There are various types of security, for instance ‘fixed charges’ and ‘floating charges’. This section provides a simplified overview of how different types of security (known as ‘charges’) can operate, although you are unlikely to be expected to discuss the concepts outlined in any real detail in an interview. However, understanding the basic principles can help if you end up interning in a banking/debt finance-related department of a commercial law firm.
Mortgage / Fixed Charge
A fixed charge (or mortgage) gives the lender a legal right to claim and sell the asset(s) over which security is taken (the ‘secured assets’) in order to recover the funds loaned out, in instances where a loan has not been repaid in accordance with the terms under which the security was taken. The borrower cannot sell the secured assets without the lender’s consent, so fixed charges will not usually be suitable for assets such as stock (which companies need to be able to sell to consumers in order to make a profit). Note, mortgages and fixed charges are not identical in all respects. However, discussion of the differences (which relate to the transfer of ownership) is beyond the scope of this handbook.
Floating Charge
Operates in a similar manner to a fixed charge, but is different in that the assets over which the floating charge is taken can be freely sold unless the charge ‘crystallises’. The parties can agree in advance the circumstances under which the charge will ‘crystallise’ and these circumstances will usually include the borrower becoming insolvent. This ability to freely sell assets makes floating charges more suitable for assets over which it would commercially impractical for the borrower to relinquish control to the lender (e.g. stock or cash held in a current account). For instance, if a borrower relinquished control of its stock to a lender, that borrower would be unable to sell that stock without receiving permission from the lender to do so each time a customer requested to buy that stock. A floating charge offers less protection for lenders however. This is because lenders that have the benefit of a floating charge are not repaid in the event of insolvency until certain other parties (such as fixed charge holders, the liquidator and unpaid employees) have been repaid in full. This often means that there is little left for floating charge holders after borrowers become insolvent.
Liquidator: a party often appointed when a company becomes bankrupt. Functions include: collecting money the (bankrupt) company is owed, collecting and selling that company’s assets, then distributing the proceeds to parties that are entitled to receive payment (e.g. existing lenders that have not been fully repaid).
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By Jake Schogger - City Career Series