Turkish Law Blog
Fixed and Floating Charges and Why it Matters
There are three basic types of security that can be created under English law:
What is a Charge?
For practical reasons, most lenders will not want to take possession of a debtor's assets and a debtor will not want to lose control of its assets, especially if they are used in the day-to-day running of its business. Accordingly, a lender will want to take security by obtaining rights over, but not necessarily possession of, specific assets of the debtor as security for the loan.
The term "charge" is often used by practitioners as a generic term for all types of security interest, but essentially represents an agreement between a creditor (chargee) and a debtor (chargor) by which a particular asset is appropriated by the chargee to the satisfaction of a debt owed to the chargor. A charge can be thought of as an encumbrance over an asset. It confers on the chargee an equitable proprietary interest in the charged property, giving the chargee the right to appropriate the charged property and have the proceeds of sale applied in satisfaction of the debt. It does not confer a right to possession.
Any asset that equity recognizes as "property", including intangible property, can be subject to a charge.
What is a Fixed Charge?
A fixed charge attaches immediately to the charged asset provided that the asset is, or is capable of being, ascertained and definite. It is important for the effectiveness of the fixed charge that the charged assets are identified as precisely as possible.
Typically, a document under which a lender takes a fixed charge will give the lender the right to do the following:
- Prevent the chargor from disposing of the asset without the lender's consent.
- Sell the asset if the chargor defaults in repaying the secured liabilities.
- Require the chargor to maintain the asset while it remains in the chargor's possession.
- Claim the proceeds of sale of the charged asset in priority to other creditors and so satisfy the purpose of taking security.
What is a Floating Charge?
A floating charge hovers above a shifting pool of assets. It is a charge on a class of assets, present and future, belonging to a chargor. That class of assets is one which, in the ordinary course of the chargor's business, changes from time to time. When a floating charge is created, it is contemplated that until some future step is taken by, or on behalf of, those interested in the charge, the chargor will carry on its business in the ordinary way in relation to that class of assets (including disposing of those assets) without the consent of the charge holder.
Fixed or Floating: Why it Matters
The question of whether a charge over a particular asset was created as a fixed or floating charge is invariably important on a chargor's insolvency. This is because the holder of a charge which was a fixed charge on its creation enjoys considerable advantage, in terms of priority of distributions to creditors, over the holder of a charge which was created as a floating charge (which includes a floating charge that has crystallised and a charge that was stated to be fixed in the document that created it but, on a proper interpretation, is floating).
On a chargor's insolvency, the holder of a charge which was created as a fixed charge over a chargor's assets will get paid out of the proceeds of sale of the assets subject to the fixed charge before all other creditors (including preferential creditors such as employees and contributions to occupational pension schemes).
On the other hand, the holder of a charge which was a floating charge when it was created is only paid out of asset realisations after the following have been paid:
- Fixed charge holders.
- Expenses of the insolvent estate.
- Preferential creditors.
Which Shares or Debt Securities is Security being Taken Over?
As with security over other assets, it is crucial to clearly identify the shares and debt securities over which security is being taken. If a lender is taking security over all the shares in a particular company, then it will be simple enough to define those shares by reference to the company in question. If, however, a lender is taking security over certain shares in a company then the relevant shares should be identified by reference to the numbered share certificates relating to those shares. It would not be sufficient to, for example, define the shares as "60% of the issuing company's shares" because it would not be clear from that description exactly which shares are subject to the security.
In the case of ambulatory movables such as ships and aircraft the U.K. approach is to apply the law of the flag to issues relating to transfer and security. A problem however arises. If the lex situs of an asset originally determines its transfer and the validity of any security, and the asset then moves to another state the state in which the asset is now located may treat its own law as having an overriding effect. Some states do this in relation to any creditor in their own jurisdiction while others only do so in the case of a bona fide purchaser of an asset there. In some states jurisdiction will be held to apply only in the case of further dispositions of the property. In many states the host state will not recognise charges over ambulatory assets unless the lender has taken possession subsequent to the charge. In some states the doctrine of constructive possession applies where the mortgage controls the indicia of possession such as the key to a building. It may also be recognised where a third party controls the movable and promises to hold it for the benefit of the mortgagee. Sometimes possession of documents of title is regarded as equivalent to possession, e.g., by possessing bills of lading.