Floating Charge
A floating charge is a security interest created over the changing assets of a company, such as inventory and receivables, which allows the company to deal with those assets in the ordinary course of business until the charge crystallises.
What is a Floating Charge?
A **floating charge** is a type of security interest that is created over the **entire class of assets** of a company — or a significant portion of them — that are **constantly changing** in the ordinary course of business. Unlike a fixed charge that attaches to a specific, identified asset, a floating charge "hovers" or "floats" over the assets without attaching to any particular item, allowing the company to freely buy, sell, and deal with those assets until a specified event causes the charge to **crystallise** (convert into a fixed charge on the specific assets then in existence).
In everyday terms, imagine a company that borrows money from a bank and offers its entire stock of goods as security. The company keeps selling old stock and buying new stock every day — the specific items change constantly. A floating charge allows the bank to have security over whatever stock the company happens to have at any given time, without requiring the company to get the bank's permission every time it sells a product.
Legal Framework in India
Companies Act, 2013
The Companies Act, 2013 governs the creation, registration, and enforcement of charges by companies:
- **Section 2(16):** Defines "charge" as an interest or lien created on the property or assets of a company, or any of its undertakings or both, as security and includes a mortgage.
- **Section 77:** Every company creating a charge on its property or assets (whether tangible or intangible) must register the charge with the **Registrar of Companies (ROC)** within **30 days** of its creation (extendable to 300 days with additional fees and the ROC's permission).
- **Section 77(1):** This applies to charges including a floating charge on the undertaking or any property of the company.
- **Section 80:** The ROC maintains a register of charges for each company, which is open for public inspection.
SARFAESI Act, 2002
The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, allows secured creditors (including those holding floating charges) to enforce their security without court intervention when the borrower defaults.
Insolvency and Bankruptcy Code, 2016 (IBC)
Under the IBC, the treatment of floating charge holders during insolvency proceedings is governed by the **waterfall mechanism** in Section 53, which prescribes the priority of distribution of assets among different classes of creditors. Secured creditors (including floating charge holders who have relinquished their security) rank in a specific order.
Characteristics of a Floating Charge
1. Covers a Class of Assets
A floating charge does not attach to any specific asset but covers an **entire class of assets** — such as all current assets, all stock-in-trade, all receivables, or the entire undertaking of the company.
2. Assets Keep Changing
The assets covered by the floating charge are of a **fluctuating nature**. Inventory is sold and replenished, receivables are collected and new ones arise, and raw materials are consumed and purchased. The charge accommodates this constant change.
3. Company Can Deal Freely
Until crystallisation, the company can deal with the charged assets in the **ordinary course of business** — selling goods, collecting debts, consuming raw materials — without seeking the charge holder's permission for each transaction. This is the essential practical benefit of a floating charge.
4. Ambulatory Nature
The charge "floats" over the assets and does not attach to any specific asset until a triggering event occurs. This distinguishes it fundamentally from a fixed charge, which attaches to a specific, identified asset from the moment of creation.
Crystallisation
**Crystallisation** is the process by which a floating charge converts into a **fixed charge** over the specific assets that exist at the moment of crystallisation. Once crystallised, the company can no longer deal freely with those assets.
Events Triggering Crystallisation
- **Winding up:** When a winding-up order is passed or a resolution for voluntary winding up is adopted, the floating charge automatically crystallises.
- **Appointment of a receiver:** When a receiver or receiver-manager is appointed by the charge holder.
- **Default:** When the company defaults on the loan agreement and the charge holder takes enforcement action.
- **Cessation of business:** When the company ceases to carry on business.
- **Express provision:** The charge document may specify events that trigger automatic crystallisation (such as breach of a financial covenant).
Floating Charge vs Fixed Charge
| Feature | Fixed Charge | Floating Charge |
|---------|-------------|-----------------|
| **Attachment** | Attaches to specific, identified assets | Floats over a class of assets |
| **Dealing with assets** | Company cannot deal without charge holder's consent | Company can deal freely in ordinary course |
| **Priority** | Ranks ahead of floating charge | Ranks below fixed charge |
| **Registration** | Must be registered | Must be registered |
| **Examples** | Charge on specific land, building, machinery | Charge on stock-in-trade, receivables, all current assets |
When Does This Term Matter?
Corporate Borrowing and Lending
Floating charges are a standard feature of **corporate lending**. When banks lend to companies, they typically take a combination of fixed charges (on specific immovable property and major equipment) and floating charges (on current assets like inventory and receivables). Understanding the nature and implications of these charges is essential for both borrowers and lenders.
Priority Disputes in Insolvency
When a company becomes insolvent and its assets are insufficient to pay all creditors, the **priority of charges** becomes critical. Fixed charge holders have priority over floating charge holders. Among floating charge holders, the one whose charge was created first generally has priority (subject to registration). Under the IBC, the waterfall mechanism in Section 53 determines the order of distribution.
Registration and Consequences of Non-Registration
Under **Section 77** of the Companies Act, every charge must be registered with the ROC. If a charge is not registered within the prescribed time:
- The charge becomes **void against the liquidator** and other creditors of the company (Section 77(3)).
- The amount secured by the charge becomes **immediately payable** — the company loses the benefit of deferred payment.
Registration is therefore critical for the floating charge to be effective.
Negative Pledge Clauses
Companies that have granted floating charges often encounter **negative pledge clauses** — contractual provisions that prohibit the company from creating any charge that ranks in priority to or pari passu with the existing floating charge. Violation of a negative pledge can trigger default and crystallisation.
Practical Significance
- **Floating charges are subordinate to fixed charges.** In a liquidation, fixed charge holders are paid first from the specific assets charged. Floating charge holders are paid from the remaining assets. This makes floating charges inherently less secure than fixed charges.
- **Preferential creditors rank ahead of floating charge holders.** Under Section 53 of the IBC, certain preferential debts (such as employee wages and dues for the insolvency resolution period) are paid ahead of floating charge holders but after fixed charge holders.
- **Verification is essential for lenders.** Before accepting a floating charge, lenders should conduct a search of the ROC's register of charges to verify whether prior charges (fixed or floating) exist on the company's assets.
- **Charge documents must be carefully drafted.** The scope of the floating charge, the assets covered, crystallisation events, and negative pledge restrictions should be clearly specified in the charge document.
- **Floating charges created within a specified period before winding up may be invalid.** Under Section 332 of the Companies Act, 2013, a floating charge created within 12 months before winding up (or within 2 years if created in favour of a related party) is invalid unless the company was solvent at the time, or fresh consideration was given for the charge.
Frequently Asked Questions
What is the difference between a floating charge and a hypothecation?
**Hypothecation** is a charge on movable property where the borrower retains possession — common for vehicle loans and stock funding. A **floating charge** is a broader concept that covers an entire class of assets (including movable assets) of a company without attaching to any specific item until crystallisation. Hypothecation can be a form of floating charge when it covers changing assets like stock-in-trade, but it can also be a fixed charge when it covers a specific identified movable asset (like a particular vehicle).
What happens to a floating charge when the company goes into liquidation?
When a company goes into liquidation, the floating charge **crystallises** and converts into a fixed charge over the specific assets in the company's possession at that moment. However, the floating charge holder ranks **below** fixed charge holders and below certain preferential creditors (like employee dues). Under Section 53 of the IBC, the distribution follows a strict waterfall: insolvency resolution costs first, then secured creditors (based on their security), then employee dues, then unsecured creditors, and so on.
Must a floating charge be registered?
Yes. Under **Section 77 of the Companies Act, 2013**, every charge — including a floating charge — created by a company must be registered with the Registrar of Companies within **30 days** of creation. Failure to register renders the charge void against the liquidator and other creditors. The company and its officers may also face penalties for non-registration.
Can a floating charge holder prevent the company from dealing with its assets?
Generally, no — not until the charge crystallises. The defining feature of a floating charge is that the company can deal with the charged assets in the **ordinary course of business**. However, the charge document may impose certain restrictions (such as maintaining a minimum stock level or not creating prior-ranking charges), and breach of these restrictions may trigger crystallisation, at which point the charge holder can prevent further dealings.
Disclaimer: This glossary entry is for informational purposes only and does not constitute legal advice.
Related Legal Terms
Collateral
Collateral is an asset or property pledged by a borrower to a lender as security for a loan, which the lender can seize if the borrower fails to repay.
Mortgage
A mortgage is the transfer of an interest in specific immovable property to secure the payment of money advanced as a loan or an existing or future debt.
Hypothecation
Hypothecation is a form of security interest where a borrower pledges movable property as collateral for a loan without transferring physical possession of the property to the lender.
Winding Up
Winding up is the legal process by which a company's operations are terminated, its assets are liquidated, its debts are paid off, and the remaining surplus (if any) is distributed among its members, leading to the dissolution of the company.
Lien
A lien is the legal right to retain possession of another person's property until a debt or obligation owed by the property owner is satisfied.