CHARGE (SHORT NOTE)

Synopsis

INTRODUCTION
DEFINITION [S. 2(16)]
KINDS OF CHARGES
A. Fixed or Specific Charge
B. Floating Charge
Smith v. Bridgend County Borougn Council
Crystallization of Floating Charge
Effect of Crystallization of a Floating Charge

INTRODUCTION

A company, like a natural person, can offer security for its borrowings. This security may be in the
form of a mortgage or a charge on any movable property. Where property, both existing and future, is
agreed to be made available as a security for the repayment of debt and creditors have a present right
to have it made available, there is a charge created.

Normally, the debentures and other borrowings of the company are secured by a charge on the assets
of the company.

DEFINITION [S. 2(16)]

According to Section 2(16) of the Act, “charge” means 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.

An analysis of the above definition implies that –

1. Charge is a creation of interest or lien

2. Such interest or lien is created on the property or assets of a company or any of its
undertakings or both
3. Charge is a security in respect of any borrowing, and
4. Charge includes mortgage.

It must be noted that the definition of charge under the Companies Act differs from that under
the Transfer of Property Act. According to the definition of charge u/s 100 of the Transfer of
Property Act, charge is a right created by any person on any immovable property in favour of
another person, as a security for the repayment of money, and it does not amount to a mortgage.
Thus, while under the Transfer of Property Act, a distinction has been made between a charge and a
mortgage, the definition under the Companies Act is inclusive and states that charge includes a
mortgage.

KINDS OF CHARGES

A charge on the property of the company as security for debts may be of the following kinds, namely:

1. Fixed or Specific Charge

2. Floating Charge

A. FIXED OR SPECIFIC CHARGE

A charge is called fixed or specific when it is created to cover assets which are ascertained and
definite or are capable of being ascertained and defined, at the time of creating the charge e.g., land,
building, or plant and machinery. A fixed charge, therefore, is a security in terms of certain specific
property, and the company gives up its right to dispose off that property until the charge is satisfied.
In other words, the company can deal with such property, subject to the charge so that the charge
holder’s interest in the property is not affected and the charge holder gets priority over all subsequent
transferees except a bona fide transferee for consideration without notice of the earlier charge. In the
winding-up of the company, a debenture holder secured by a specific charge will be placed in the
highest ranking class of creditors.

B. FLOATING CHARGE

A floating charge, as a type of security, is peculiar to companies as borrowers. A floating charge is not
attached to any definite property but covers property of a fluctuating type e.g., stock-in-trade and is
thus necessarily equitable. A floating charge is a charge on a class of assets present and future which
in the ordinary course of business is changing from time to time and leaves the company free to deal
with the property as it sees fit until the holders of charge take steps to enforce their security. “The
essence of a floating charge is that the security remains dormant until it is fixed or crystallised”. But a
floating security is not a future security. It is a present security, which presently affects all the assets
of the company expressed to be included in it.

On the other hand, it is not a specific security; the holder of such charge cannot affirm that the assets
are specifically mortgaged to him. The assets are mortgaged in such a way that the mortgagor i.e. the
company can deal with them without the concurrence of the mortgagee. The advantage of a floating
charge is that the company may continue to deal in any way with the property which has been
charged. The company may sell, mortgage or lease such property in the ordinary course of its business
if it is authorized by its memorandum of association.

In
 Smith v. Bridgend County Borougn Council

The agreement allowed the employer, in various situations of default by the contractor, to sell the
contractor’s plant and equipment and apply the proceeds in discharge of its obligations.

The Court held that this agreement constitutes a floating charge. It was observed that a right to sell an
asset belonging to a debtor and appropriate the proceeds to payment of the debt is nothing but a
charge. It was a floating charge because the property in question was a fluctuating body of assets
which could be consumed or removed from the site in the ordinary course of the contractor’s business.

In

Maturi U. Rao v. Pendyala

It was held that when the floating charge crystallizes it becomes fixed and the assets comprised
therein are subject to the same restrictions as the fixed charge.

Crystallization of Floating Charge

A floating charge attaches to the company’s property generally and remains dormant till it crystallizes
or becomes fixed. The company has a right to carry on its business with the help of assets over which
a floating charge has been created till the happening of some event which determines this right. A
floating charge crystallizes and the security becomes fixed in the following cases:

1. when the company goes into liquidation;

2. when the company ceases to carry on its business;
3. when the creditors or the debenture holders take steps to enforce their security e.g. by appointing
receiver to take possession of the property charged;
4. on the happening of the event specified in the deed.

In the aforesaid circumstances, the floating charge is said to become fixed or to have crystallized.
Until the charge crystallizes or attaches or becomes fixed, the company can deal with the property so
charged in any manner it likes.

Effect of Crystallization of a Floating Charge

On crystallization, the floating charge converts itself into a fixed charge on the property of the
company. It has priority over any subsequent equitable charge and other unsecured creditors. But
preferential creditors who have priority for payment over secured creditors in the winding-up get
priority over the claims of the debenture holders having floating charge.