Floating Lien

What Is a Floating Lien?

A floating lien, also known as a floating charge, is a way for a company to obtain a loan using a security interest in a general set of assets, in which the individual assets are not specifically identified, as collateral.

Typically, a loan would be secured by fixed assets such as property or equipment, but with a floating lien, the underlying assets are usually current assets or short-term assets that can change in value.

How a Floating Lien Works

Floating liens are an effective way for retailers and other product-based businesses to use their inventory or accounts receivable as collateral. The actual items may be constantly changing, but the floating lien assures the creditor that its loan is secured against any new items. The borrower has the right to sell, transfer or dispose of any of its assets in the ordinary course of business.

Floating liens thus allow business owners to access capital secured with dynamic or circulating assets. The assets backing the floating charge are short-term current assets, usually consumed by a company within one year. The floating charge is secured by the current assets while allowing the company to use those assets to run its business operations.

If the company defaults or otherwise fails to repay the loan, the floating charge "crystallizes" into a fixed charge, and the lender becomes the first-in-line creditor to be able to draw against the underlying asset.

Crystallization of Floating to Fixed Charges

Crystallization is the process by which a floating lien or charge converts into a fixed charge. If a company fails to repay the loan or goes enters liquidation, the floating charge becomes crystallized or frozen into a fixed charge. With a fixed charge, the assets become fixed by the lender so the company cannot use the assets or sell them.

Crystallization can also happen if a company ends operations or if the borrower and lender go to court and the court appoints a receiver. Once crystallized, the now-fixed rate security cannot be sold, and the lender may take possession of it.

Typically, fixed charges are related to debts secured by tangible assets, such as buildings or equipment. For example, if a company takes out a mortgage on a building, the mortgage is a fixed charge, and the business cannot sell, transfer or dispose of the underlying asset — the building — until it repays the loan or meets other conditions outlined in the mortgage contract.