1. Introduction
Financial inter-dependence is commonplace for humans and companies alike. Recourse is usually made to surplus units (humans and companies) when a company seeks to finance its objectives. This general requirement for financing is dependent on repayment. When repayment of financing provided for a company's objectives is restricted to the company's earnings, it is termed corporate finance. Corporate finance can be obtained through equity or debt. On the other hand, project finance (the financing of a company's specific project), can only be obtained through debt (which is repayable from the project's cashflow).
Whether it is corporate finance or project finance, creditors are inclined to mitigate the inherent risks of a debt transaction (e.g. default in repayment) by questing for, evaluating and opting for assets of the borrowing company as security. Whilst the quest is confined to the borrowing company's available assets, evaluating assets is multifaceted. An evaluating creditor will not only assess the available assets, but also the mode (mortgages, pledges and charges) best suited to create security over them. This paper focuses on one of such modes, a charge, revealing its classifications, and the advantages and disadvantages of its classification to creditors.
2. Nature of a Charge and Chargeable Assets
A charge is created when a borrowing company (the chargor) uses its asset(s) to secure a debt which it owes to a creditor (the chargee). The asset(s) secures the debt in the sense that the creditor is empowered to realise the debt from the asset(s) (through the aid of a receiver) when the borrowing company fails to repay the debt or becomes insolvent.
In corporate finance, the assets used for security can be a single asset, a pool of assets (with similarities), a group of assets, or all of the assets on the borrowing company's balance sheet. On the other hand, in project finance, the debt can either be secured over only the project (non-recourse), or an intermix of the project and some other assets on the borrowing company's balance sheet (limited recourse). The assets on the borrowing company's balance sheet usually consist of real property, and personal property (tangible or intangible). In law, tangible personal properties are palpable properties capable of physical possession (e.g., the borrowing company's vehicles and equipment). On the other hand, intangible personal properties are legally referred to as things-in-action because legal action is required to possess them (e.g. the borrowing company's shares and bank account).
Opting for any of the aforementioned types of assets largely depends on the creditor's discretion which is influenced by things like its personal interests, end goal and safety. For instance, a cautious creditor may insist on a charge on real property, because it is less unlikely to be an object of fraud. In another light, a creditor who may have an underlying interest in attaining ownership in a borrowing company may tilt towards a charge on shares. This is because, upon failure to repay, the creditor can apply to the court to convert the debt owed to an equity share in the borrowing company.
When the creditor finally selects the asset(s) to be used as security in agreement with the borrowing company, its particulars, mode of realisation, rank in priority, and other terms are usually documented in a Security Agreement. A Security Agreement may be in the form of:
- A Security Deed; used when one, a group, or a pool of the chargor's assets is used to secure a debt (e.g., a Deed of Share Charge, a Deed of Account Charge).
- A Deed of All Asset Debenture; used when all the chargor's assets are used to secure a debt.
3. Differentiating a Charge from a Mortgage and a Pledge.
A mortgage and a pledge share many similarities with a charge. However, the difference between these formal transactions and the latter is the interest they transfer. A charge only gives the chargee a proprietary interest over the charged asset(s), that is a registrable and transferable right to realise the debt from the asset(s). 1
On the other hand, a mortgage gives the mortgagee legal title (which ceases upon redemption) over the mortgaged asset(s), and a pledge gives the pledgee possessory interest. The effect of the legal title held by a mortgagee is that the mortgagee becomes entitled to the mortgaged asset(s) over all persons including the mortgagor,2 and therefore can unilaterally divest the mortgaged asset(s) in other to recover the rendered facility.3 Contrariwise, a chargee cannot exercise this power of sale. A chargee can only exert slight dominance over a charged asset(s), by precluding the chargor from dealing with the asset(s) without its consent, which then makes the charge a fixed one. Aside from a fixed charge, the second way of creating a charge over assets is called the floating charge.
4. Ways of Creating a Charge: A Fixed or Floating Charge
As earlier identified, there are two ways of creating a charge over assets: a fixed charge and a floating charge. These two ways are employable in both corporate finance and project finance. Whichever it is employed in, a fixed charge is one which, from its inception, precludes the chargor from dealing with the charged asset(s) without the chargee's consent. Inversely, a floating charge permits the chargor to deal with the charged asset(s) until it crystallises.
The designation, floating charge, is predicated on the fact that the charge floats/hovers over the charged asset(s) and only becomes fixed when a crystallising event occurs. What amounts to a crystallising event is dictated by the express terms (the terms of the security agreement) and the implied terms (the applicable law). In Nigeria, section 203 of the CAMA, 20204 provides that a floating charge that was used to secure a debenture (a type of debt corporate finance) crystallises when the company goes into liquidation, or the chargee of a floating charge that has become enforceable appoints a receiver as empowered by the debenture, or the appointment of one by the court on the application of the chargee.
The fact that a floating charge needs to crystallise and a fixed charge does not gives the fixed charge priority over a floating charge. This means that if a company's debt that was secured by a floating charge on all its factories, and another secured by a fixed charge on a factory, become enforceable at the same time, the fixed charge's debt will be settled first. If it is the floating charge's debt that becomes enforceable first, any appointed receiver is mandated by law to realise the fixed charge's debt from the factory before the floating charge.5 Similarly, when the chargor is in liquidation, a fixed charge's debt will be realised before the floating charge.6 However, the floating charge can take priority if the security agreement provides as such, and the chargee of a future fixed charge is given notice of this priority claim.7
5. The Distinctive Features between a Fixed Charge and a Floating Charge
Historically, there have been three distinctive features which separate a fixed charge from a floating charge. They are as follows:
- A fixed charge is a charge on specific identifiable asset(s), while a floating charge is a charge on a group or pool of assets, both present and future;
- the asset(s) of a floating charge changes periodically in the ordinary cause of business, a fixed charge does not; and
- a fixed charge, from its inception, precludes the chargor from dealing with the asset(s) without the consent of the chargee, while a floating charge allows the chargor to deal with the charged asset(s) until it crystallises.8
More recently, there has however, been a fundamental shift from two of these distinctive features. This was due to trends where security agreements place a charge on a group or pool of assets, past or present, but still preclude the chargor from dealing with the assets. It therefore became widely accepted that the only true difference between a fixed charge and a floating charge is that the former precludes the chargor from dealing with the charged asset(s).9
The writer aligns with the view that, while the asset(s) of a fixed charge and floating charge have their usual nature,10 the reverse could be the case. Nothing stops a chargor and a chargee from agreeing to preclude the chargor from dealing with an ever-changing group or pool of assets sought to be charged, e.g., a bank account. Another reason to align with this view is that it is commonly accepted that a floating charge converts into a fixed charge upon crystallisation. This conversion, which henceforth precludes the chargor of a floating charge from dealing with the asset(s), does not change the dynamic nature of the asset(s).
It is therefore reasonable to deduce from this that, the only true distinctive feature, is the prohibition from dealing with the charged asset(s) placed on a fixed charge, and not the ever-changing nature of the asset(s) of a floating charge. This prohibition placed on a fixed charge means two things: the chargor cannot utilise the asset(s) in the ordinary course of running its business, nor create other securities over the asset(s). On the other hand, the extent to which a chargor of a floating charge is permitted to deal with the charged asset(s) depends on the terms of the security agreement between the chargor and chargee. Notwithstanding this, the permitted dealings will usually not include dealings that can bring an end to the life of the security, or the chargee's interest in the security. For the chargor, these two aforesaid implications of the prohibition from dealing with the asset(s) of a fixed charge, are the disadvantages of selecting a fixed charge over a floating charge, and vice versa. For the chargee, there are numerous advantages and disadvantages that must readily come to mind, which are discussed below.
6. Advantages and Disadvantages of a Fixed Charge
6.1 Advantages
6.1.1 In corporate finance and limited recourse project finance, realising the traditionally small assets of a fixed charge is faster and easier for a receiver than that of a floating charge.
6.1.2 In corporate finance and project finance, there is no possibility of the charged asset(s) depreciating due to managerial inadvertence by the chargor.
6.1.3 In corporate finance and project finance, a fixed charge takes priority over a floating charge.
6.2 Disadvantages
6.2.1 In corporate finance and limited recourse project finance, there is a relatively higher risk of depreciation of the traditionally small assets of a fixed charge.
7. Advantages and Disadvantages of a Floating Charge
7.1 Advantages
7.1.1 In corporate finance and limited recourse project finance, there is a relatively lower risk of depreciation of the traditionally large assets of a fixed charge.
7.1.2 A chargee whose floating charge was used to secure a chargor's debenture, (a long-term debt corporate finance)11 takes up unique rights in that chargor as a corporate entity. These rights include:12
- The right to dissent to change in objects of the chargor, which succeeds if an aggregate of 15% of the holders of the chargor's debentures that are secured by a floating charge dissent.
- The right to appoint an administrator to revive an insolvent chargor, if the chargee's charge is one on all or substantially all of the chargor's assets, and the debenture document empowers the chargee to appoint an administrator and receiver.
7.2 Disadvantages
7.2.1 In corporate finance and project finance, a floating charge generally ranks lower in priority than a fixed charge.
7.2.2 In corporate finance and limited recourse project finance, it may prove difficult and time-wasting for the receiver to possess relatively large assets and carry out its duty to realise the debt.
8. Conclusion
A charge, which entails a borrowing company(chargor) using its asset(s) to secure a debt owed to a creditor(chargee), gives the chargee proprietary interest in the charged asset. This proprietary interest may be fixed on or floated over the charged asset(s). It is to the benefit of the chargor if he agrees with the chargee to float the charge. This is because the chargor can still utilise the charged asset in the ordinary course of business and create subsequent security over it. For the chargee, making an investment decision between a fixed charge or floating charge comes with equal advantages and disadvantages. The chargee must assess this and select either a fixed or a floating charge, depending on which aligns with its business interests or goals.
Footnotes
1. See generally, Ayodele Ashiata Kadiri, 'A Review of the Nigerian Law and Practice on Perfection of Charges' The Gravitas Review of Business & Property Law Vol.12 No.3 September 2021.
2. Adetona v. Zenith Bank Plc (SC) (2011) 18 NWLR (Pt. 1279) 627 at pp. 644-645, paras. A-G.
3. This is conditional upon the happening of the events prescribed by the law and the deed of mortgage for the mortgagee's power of sale to arise and become exercisable. See, Ihekwoaba v. A.C.B. Ltd (SC) (1998) 10 NWLR (Pt. 571) 590 at p. 609, paras. D-G; at p. 612.
4. Companies and Allied Matters Act, 2020.
5. Kadzi Intl Ltd. v. Kano Tannery Co. Ltd (SC) (2004) 4 NWLR (Pt. 864) 545 at p. 577 paras A-D.
6. Ibid.
7. Section 204 Companies and Allied Matter Act, 2020. This does not apply to project finance.
8. Deduced from the old English case of Re Yorkshire Woolcombers Association Ltd [1903] 2 Ch 284.
9. Sarah Worthington, "Floating Charges An Alternative Theory", The Cambridge Law Journal 53, No. 1 (1994): 81–103, available at http://www.jstor.org/stable/4507904, accessed 23rd January2025.
10. The assets used to secure fixed charges are usually specific and identifiable. Inversely, floating charges are usually secured by groups or pools of assets (present and future).
11. Debentures differ from normal debts, in that debentures can be redeemable or irredeemable.
12. Section 51 (5) Companies and Allied Matter Act, 2020; section 452 Companies and Allied Matters Act, 2020.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
