What are Fixed and Floating Charges

The most common form of bank lender security over a company is a fixed and floating charge. If the company breaches the terms of the loan, the bank lender can demand immediate repayment under the default clauses of the loan and the bank lender may enforce its security after issuing a notice of breach and demand. A priority claim (or charge, or contingent ownership) is created over particular assets as security for borrowings or other indebtedness (mortgage, debenture or other security documentation).

There are essentially two types of charge – ‘floating’ and ‘fixed’.

The ‘fixed charge’ is over substantial physical assets – most commonly, equipment such a vehicles and plant.

A floating charge relates to assets and materials which are subject to change on a day-to-day basis, such as stock. Individual items move into and out of the charge as they are bought and sold in the ordinary course of events. The reason floating charges were invented was to allow businesses to buy and sell business inputs and stock without checking with the bank lender all the time.

The floating charge crystallizes if there is a default or similar event (typically recorded in the loan document). At that stage, the ‘floating charge’ is converted to a ‘fixed charge’ over the assets of the company which it covers at that time. What this means is that the person providing the charge cannot legally sell or otherwise deal with the assets from this point. A floating charge is not as effective as a fixed charge but is more flexible.

IN MORE DETAIL…

Let’s take an example from the mortgagee’s point of view (the bank lender), the entity who provides credit and requires the security of a charge for doing so. Rebuild Now also provides advice to businesses (and individuals) who are concerned about their exposure to insolvent borrowers and purchasers on credit terms. It is helpful to look at what they are trying to, and can achieve, against your firm.

Looking at the example of you in the position as Credit Manager of a key supplier of BigBuyer Pty Ltd (BB). You have enjoyed a close relationship over a number of years and your company’s production lines are now integrated through a just-in-time manufacturing model. Over the past 12 months, BB has experienced financial difficulties and has let your company’s trading terms deteriorate. As a result of BB’s financial difficulties, a debt of $500,000 has built up. Your General Manager now wants to know whether your company can create a security interest over BB because to enure your company is not an unsecured creditor if BB is placed in administration or liquidation. You have heard from your contacts at BB that insolvency accountants have been attending its head office this week to look at its books in preparation for appointment as voluntary administrator. You were also told that this may be months away, but at this point in time your company is an unsecured creditor without any security.

A. What is a fixed and floating charge?

It is a form of combined security, akin to a mortgage over the assets and undertaking of a company. It is fixed to the extent that it is a security covering all non-trading assets of the company such as real property, plant and equipment and intellectual property. It is also a floating security over the other assets of the company that circulate during the ordinary course of business until such time as it crystallizes and becomes a fixed charge over these assets as well. Examples of circulating assets include inventory and cash, assets that the business buys and sells in the ordinary course of business.

The fixed and floating charge is distinguished from other forms of security because it also covers future property of the debtor company. Without exploring the technical meaning of “crystallise” or “circulating assets” or “asset” in summary the fixed and floating charge is the best form of security a creditor can have against your company debtors because it covers all the corporate debtor’s assets and undertaking as the business develops as a going concern.

B. What does a fixed and floating charge do for a creditor?

Credit Managers who have attended meetings of creditors of companies placed in administration or liquidation will understand that the banks typically have priority over the other creditors through fixed and floating charges. It is more often than not a frustrating experience for credit managers to attend a meeting of creditors only to be informed that the assets of the insolvent company will be distributed to a bank as a priority, and in other situations, the banks appoint their own receivers who take over the assets and undertakings of the company. This often leaves only a corporate shell to unsecured creditors with no prospects of recovering a dividend for their debt.

A valid fixed and floating charge may be a ‘royal flush’ if you imagine creditor priorities to be a game of poker. It tends to be the best “hand” to have when a company debtor goes into administration. The most important right of a fixed and floating charge holder is priority against other unsecured creditors. The fixed and floating charge holder is a secured creditor of an insolvent company and through the fixed element of the charge it has an actual proprietary interest in the company’s property. For example, in the scenario the credit manager may wish to obtain a fixed charge over certain equipment that is part of the just-in-time production process. This equipment might be useful to the credit manager’s company in the event that BB ceases trading upon liquidation.

The fixed and floating charge holder has the right under the Corporations Act to appoint a voluntary administrator over the debtor company if it has a charge over all (or the substantial majority) of the assets of the debtor company. Further, the charge creates a right for your company to privately appoint its own Receiver to protect the assets under the charge, and to pursue action to collect the debt owed. In the scenario outlined above, a voluntary administrator or privately appointed receiver may be necessary to ensure that operations at BB continue if it is insolvent. In this scenario the credit manager’s company is able to ensure that the production process continues because the receiver is able to take over the management of BB’s production line and maintain operation, at least temporarily.

C. A fixed and floating charge must be registered

Under the Corporations Act, a new charge over a company is required to be registered with the ASIC within 45 days of its creation. The ASIC form 309, together with the charge instrument, and an ASIC form 350 to certify that mortgage duty has been paid, must be lodged with the ASIC within this timeframe.

Assuming that a charge is validly registered with the ASIC within 45 days of its creation, the next issue to be considered is whether there are other charge holders with a priority that are entitled to all of the assets of the debtor company in the event of liquidation. For example, is there a bank with a prior registered charge in the scenario that would “clean up”? It would not be commercial to take a charge over a debtor company if there is a prior charge holder whose debt will swallow up all of the assets of the debtor company. There is also likely to be a requirement in standard bank charges for bank consent to be provided before any further charges may be granted. The benefit of registration of charges, however, is that you will be able to obtain information about another charge holder’s security interest through ASIC company searches.

“…in summary the fixed and floating charge is the best form of security you can have against your company debtors because it covers all the corporate debtor’s assets and undertaking as the business develops as a going concern.”➤ The royal flush 16 CREDIT MANAGEMENT IN AUSTRALIA • May 2010

D. Should the credit manager obtain security in the scenario?

In the above scenario, there is a risk that if a charge were obtained it would be void should a liquidator or administrator be appointed within 6 months of registration. This would mean the security may be ineffective as the Corporations Act provides that a floating charge created within 6 months of the appointment of administrators is void, should the company subsequently be placed in liquidation.

This means that in this scenario, if the credit manager believed that BB was likely to go into administration within the next 6 months, it may be fruitless to explore taking a charge, at the death of BB.

Further, if the credit manager is aware that BB is insolvent, then this also puts any fixed charge obtained at risk of being voided by a liquidator. Insolvency means that a company is unable to pay its debts as and when they fall due and payable. One basis for a liquidator setting aside a fixed charge may be if they are able to prove that BB was insolvent at the time the charge was obtained. Under the Corporations Act, the charge may be deemed voidable under the two categories of insolvent transactions – either as an unfair preference or as an uncommercial transaction.

The first step would be to discuss with BB’s management its intentions. If BB is preparing for the imminent appointment of an administrator, this is not the end of the story. There has been a development of “Pre-pack Administrations” in Australia recently, and this comes out of insolvency practice in the United States. The credit manager’s company may be able to position itself move favourably under a “Pre-pack Administration”.

In Australia, under the Voluntary Administration regime, the insolvent company is placed under a moratorium from creditor action for a period of one month. The “Pre-Pack” is where the debtor company, its creditors and stakeholders come to an arrangement regarding the post-bankruptcy status of all parties before entering into Voluntary Administration, or even better sometimes. a pre-arranged liquidation of the existing company. This means that by the time the debtor corporation appoints a liquidator or voluntary administrator, it is a mere formality because the key parties have already agreed upon the corporation’s restructure. This is the sort of route that may be best for your company, you AND YOUR CREDITORS. There are other options as well.

If BB successfully organises a “Pre- Pack Administration” it could mean that all the restructuring of the company, through a deed of company arrangement, would be accepted by key stakeholders in advance. The benefit is that it may allow the credit manager’s company to protect its real interests in the scenario, business continuity and the minimisation of the debt write off.

Alternatives in this scenario …

Other than exploring what restructuring proposals BB may make under a “Pre- Pack Administration”, the Credit Manager may look into all forms of security that may be obtained, including:

• Director’s guarantees;
• Bank guarantees;
• Security over property of the debtors;
• Mortgages of real property owned by directors of the debtor; and
• An increased margin on sales.

For example, in the above scenario there may be a concern that the production process, including registered designs owned by BB, may be sold by a liquidator to a competitor. This may be addressed by licensing or assignment of these registered designs from BB in consideration for reduction in the value of the debt owed. Other commercial negotiation may involve changing production contracts so that they are more favourable to the Credit Manager’s company by increasing margins on future orders.

The above information does not address any of the issues relating to the registration of personal property security interests in the new register which took effect in May of 2011.