Write a note on Floating
Charge and when it will
Crystallise ?
INTRODUCTION
The word ‘company’ is derived from the Latin word and it originally
referred to an association of persons who took their meals together. In the
leisurely past, merchants took advantage of festive gatherings, to discuss
business matters.
Nowadays, business matters have become more complicated and cannot
be discussed at festive gatherings. Therefore, the company form of
organisation has assumed greater importance. It denotes a joint-stock
enterprise in which the capital is contributed by several people. Thus, in
popular parlance, a company denotes an association of likeminded
persons formed for the purpose of carrying on some business or
undertaking.
A company is a corporate body and a legal person having status and
personality distinct and separate from the members constituting it.
Definition of floating charge
A floating charge is a type of security interest created over a company’s present and
future assets which are constantly changing or circulating in the course of business,
such as stock-in-trade, receivables, or raw materials. Unlike a fixed charge, which
attaches to specific, identifiable assets, a floating charge "floats" over a shifting body
of assets until a triggering event causes it to crystallise into a fixed charge.
Floating charges allow business owners to access capital secured with dynamic or
circulating assets. The assets backing the floating charge are short-term current
assets, usually consumed by a company within one year. The floating charge is
secured by the current assets while allowing the company to use those assets to run
its business operations. Current assets are those business possessions that the firm
can quickly liquidate for cash and include the accounts receivable, inventory, and
marketable securities, among other items. For example, if inventory is used
as collateral for a loan, the company can still sell, restock, and change the value and
quantity of its inventory. In other words, the value of the inventory changes over time
or floats in value and quantity.
Features of Floating Charge
1. General Charge over Assets :- It covers a class of assets, often
current or circulating assets (like stock, raw materials, receivables),
which can change over time.
2. Floating Nature :- The charge "floats" over the assets, meaning the
borrower can deal with them freely (e.g., sell, replace, use) until the
charge crystallises
3. Crystallisation :- The floating charge becomes a fixed charge (i.e., it
"crystallizes") upon certain events like Company liquidation, default or
breach of term, appointment of a receiver
4. Created by companies :- Usually created by companies, not
individuals, to secure borrowing without interfering with daily
operations.
Fixed and Floating Charges
Crystallization of Floating Charge
Crystallization is the process by which a floating charge converts into
a fixed charge. If a company fails to repay the loan or enters liquidation,
the floating charge becomes crystallized or frozen into a fixed charge.
With a fixed charge, the assets become fixed by the lender so the
company cannot use the assets or sell them.
Crystallization can also happen if a company ends operations or if the
borrower and lender go to court and the court appoints a receiver. Once
crystallized, the now-fixed rate security cannot be sold, and the lender
may take possession of it.
Typically, fixed charges are secured by tangible assets, such as buildings
or equipment. For example, if a company takes out a mortgage on a
building, the mortgage is a fixed charge, and the business cannot sell,
transfer or dispose of the underlying asset—the building—until it repays
the loan or meets other conditions outlined in the mortgage contract.
When Does a Floating Charge Crystallize?
Default by the borrower: If the company fails to repay the loan as agreed, the lender
may take action to convert the floating charge into a fixed charge, allowing them to
seize the assets to recover the debt.
Winding up of the company: When a company is liquidated, all floating charges are
automatically crystallized.
Cessation of business: If the company stops operating, the floating charge will
typically crystallize to protect the lender's interest.
Court appointment of a receiver: If a receiver is appointed by the court to manage
the company's affairs, the floating charge may crystallize.
Notice of Crystallization: Some debentures will specify that a floating charge will
crystallize upon the lender's notice, and the debenture may outline the events that
trigger this.
Case Laws
1. Re Yorkshire Woolcombers Association Ltd (1903)
This case provided one of the earliest and most cited definitions of a floating
charge Justice Romer described a floating charge as: "a charge... on a class of
assets present and future of a company... so long as they are not disturbed
and so long as the company remains a going concern.”
2. Illingworth v Houldsworth (1904)
The House of Lords affirmed that a floating charge is an equitable charge.
Lord Macnaghten emphasized that it “floats over” the changing assets until
an event causes it to crystallize.
Conclusion
Floating charges play a crucial role in modern commercial financing by allowing companies
to secure loans while continuing to manage their circulating assets in the ordinary course of
business. Their flexibility benefits both borrowers and lenders by enabling businesses to
operate smoothly without sacrificing access to credit.
However, the nature of floating charges — particularly their "floating" character — means
they must eventually crystallize to provide real security to creditors. Crystallization occurs
when certain events, such as liquidation, appointment of a receiver, business cessation, or
default, cause the floating charge to attach firmly to the company's assets. It transforms
the charge into a fixed form, restricting the company's dealings and prioritizing the
creditor's rights.
While floating charges offer practical advantages, they also pose risks, particularly in
insolvency, where they can be abused to the detriment of unsecured creditors. Legal
safeguards, such as invalidation of late-created floating charges without new consideration,
seek to address these concerns and maintain fairness in the insolvency process.
Overall, understanding the creation, operation, and crystallization of floating charges is
essential for anyone involved in company law or commercial lending, ensuring that the
balance between flexibility and creditor protection is properly maintained.
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