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Most loans banks make to businesses contain fixed and floating charges. However, many business owners are not always clear about these charges. For instance, you may not be aware that a charge is a form of security or different from other security agreements. This article will explain what fixed, and floating charges mean for your company, their effect, and what happens if a bank enforces a charge.
What Are Charges?
Charges are one of three kinds of security. A charge is an agreement between your company and the bank. Under this agreement, you give the bank rights to your company’s property in exchange for the loan. This differs from other forms of security, such as where the bank takes ownership or possession of the secured asset.
A charge is either fixed or floating. In practice, a bank takes a fixed and floating charge over all of the company’s assets. The main distinction between a fixed and floating charge is how your company is free to use the secured property.
Fixed Charges
From the perspective of a bank lending money to a company, the most secure form of security would be to physically take hold of the property and keep it under the bank’s lock and key. However, from a practical point of view, taking possession of assets is not feasible.
Instead, your company can grant the bank rights over the property that allows them to take possession of the property in the event of default. This is referred to as a fixed charge. However, if you grant a fixed charge over your property, you:
- cannot sell the property or otherwise transfer that covers it;
- will generally have to keep the asset in good condition; and
- cannot try to borrow additional money from another lender by granting another charge over the same asset.
Floating Charges
One of the critical effects of a fixed charge is that you cannot sell or transfer ownership of the property over which the bank has the fixed charge. This can cause issues, particularly when your business needs to be able to sell the property.
Hence, banks can take a floating charge over all the assets you use to trade to get around this issue. As long as your business observes the loan terms, you are free to buy and sell these assets. However, in the event of default, the bank reserves the right to freeze your ability to trade these assets. At this point, the floating charge “crystalises” to a fixed charge so that you can no longer dispose of these assets without the bank’s permission.
What is the Purpose of a Charge?
Fixed and floating charges are kinds of security. Therefore, to understand how fixed and floating charges work, you need to know how security agreements in loans generally operate.
It is possible to grant security over any asset. In other words, if your business owns something of value, a bank can take security in it. This includes:
- land;
- machinery;
- intellectual property;
- bank accounts;
- shares in the company; and
- money owed to your company.
The bank’s exact mechanism to enforce its security depends on the type of security interest the bank has in your company’s property.
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Practical Considerations
For most businesses that receive a bank loan, the bank will seek to secure as much of the business’ assets as possible through a fixed charge. Any assets that are not suitable to be secured by a fixed charge, such as your widget inventory, will be secured by a floating charge. Nevertheless, since loan agreements and other debt documents are complex, you should always obtain a solicitor’s advice before your business enters into a loan agreement.
Key Takeaways
Fixed and floating charges are the cornerstone of most business loan agreements’ security packages. This is because they allow businesses to use their valuable assets while granting the bank rights to the property. If a business defaults on the secured loan terms, the bank can use these rights to take ownership and possession of the property and sell it to recover the borrowed money.
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Frequently Asked Questions
A fixed charge is a form of security that grants the lender (a bank) the right to take hold of the property and sell it if the borrower defaults under the terms of the loan. A fixed charge differs from a floating charge because the borrower cannot sell the secured property.
A floating charge grants the bank a similar right to take possession of the property and sell it where the borrower has defaulted. However, as long as the borrower observes the terms of the loan, they are free to sell and dispose of the property.
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