Fixed Charges, Floating Charges and Crystallisation

The fixed charge

A fixed, or specific, charge is created over identified, ascertained property, and it attaches to that property at once, on creation.

Its features follow from that:

1. The property is identified when the charge is made: this factory, this machine, this piece of land.
2. It attaches immediately, so the chargeholder has an interest in that property from the date of creation.
3. The company cannot dispose of the property free of the charge without the chargeholder's consent.
4. It ranks ahead of a floating charge over the same assets, even a floating charge created earlier, because the floating charge by its nature permits dealings until crystallisation.
5. It is unaffected by section 332, which speaks only of a floating charge.

Typical subjects: land and buildings, plant and machinery, a specific vehicle, a specific investment.

The floating charge

A floating charge has three characteristics, and an answer should give them as three:

1. It is a charge on a class of assets, present and future. Not this bag of cotton, but "the company's stock in trade".
2. That class is one which, in the ordinary course of business, changes from time to time. Stock is bought and sold, book debts arise and are collected.
3. Until the chargeholder takes some step to enforce it, the company may carry on business and deal with the assets in the ordinary course.

The third is the defining one. A charge that stops the company dealing with the assets is not floating, whatever the document calls it, and a charge that leaves the company free to deal is floating even if the document calls it fixed. Substance, not the label.

Typical subjects: stock in trade, raw materials, book debts, and the undertaking of the company as a whole.

Where the Act notices it. Section 2(16) is wide enough to cover both, and section 85(1) requires the company's own register to include "all charges and floating charges affecting any property or assets of the company or any of its undertakings", which is the Act's own acknowledgement that the two are different things. The substantive provision is section 332.

Crystallisation

Crystallisation is the moment the floating charge stops floating and fastens on the assets then comprised in the class. From that moment the company can no longer deal with them in the ordinary course, and the chargeholder has, in effect, a fixed charge over them.

When it happens. The recognised events are:

1. The company goes into winding up. The business the licence to deal was given for has ended.
2. A receiver is appointed, whether by the court or under a power in the instrument. Section 84 requires notice of such an appointment to the company and the Registrar within thirty days.
3. The company ceases to carry on business, so there is no ordinary course left.
4. An event specified in the charge instrument occurs, where the document says the charge shall crystallise on it, for example a default in payment or the creation of a further charge over the same assets.

Why it matters. Before crystallisation a buyer of the charged goods in the ordinary course takes them free of the charge. After crystallisation he does not. So the date of crystallisation decides who owns what.

Section 332: the twelve month rule

Where a company is being wound up, a floating charge on the undertaking or property of the company created within the twelve months immediately preceding the commencement of the winding up shall, unless it is proved that the company immediately after the creation of the charge was solvent, be invalid, except for the amount of any cash paid to the company at the time of, or subsequent to the creation of, and in consideration for, the charge, together with interest on that amount at the rate of five per cent per annum or such other rate as may be notified by the Central Government in this behalf.

Take it apart, because every phrase is doing work.

It applies only in a winding up. Outside one the section is silent.

It applies only to a floating charge. A fixed charge created in the same period is untouched by this section.

The window is twelve months immediately preceding the commencement of the winding up.

The default position is invalidity. The charge shall be invalid unless something is proved.

The escape is solvency, and the burden is on the person asserting it. It must be proved that the company immediately after the creation of the charge was solvent. A company that was already sinking cannot save the charge.

And the saving is confined to new money. The charge is valid for the amount of any cash paid to the company at the time of, or subsequent to, the creation of the charge, and in consideration for it, with interest at five per cent per annum or such other rate as the Central Government notifies.

That last point is the whole purpose of the section. If the lender gave fresh cash in exchange for the charge, the company is no worse off and the charge stands to that extent. If the lender merely took security for money he had already lent, he has taken value out of the pool of unsecured creditors at a time when the company was failing, and the charge is invalid.

Note also the words "cash paid". Goods supplied or services rendered in consideration for the charge are not within the saving as the section is worded.

The floating charge's other disadvantage

Even a perfectly valid floating charge is not as good as a fixed one in a winding up, and for a reason outside this Chapter. Section 327 gives certain claims, including wages and salaries and some statutory dues, priority as preferential payments, and section 326 gives overriding preferential payments to workmen's dues and certain secured creditors' debts. Those claims bite on assets subject to a floating charge ahead of the chargeholder.

So the practical ranking, roughly, is: fixed chargeholders, then overriding preferential and preferential payments, then floating chargeholders, then unsecured creditors, then members.

A worked example

Chandrapur Alloys Limited borrows from two lenders.

In January 2027 it mortgages its rolling mill to Bank A. That is a fixed charge: identified property, attaching at once, and the company cannot sell the mill free of it.

In March 2027 it gives Bank B a charge over "all its present and future stock in trade and book debts". That is a floating charge: a class of assets, changing in the ordinary course, with the company free to buy and sell stock and collect its debts.

Day to day. The company sells finished alloy to customers. Each buyer takes free of Bank B's charge, because until crystallisation the company may deal with the assets in the ordinary course of business.

In November 2027 Bank B appoints a receiver under a power in its debenture. The charge crystallises. Notice of the appointment must go to the company and the Registrar within thirty days under section 84. From that moment the company can no longer sell the stock free of the charge, and Bank B has in effect a fixed charge over whatever stock and book debts exist at that date.

Winding up. The company goes into winding up in February 2028.

Bank A's fixed charge is unaffected by section 332.

Bank B's floating charge was created in March 2027, which is within the twelve months immediately preceding the commencement of the winding up. So by section 332 it is invalid unless it is proved that the company was solvent immediately after its creation, except for cash actually paid to the company at or after its creation in consideration for it, with interest at five per cent per annum.

Two versions of the facts.

If Bank B advanced four crore rupees of fresh cash when it took the charge, the charge stands for that four crore and interest at five per cent, even if the company was insolvent, because the company received value.

If Bank B took the charge as security for four crore rupees it had lent in 2024, no cash was paid at or after the creation of the charge in consideration for it. Unless solvency immediately after creation is proved, the charge is invalid and Bank B ranks as an unsecured creditor.

And even if valid, Bank B's floating charge yields to the preferential payments under section 327 and the overriding preferential payments under section 326, which Bank A's fixed charge does not.

Distinctions that carry marks

What this does NOT mean

It does not mean the label in the document decides. A charge that leaves the company free to deal in the ordinary course is floating whatever it is called, and one that does not is fixed.

It does not mean section 332 invalidates every recent floating charge. It is saved by proof of solvency immediately after creation, and in any event to the extent of cash paid at or after creation in consideration for it, with interest.

It does not mean a floating charge is worthless. It is the only practical way to take security over stock and book debts, and once crystallised it behaves like a fixed charge over the assets then in the class.

It does not mean crystallisation needs a court. An appointment of a receiver under a power in the instrument, or an event the instrument specifies, will do it.

Quick revision

• Neither kind is defined in the Act. Section 2(16) covers both; section 85(1) names "all charges and floating charges"; the substantive provision is section 332.
• Fixed: identified property, attaches on creation, company cannot deal free of it, ranks first, outside section 332.
• Floating, three characteristics: a class of assets, present and future; a class that changes in the ordinary course; and the company free to deal until the holder intervenes.
• Crystallisation: winding up; appointment of a receiver, with section 84 notice to the company and the Registrar within thirty days; ceasing to carry on business; or an event specified in the instrument.
• Section 332: in a winding up, a floating charge created within the twelve months immediately preceding its commencement is invalid, unless solvency immediately after creation is proved, except for cash paid at or after creation in consideration for the charge, with interest at five per cent per annum or as notified.
• Sections 326 and 327: preferential and overriding preferential payments rank ahead of a floating charge.

Test yourself

1. State the three characteristics of a floating charge. It is a charge on a class of assets, present and future; that class is one which in the ordinary course of business changes from time to time; and until the chargeholder takes steps to enforce it the company may carry on business and deal with the assets in the ordinary course.

2. What is crystallisation, and what causes it? The conversion of a floating charge into a fixed charge over the assets then in the class. It is caused by the winding up of the company, the appointment of a receiver, the company ceasing to carry on business, or the happening of an event specified in the charge instrument.

3. State the rule in section 332. Where a company is being wound up, a floating charge on its undertaking or property created within the twelve months immediately preceding the commencement of the winding up is invalid, unless it is proved that the company was solvent immediately after the creation of the charge, except for the amount of any cash paid to the company at or after its creation and in consideration for it, with interest at five per cent per annum or such other rate as the Central Government may notify.

4. A bank takes a floating charge in month ten before winding up, for a loan it made three years earlier. Is the charge good? Not unless solvency immediately after the creation of the charge is proved. No cash was paid at or after creation in consideration for the charge, so the saving in section 332 does not apply and the charge is invalid.

5. Which ranks first, a fixed charge created later or a floating charge created earlier, over the same assets? The fixed charge, because a floating charge by its nature permits the company to deal with the assets until crystallisation.

6. Must anyone be told when a receiver is appointed? Yes. Under section 84(1) the person obtaining the order or making the appointment must, within thirty days, give notice to the company and the Registrar with a copy of the order or instrument, and the Registrar registers the particulars in the register of charges. On ceasing to hold the appointment he must give notice of that too.