in the ordinary course of business.
– A floating charge “crystallizes” into a fixed charge (the assets become locked and cannot be freely dealt with) on certain events: default, insolvency, appointment of a receiver, or other agreed triggers.
– Floating charges are useful to finance working capital but typically rank below fixed-charge holders and certain preferential creditors in insolvency; exact priorities and rules depend on local law.
– Documentation, registration/perfection, active monitoring, clear covenants and inter-creditor arrangements are essential for both lenders and borrowers to manage risk.
What is a floating charge?
A floating charge is a security interest over a category (or pool) of assets whose composition and value change over time. Unlike a fixed charge that attaches to a specific, identifiable asset (for example, a particular building or machine), a floating charge covers assets that are expected to be converted into cash or replaced in the normal cycle of business—typically inventory, accounts receivable, and other current assets. The company can continue to sell, replace and use those assets until the floating charge crystallizes.
Why companies use floating charges
– Preserve operating flexibility: a company can keep selling inventory and collecting receivables while still granting security to a lender.
– Access to working capital: lenders accept floating charges when borrowers lack sufficient fixed assets to secure loans.
– Efficient for revolving facilities: floating charges suit lines of credit and factoring-like arrangements where the collateral base changes frequently.
Key legal/economic features
– Attachment: The charge is created by agreement between lender and borrower and usually documented in a security agreement (charge instrument).
– Floating character: The debtor can deal with the secured assets in the ordinary course of business without the lender’s consent.
– Crystallization: On specified events (default, insolvency, appointment of a receiver, sometimes cessation of business, or other contractual triggers) the floating charge converts into a fixed charge over the assets then comprised in the pool—i.e., the lender’s security “freezes.”
– Priority: Floating charge holders generally rank behind fixed charge holders and may be subordinate to certain preferential creditors (taxes, wages) under applicable insolvency laws. Priority rules vary by jurisdiction.
– Registration/perfection: Many jurisdictions require registration or filing to perfect the floating charge and preserve priority against other creditors—failure to register can render the charge void against some parties.
Crystallization — how and why it happens
Common crystallization triggers
– Borrower default under loan terms (nonpayment, covenant breach).
– Insolvency events (administration, liquidation, bankruptcy filings).
– Appointment of a receiver over the company or its assets.
– Contractual triggers specified in the security agreement (e.g., an express notice from the lender).
Effects of crystallization
– The floating charge becomes fixed over the assets that exist at that time.
– The borrower loses freedom to sell or otherwise dispose of those assets without the lender’s consent.
– The lender gains enforcement options (seizure, sale of secured assets, appointment of receiver) subject to insolvency laws and any inter-creditor agreements.
Practical steps — for borrowers (companies considering using a floating charge)
1. Assess need and asset mix
– Determine whether working capital needs are best financed with a facility secured by current assets.
– Inventory and receivables are typical collateral; valuate expected volatility and lifecycle.
2. Compare security structures
– Evaluate fixed vs floating charge trade-offs: fixed charges give lenders more control (often cheaper credit) but limit operational flexibility; floating charges preserve flexibility.
3. Negotiate terms carefully
– Limit crystallization triggers where possible, or add cure periods and notice requirements.
– Negotiate thresholds for covenants (financial ratios, permitted disposals, liens).
– Address reporting and inspection rights (frequency and scope).
4. Inter-creditor arrangements
– If other secured creditors exist (e.g., mortgage holders with fixed charges), negotiate priority and subordination arrangements.
– Clarify ranking on insolvency and any carve-outs.
5. Draft and execute documentation
– Engage counsel to prepare a clear charge/security agreement describing the asset class, triggers, and remedies.
6. Register/perfect the charge
– File required notices/registrations in the relevant registry (Companies House or equivalent; UCC filings in U.S. contexts) to preserve priority—check local deadlines and requirements.
7. Maintain asset records and compliance
– Keep accurate, up-to-date records of the charged asset pool, inventory, collection activity and covenant compliance.
– Provide required lender reports and reconcile accounts regularly.
8. Plan for distress scenarios
– Have contingency plans for cure, refinancing, or negotiated standstill before triggers like insolvency become unavoidable.
Practical steps — for lenders
1. Due diligence
– Verify the nature, value and ownership of the proposed asset pool. Identify fixed-charge creditors and statutory preferential claims.
2. Structure protection
– Seek a floating charge for circulating collateral, but require stronger covenants, financial reporting, and possibly security over key receivables or specific assets where feasible.
– Consider a combination of fixed charges over key assets plus a floating charge over working capital.
3. Perfection and priority
– File/register the security instrument promptly and continually monitor other filings by the borrower that could affect priority.
4. Covenant and control rights
– Include affirmative and negative covenants to limit dispositions, change in business, additional liens, and to trigger pre-emptive rights on covenant breaches.
5. Monitoring and early enforcement
– Monitor covenant compliance, liquidity and financials. If signs of distress appear, act early to consider enforcement, enforcement alternatives (workouts), or crystallization.
6. Inter-creditor agreements
– Agree priority and enforcement protocols with other lenders to avoid racing to enforce and to manage distribution of proceeds in insolvency.
Priority and insolvency considerations
– Floating charge holders generally have lower priority than fixed charge holders. Many jurisdictions also give priority to statutory claims (taxes, employee wages) and insolvency-related costs.
– Some jurisdictions limit the amount recoverable by floating charge holders in administration/insolvency for the benefit of unsecured creditors (e.g., statutory “prescribed part” provisions in some laws). Always check local insolvency statute details.
Example (hypothetical; illustration only)
– Company: “RetailCo” has inventory worth $10 million (turnover asset) and seeks a $3 million working-capital loan.
– Lender accepts a floating charge over inventory and accounts receivable.
– While business is healthy, RetailCo sells and replenishes inventory without lender consent—floating charge continues to “float.”
– RetailCo misses payments and the security agreement’s default provisions allow the lender to declare default and crystallize the charge. At crystallization, the lender’s security becomes fixed over the remaining inventory and receivables at that moment; the lender can appoint a receiver or seize and sell assets under applicable law.
Accounting and reporting notes
– A floating charge is a legal security; its existence is disclosed in financial statement notes (e.g., “assets subject to floating charges”).
– The charge does not remove assets from current asset classification while floating, but crystallization and enforcement may affect presentation/disclosures—follow applicable accounting standards and disclosure rules.
Common pitfalls and risk mitigants
– Failure to register or imperfect perfection: ensure timely filing where required.
– Overbroad crystallization terms: negotiate reasonable cure periods and define events clearly.
– Priority surprises: map all existing encumbrances and statutory priorities before agreeing.
– Operational disruption on crystallization: include business continuity or sales protocols where possible to preserve value.
Jurisdictional differences
– The concept and treatment of floating charges vary widely. In common-law jurisdictions (e.g., UK, some Commonwealth countries), “floating charge” is a well-established security device with specific statutory consequences. In the U.S., secured transactions are typically governed by Article 9 of the Uniform Commercial Code (UCC) and use different terminology (security interests, purchase-money security interests), but the functional equivalent of security over changing assets exists.
– Always consult local counsel to confirm filing requirements, priority rules, registration deadlines and insolvency consequences.
When to use a floating charge (practical decision points)
– Appropriate when working-capital assets are the primary collateral and the borrower needs operational freedom.
– Consider a mixed approach (some fixed charges over key assets + floating charge over the rest) when lender wants stronger security for specific high-value items.
– Avoid if the borrower expects rapid decline in asset values, jurisdictional priority rules disadvantage floating-charge holders, or if lenders require tight control over inventory/receivables.
Further reading and source
– Investopedia: “Floating Charge” — https://www.investopedia.com/terms/f/floating_charge.asp
If you’d like, I can:
– Draft a sample clause for a floating charge and crystallization trigger to use for negotiation (tailored to a chosen jurisdiction), or
– Create a checklist for lenders/borrowers with jurisdiction-specific registration steps if you tell me which country or state you’re focused on.