In general, a floating charge is a type of a security which “floats” all over the assets of the borrower-company, until an event of default occurs or until the company goes into insolvent liquidation, at which time the floating charge crystallises and attaches to all the then existing assets. Until such an event takes place, the company may carry on its business in the ordinary course and subject to the terms of the debenture may sell, mortgage or otherwise deal with its assets and pay dividends out of profits as though the floating charge had not been created.
Effect of the Floating Charge
Until a crystallizing event occurs- and therefore until a conversion of a floating into a fixed security takes place, the debenture holders are not entitled to intervene except in accordance with the terms of their contract, unless the borrower does some act which is ultra vires the memorandum or endangers the debenture holders’ security.
A floating security crystallises and consequently converts into a fixed security, in the following circumstances:
1. On the company going into liquidation;
2. On the intervention of the debenture holder by taking possession or by the appointment under the relevant charge of a receiver; and
3. On cessation of the company’s business.
Effect of Crystallisation
After the security becomes a fixed charge the borrower-company cannot sell or mortgage any part of the property affected by that fixed charge, except subject to the fixed charge.
Why to choose a floating charge as a security
Although a fixed charge is a stronger security for a lender since it has priority over any floating charges, there are various reasons why it is worthwhile having a floating charge, from the lender’s perspective, including:
Further, the possibility that the borrower might grant subsequent charges over the assets within the reach of the floating charge (and so diminish its value) has resulted in the practice of including clauses in the debenture, namely, “negative pledges”. The latter prohibits the borrower from creating further fixed or floating charges ranking pari passu with or in priority to the current charge. A negative charge may influence both a fixed and a floating charge, irrespective (as to the first case) that a fixed charge – as a general rule- has a priority over a floating charge. However, if the chargee of the new charge had no actual notice of the floating charge and the negative pledge attached to it, the negative pledge has no effect.
In effect, it can be concluded that once a floating charge has priority over any other floating charges and at the same time it is either (1) coupled with a fixed charge or (2) subject to a “negative pledge” clause, it is a strong security for the benefit of any lender who wants to be secured once the borrower is in breach of his or her obligations.