Simply put a debenture is a document that records the borrowing of money by a company with reference to the debt. As such, debentures are security documents evidencing a debt, and repayment plans.
An Indenture is found within a debenture and outlines the security interests associated with the debt, which will come into action upon default of the borrowing party or any other named event stated in the indenture for example the launch of insolvency proceedings against the borrowing party.
A fixed charge is a form of security interest over specific and identifiable assets, which by their nature must be ‘fixed’, for example, a warehouse. Contrastingly a floating charge is held primarily to secure assets that are free to change in the day-to-day operation of the firm for example stocks of unfinished goods.
A holder of a fixed charge may force the sale of the asset in order to secure payment of a debt in the event that the debt is not paid. A lender holding a fixed charge takes priority over other creditors in respect to payment of debts. Fixed charges must adequately specify the property over which the security interest is intended to apply. On the other hand, a floating charge does not specify a particular asset but instead “floats” over classes of assets.
A holder of a fixed charge takes priority over a holder of a floating charge in insolvency. Fixed charges should include an irrevocable power of attorney and right to sell the assets, which are subject to the charge in the event of a default.
Due to the lower priority of floating charges the lending party (through the debenture) has often sought to place fixed charges on as many assets as possible. However, due to the nature of some assets these fixed charges have later been re-characterised as floating charges by the courts.
Whether a charge is characterized as fixed or floating is not often clear and for many years book debts had caused much confusion and several contradicting decisions from the courts as to whether the charge on book debts was a floating charge or a fixed charge.
The argument for book debt being a floating charge is that in many cases book debt will change in the day-to-day course of normal business and so by definition should only be subject to floating charges. However, in some cases, the holder of the charge has significant control over the charge, in which case the book debt is subject to a fixed charge.
The re-characterisation of floating charges to fixed charges particularly in the case of book debt was finally clarified by the House of Lords in the case of National Westminster Bank plc v Spectrum Plus Ltd .
The legal focus of the case was whether book costs granted by Spectrum Plus ltd to National Westminster Bank plc in the debenture was a fixed charge (which it was expressed to be) or a floating charge. The outcome of the case was that Spectrum Plus plc was free to deal with its debtors and the proceeds of the debts and so, in this case, the book cost was inconsistent with a fixed charge and so would be re-characterised as a floating charge.
The House of Lords clarified that a charge over book debt could in fact be a fixed charge as long as the holder of the charge had a significant level of control over the proceeds of the book debt, normally meaning that the proceeds are paid into a blocked account or are directly paid to the secured creditor.
One significant change that the case bought about was how security documents and debentures are drawn up, now many debentures will state, where they did not previously, that proceeds from book debt must be paid into a blocked account.
A floating charge is a security interest over moveable property. Floating charges do not attach to any particular asset. These charges are a preferred security interest over assets that change from day to day, such as inventory or stock in trade. The debtor is entitled to use the assets in the ordinary course of business provided that this does not fall into breach of the terms upon which the charge was given.
A floating charge is security interest that:
- Applies to classes of assets of a company or individual in the present, as well as assets coming into possession of the business in the future.
- Applies to assets that change from time to time during the ordinary course of business.
- Floats over the assets of the business until some named event takes place.
A floating charge “hovers” over the assets and becomes a fixed charge only upon ‘crystallisation’ at which point the charge will attach to specific assets. This change (crystallisation) from a floating charge to a fixed charge can occur for a number of reasons for example non-payment, or the launch of insolvency proceedings.
Floating charges are enforced by the appointment of an administrative receiver. It is a more flexible and dynamic security than a fixed charge and is usually granted in a debenture.
Often in business, it is necessary to lend money from a bank or other lending institution. The way in which the lender attempts to protect their investment is through a security interest. A security interest is an agreement or operation in law that gives the lender certain rights over assets to secure the performance of an obligation; the obligation in most cases will be regular repayment of the debt. The purpose of a bank or other lending institution taking security over commercial property is to ensure a quicker and more assured payout in the event that a borrower company goes into receivership, examinership or liquidation.
The bank or lender will attempt to retrieve their investment from a company in trouble due to the fear of losing their investment completely through bankruptcy. A security interest is a useful tool for a lending institution as it often gives them priority over other lenders to recoup their money. A security interest is often a key feature to a debenture (a debenture being, in its simplest form, the agreement between the borrower and the lender, that the borrowing party will in some manor repay the debt to the lending party).
By signing the debenture the borrowing party agrees to the security interest stated. The lending institution is now a ‘secured’ creditor. A secured creditor will take precedence over an ‘unsecured’ creditor in reclaiming debt from a defaulting borrower. Although there are many types of security interest the most common two are floating charges and fixed charges.