What it means
A floating charge hovers over a category of assets instead of attaching to named ones. A manufacturer can sell finished goods, collect invoices and restock without asking the lender for permission each time.
That flexibility is the entire reason the instrument exists. Contrast this with a fixed charge, which pins to a specific asset such as a building or a named machine, and the borrower cannot sell it without the lender's consent.
Fixed charges give stronger protection but only work for assets that sit still. Most trading businesses have far more value tied up in stock and debtors than in property, which is why floating charges are so common in working capital lending.
Crystallisation is the moment the charge stops floating and fastens onto whatever assets are then in existence. It is usually triggered by a default, by the appointment of an administrator or receiver, or by the company ceasing to trade.
From that point the borrower loses its freedom to deal with the charged assets. Ranking matters enormously once a business becomes insolvent.
A floating charge sits behind fixed charge holders and behind certain preferential claims such as some employee entitlements and specified tax debts, so floating charge holders frequently recover far less than the headline asset values suggest. Lenders price that expected shortfall into the interest rate they quote.
Terminology varies by country and it is easy to talk past people. Floating charges are a feature of English law and jurisdictions that follow it, including much of the Commonwealth, while the United States achieves a similar commercial result through a security interest in after-acquired property, generally called a floating lien.
The economics are the same even though the legal machinery differs.
In practice
Real-world examples
Example 1
A wholesale food distributor arranges a $2,000,000 overdraft secured by a floating charge over stock and debtors. Because stock turns over roughly every three weeks, a fixed charge would have been unworkable, and the floating structure lets the business trade normally while the bank retains security across the pool.
Example 2
A construction supplier grants a floating charge to its bank and later wants an equipment loan from a different lender. The existing charge contains a negative pledge clause preventing new security ranking ahead of it, so the equipment lender must obtain a deed of priority from the bank before it will advance funds.
Example 3
A printing company enters administration owing $750,000 to a lender holding a floating charge. Realisations reach only $410,000 before preferential claims of $95,000, so the lender recovers $315,000 and writes off the rest. The case prompts the lender to require monthly stock reports on all similar facilities.
Think of it
Imagine a security guard watching a herd of sheep in an open meadow. The sheep can graze, run around, and move freely day-to-day. But if a dangerous storm approaches, the guard closes the gate and rounds them all up into a single, fixed pen.
Formula
Calculation
Recovery = min(Realised value of charged assets - Prior ranking claims, Debt outstanding)
Recovery Rate = Recovery / Debt outstanding
Ashbourne Components borrows $500,000 on a revolving facility secured by a floating charge over its inventory, receivables and cash. The company fails, an administrator is appointed, and the charge crystallises on the assets present that day.
The administrator realises inventory for $180,000, collects receivables of $260,000 and finds $40,000 in the bank, giving total realisations of $180,000 + $260,000 + $40,000 = $480,000. Preferential claims, mostly unpaid wages and holiday pay, take $60,000 ahead of the floating charge holder, leaving $480,000 - $60,000 = $420,000.
The lender recovers $420,000 against a $500,000 debt, a recovery rate of $420,000 / $500,000 = 84%, and the remaining $500,000 - $420,000 = $80,000 ranks as an ordinary unsecured claim alongside trade creditors. Had the same lender held a fixed charge over a $500,000 warehouse instead, it would have been paid in full before preferential claims were considered.Case study
Seen in the real world
This is a fictional, illustrative scenario. Thornhill Textiles, an invented mid-size fabric wholesaler, funded its working capital with a $1,200,000 facility from a regional bank secured by a floating charge over inventory, receivables and cash at bank. For six years the arrangement worked exactly as intended: Thornhill bought and sold fabric freely, and the bank never intervened.
When Thornhill's largest customer went into liquidation owing $480,000, Thornhill breached its covenants within two months. The bank crystallised the charge and appointed an administrator, who found $520,000 of saleable stock, $390,000 of collectable receivables and $30,000 of cash, a total of $940,000. Preferential employee claims of $110,000 came first, leaving $830,000 for the bank against $1,200,000 owed, a recovery of about 69%.
The illustrative takeaway is that a floating charge is only ever worth what the underlying pool realises on a bad day, not what it is worth on the balance sheet during good trading. Thornhill's bank subsequently required a fixed charge over the company's freehold depot on comparable facilities.
Watch out
Common mistakes
- Believing a floating charge gives the same protection as a fixed charge. It ranks lower, is exposed to preferential creditors and depends entirely on what the shifting pool of assets is worth at the moment of crystallisation.
- Assuming the charge covers whatever the accounts say the assets are worth. Inventory sold in an insolvency routinely realises a fraction of its book value, and receivables are harder to collect once customers know the supplier has failed.
- Granting a second floating charge without checking the first. Most charges contain a negative pledge, and breaching it can itself amount to an event of default on the original facility.
Questions
People also ask
What actually causes a floating charge to crystallise?
Typically a default, the appointment of a receiver or administrator, a resolution to wind up the company, or the company simply ceasing to trade, though the charge document can specify additional triggers.
Can a business still sell charged stock in the ordinary course?
Yes, that freedom is the defining feature of a floating charge, and it continues right up until the moment of crystallisation.
Does a floating charge rank ahead of trade creditors?
Yes, ordinary unsecured trade creditors rank behind it, but the charge itself ranks behind fixed charge holders, insolvency costs and defined preferential claims.