Floating Charge: a Worked Example

A wholesaler cannot ask its bank's permission every time a pallet leaves the warehouse. Stock is sold, debtors pay, new stock arrives, and the balance sheet that secured the loan in September is made of different goods by January. Security that froze those assets would stop the business. The floating charge solves this by covering a class of assets, present and future, while leaving the company free to deal with them in the ordinary course until something happens to end that freedom. That freedom is what makes the charge floating, and the House of Lords in [2005] UKHL 41 treated it as the decisive feature.

The label is at home in the United Kingdom, where a company's charges are registered at Companies House, generally within 21 days of creation. New Zealand and Australia moved personal property to registration regimes, in which a charge of this kind is one form of security interest. The working document there is the general security agreement, and the statutes turn on the asset: accounts receivable and inventory in New Zealand, circulating assets in Australia. The commercial problem is the same in all three.

Under English law a floating charge converts on crystallisation: the company's freedom to deal ends and the charge attaches to what is there. Winding up, a receiver's appointment and ceasing business are the familiar triggers, and the document can add notice or automatic events. Crystallisation does not improve the lender's rank against the claims below, because the UK Insolvency Act defines a floating charge as one that was floating as created. In the United Kingdom, a holder of a qualifying floating charge over substantially all of a company's property can also appoint an administrator, which gives the charge a control value beyond its proceeds.

The prescribed part is a sliding scale on the net property. It reaches a statutory maximum, and that maximum depends on when the charge was created. New Zealand and Australia have no equivalent, but their preferential claims reach the same assets first.

A toy wholesaler in England, constructed for this page like every figure in it, has a US$7.0m facility from its bank, secured by a debenture with a floating charge over stock and debtors. The company banks its receipts freely, so the debtors are floating-charge assets, whatever the document calls them. In September, ahead of Christmas, the pool is at its peak. After a weak season the company enters administration in February.

The bank's recovery from its floating charge is about 13% of the facility. The prescribed-part scale is set in sterling; at this size the line is close to 20% of the net property, and the example applies it to the dollar figures for simplicity.

The first two lines are the point. Between September and February the company sold its stock, collected its debts, paid its suppliers and did not replace what it sold, because orders were falling. It did nothing the charge forbade. A lender who valued the security from the September balance sheet was valuing goods that had been sold, and the document had permitted every step.

A fixed charge attaches at once to identified property, and the owner cannot dispose of it without the lender's consent. It is paid from that asset after the costs of selling it, ahead of preferential claims and the prescribed part. A floating charge bears those deductions. That difference is why lenders draft for fixed charges over debtors, and why a label alone does not achieve one: the English courts look at whether the lender actually controls the asset and its proceeds. The debenture page works that contest through, and the pool's fall in value above is a separate weakness, which applies however the charge is labelled.

On ranking between the two, a fixed charge over an asset generally takes priority over a floating charge on the same asset under English law, unless the floating charge restricted later security and the later lender knew of that restriction. Under the New Zealand and Australian registers, priority between security interests turns largely on the order of registration, subject to rules such as those for a purchase money security interest.

DEFINED IN ONE PARAGRAPH → · THE DEBENTURE → · WHAT YOUR BANK HOLDS AS SECURITY →

A floating charge is read as a claim on a future balance sheet. The credit paper therefore starts from what the pool would hold at the point of failure, not from the last set of accounts. It then deducts the costs and the claims above, using the borrower's headcount and tax position. A desk may read a seasonal business nearer its low point, and a shrinking one below its latest figures.

The lender's answers lie in monitoring and structure. A borrowing base certificate ties drawings to the pool as it moves, and aged debtor and stock reports show the decline before it reaches a set of accounts. A negative pledge restricts other security being granted over the same assets. Timing matters too: in the UK a floating charge granted shortly before insolvency to secure existing debt can be set aside in part, and New Zealand and Australia have their own rules for late security. A floating charge taken after trouble starts, to secure existing debt and not new money, is the one most exposed.

THE RECOVERY WATERFALL → · PREFERENTIAL CREDITORS → · ASSET-BASED LENDING →