We helped Ruthin Castle Hotel use the value of their commercial property to secure finance

Debentures and floating charges

Debentures and charges are ultimately about insolvency: if a business borrows money but the worst happens and it becomes insolvent, what happens next? It’s quite a technical area, but it’s important to know about if you’re considering a financial agreement that requires a debenture or a floating charge.

What is a debenture?

A debenture is designed to give protection to a company or individual which lends money to a business. It gives lenders a priority position in the list of companies or people who’ll get their payment if a company becomes insolvent.

The debenture document defines the terms of the loan agreement — the total loan amount, interest rate, repayment amount and any other charges. It should be filed with the Registrar of Companies at Companies House within 21 days of the loan being taken out.

If it’s not filed, the business’s administrator could ignore the debenture and the lender would simply join the list of unsecured creditors.

What is a fixed charge?

A fixed charge on a debenture offers lenders extra protection for their money if the borrower’s business becomes insolvent. The extra protection comes from material assets like machinery, property and land, and these assets cannot be sold on without the insolvent company either repaying the loan or getting consent from the lender.

What is a floating charge?

A floating charge is like a fixed charge, but instead of using fixed assets it uses a group of assets. With a floating charge, the business can buy and sell assets as a normal part of business.

While a fixed charge essentially blocks the borrower from selling the assets without first repaying the lender or getting their agreement, a floating charge isn’t held against specific assets, but rather over groups of assets or even a business’s total assets.

Because floating charges are applied to assets which are more naturally bought and sold through day-to-day business, the groups of assets which often have the floating charge applied to them include:

  • Raw materials
  • Stock
  • Part-built products
  • Cash

You might hear about floating charges ‘crystalising’. This is what happens to a floating charge when a business enters insolvency. Before insolvency the floating charge applies abstractly to groups of assets; during insolvency the charge is applied to specific assets and so becomes clearly defined — it’s crystalised.

It’s important to note that if a fixed charge and a floating charge are applied to the same asset, the fixed charge takes priority during insolvency. You may also hear terms like ‘first charge’, ‘second charge’, and so on — these refer to the order of priority given to each charge.

What are debentures and charges for?

A debenture can be a cost-effective way for a business to get long-term funding. Without the debenture the lender could receive less money during insolvency than they’re due and would likely want to increase their other costs (like interest rates) on the loan to account for that increased risk.

Debentures vs personal guarantees

All of the debentures and charges we’ve looked at use various methods to tie a borrowed amount to a specific business asset (or a floating group of assets). Therefore, you’d probably consider these to be secured lending.

For various unsecured products, lenders will use personal guarantees to mitigate their risk, instead of debentures or charges. Personal guarantees essentially mean the business owner is personally responsible for paying back the loan if the business is unable to do so.

In some particularly complex cases, or cases where the business is borrowing a large sum of money, lenders may use a combination of debentures, charges, and personal guarantees — so the finance is both secured and unsecured. This type of arrangement might be called asset-based lending.

Whether it’s secured or unsecured, debentures or personal guarantees, these arrangements are all about lenders having a second option for getting their money back if things go wrong and the business they’ve lent to can’t pay.