Floating Charges vs Fixed Charges

Floating Charges vs Fixed Charges

Capital is the most crucial aspect of establishing any business. It is pivotal for creating infrastructure, producing goods, rendering services to the consumers, carrying out operations; so much so that it is the quintessential pre-requisite of any start-up. There are many ways to acquire capital. However, when certain requirements cannot be met by the existing capital, a company may grow its capital is by taking loans. These loans, which are usually taken from the financial institutions or individuals, require security on behalf of the borrower/debtor. The security is given in the form of assets/property of the company. This secured loan is called a mortgage wherein the loan is tied to any property until the debt is fully discharged. Therefore, the concept of ‘charge’ comes into the picture.

What is a Charge?

In general, ‘charge’ is the interest of the creditor in the assets provided by the debtor as security to the former in the event of a secured loan. Charge gives a right of lien over the property to the creditor, i.e., the creditor can have the possession of the property till the debt is fully repaid to him by the debtor. In Companies Act 2013, Charge is defined under Section 2(16) and are dealt under Sections 77 to 87. There are two types of charges, i.e., Fixed Charge and Floating Charge, which is explained in this article.

Fixed Charge

A fixed charge is created on fixed assets like property which includes land, buildings, or anything static (which does not change) and specific. Apart from the tangible ones, it also extends to intangible assets like trademarks, copyrights, patents, etcetera. Here, though the possession is with the debtor, control over the property is with the creditor. If the debtor wants to sell, buy or in any way transact on the charged asset, he/she has to obtain the prior permission of the creditor since the hold on the property lies with the latter. A fixed charge is very solid and assuring given the nature of assets involved (constant).

Floating Charge

A floating charge is created on assets which are involved in the ordinary course of business that is dynamic in nature. As these assets are not ‘fixed’ in nature, they are known as floating charges. A company may also dispose of such assets without the permission of the creditor. For example, if the security for a loan is in the form of ‘a building’, it is a fixed charge on the property for the creditor because it does not change or fluctuate in its state of being. But if the security is on goods in a warehouse, the type of charge created is a floating charge because of the dynamic nature of the assets. To be specific, every business transacts on a daily basis with goods, the availability of which could be either high or low. So, when a floating charge is created on such goods which are not constant and keep changing from time to time, the creditors own whatever goods are left after the actual transactions by the company. This is because the creditor cannot lay restrictions on the business activities which make money if he wants his debt to be paid off by the debtor. Since the assets are not specific and hence the rights over such assets are also not specific, the charge created is called a floating charge.

Crystallisation of Floating Charge

There are instances where a floating charge may become a fixed charge. This conversion of floating charge into a fixed charge is usually called Crystallisation of floating charge. When such conversion takes place, the floating charge is no more floating, even on the assets that are not static. It becomes a fixed charge so that the whole control over particular assets belong to the creditor in the event of default in repayment of debts. Such an event happens under the following circumstances:

• The debtor is unable to pay off the debts.
• The company is about to wind up.
• The business couldn’t be carried out when the creditor takes action against the debtor for not repaying the debts and in all such circumstances which are listed out under the relevant provisions of the Companies Act, 2013.

Registration of Charges

Whenever a charge is created, it has to be registered with the Registrar of Companies within 30 days from the creation of the Charge. A charge so registered acts as a notice to the public about the interest of the creditor in charged assets/property so that no one would interfere with the same. If there is any delay in such registration, then the same will incur additional registration fee (if registered within the extended period of 300 days), as specified under the Companies Act (Registration offices and fees) Rules, 2014.

The Registrar of Companies issues a Certificate of Registration and a Certificate of Modification for the registered and modified charges, respectively. If the charges are not registered at all, then the creditor will not be given priority during the settlement of claims in the event of dissolution of the company, even if he/she remains a creditor whose debt is to be repaid. These details must be updated in a register, which is to be maintained by the company wherein all the details regarding the charges shall be entered without fail. The e-forms in which these details have to be filed are mentioned in the Companies Act (Registration offices and fees) Rules, 2014. At the moment, there are ten such e-forms dealing with Charge Management, i.e., CHG-1 to CHG-10.

At a Glance

• Floating and fixed charges are concepts which everybody concerned with loans has to be aware of to know the consequences of debtors’ non-repayment of debt or the rights available to the creditors in case of default in repayment.
• Crystallisation, as discussed above, is a process where the floating charge is converted into a fixed charge. This is like instilling confidence in a creditor to make sure he gets something out of the transaction when things get worse.
• The companies have to maintain a register consisting of all the details concerning the charges and avoid any unwanted litigation in future. For creditors, it is very much advisable to get the charges registered to not lose their preferential position in case of settlement of claims.