Definition of charges

The term charge has not been defined under the Companies Act, 1956. Section 124 states that the expression "Charge" includes a mortgage. However, the language of section 125 use the expression "so far as any security on the company's property or undertaking is conferred thereby" makes it clear that a charge is nothing but security of its property by the company in favor of a creditor with the intent of securing his debt. A security (or charge) is a pledge of an asset to a particular creditor to support a debt. A creditor who holds a security is known as a secured creditor and the asset is known as being 'charged'. Securities or charges are over assets, not over companies or people. The best know form of security is a mortgage over a house granted to a bank to support the loan used to buy the house. Securities over other assets have different rules than real property mortgages, particularly with regard to registration, but they have the same general purpose and effect.

Types of charges and explanation

Fixed Charges The bank or lender may have provided money to acquire an asset like a building or vehicle. The company cannot sell this without the lenders permission. The debt must be repaid as per the loan agreement or facility letter. - Consider a mortgage, which is a form of fixed charge. When a borrower borrows money to buy a house, he or she does not own the house outright until the debt is repaid in full, nor can the borrower sell the property without the lenders permission. - Another example is an assignment of a companys debtor book through factoring or invoice discounting. In this situation, the bank purchases the outstanding invoices and lends money against them. The debtor book is then subject to a fixed charge. In effect as with a mortgage, the book debts belong to the bank or factoring company, not the company to whom the debt is owed.

Floating Charges Fixtures and fittings, cash, stock, finished or raw material, work in progress, unfactored debtors, or assets not subject to fixed charges are the types of things that the company uses to generate business. It would not be practical to place a fixed charge over every item of stock or desks and chairs. In this situation, where security over a group of these changing assets of a company, a floating charge is used. The floating charge floats until conversion into a fixed charge, at which point the charge attaches to specific assets. The conversion to a fixed charge, called crystallisation, can be triggered by a number of events and it has become an implied term in debentures under English law that a cessation of the companys right to deal with the assets in the ordinary course of business will lead to automatic crystallisation. Under a typical typical loan agreement, default by the borrower is a trigger for crystallisation. Such defaults typically include nonpayment of the debt, invalidity of any of the lending or security documents, liquidation or insolvency.

Crystallization of charges

When the charge holder takes steps to enforce his charge, a floating charge becomes a fixed charge on the assets covered by that charge. Until a floating charge becomes a fixed charge, the company is free to deal with the property charged in any manner it deems fit. But once the floating charge crystallises, the company cannot dispose off the charged assets without paying of the chargeholder. Otherwise, the chargeholder can recover his dues from the proceeds. A floating charge crystallises or becomes the fixed in following situations :-Where the company ceases to carry on the business, whether the principal money has become payable or not, unless the debenture or trust deed contains the stipulation to the contrary. -Upon the commencement of winding up of the company. - If a debentureholder, having become entitled to realise the securities by the reason of the fact that the principal money has become payable, intervenes for the purpose by appointing the receiver or by making an application to the court for appointment of the receiver.

Negative pledges A negative pledge is a term in a borrowing agreement which prohibits the borrower from taking on additional debt without consent from the original lender. This is designed to protect the lender from dilution of security, in which it would be unable to recover its debt in the event of a default. These types of clauses are used in a variety of agreements related to borrowing and lending money and they are one reason why people should review the terms with care before borrowing funds. One classic reason to use a negative pledge is a large unsecured loan. Lenders who make unsecured loans are aware that if the borrower takes out another loan and pledges assets as security, the new lender can seize those assets in the event of a default, leaving the unsecured lender with less chance of recovering the funds it is owed. Likewise, lenders want to prevent situations in which people pledge the same assets twice.

Registration of charges
Every company must keep at its registered office a register of charges in which all the charges and mortgages specifically affecting the property of the company must be entered. The register must contain short description of the property charged, the amount of the charge, the name of the person entitled to the charge, etc. The company must keep at its registered office, a copy of every instrument creating any charge requiring the registration. During the business hours inspection by the creditor or member of the company is allowed to be without charge of the register and documents. Any outsider can inspect them on the payment of Rs10 for each inspection during the business hours. Registrar of the company must keep also the register of charges in respect of each company and register therein full particulars relating to the charge created by the company and registrable under the Act. This register is also open to inspect by any person on payment of Rs 10 as fees . The company must submit to the Registrar the instrument creating the charge or its certified copy which will be returned after the registration along with the certificate of registration. The company must cause the copy of every registration to be endorsed on every debenture or certificate of debentures stock which is issued by the company and the payment of which is secured by the charge.

Registration of charge in connection with the issue of debentures Section 128 allows registration of certain particulars in case where a company issues a series of debentures and the debenture holders are entitled pari passu to the benefit of a charge created for the benefit of debenture holders. The company shall file following particulars with the concerned Registrar of Companies for registration of charge under section 125(4):
(1) The total amount secured by the whole series. (2) The dates of the resolutions authorising the issue of the series and the date of the covering deed, if any, by which the security is created or defined. (3) A general description of the property charged. (4) The names of the trustees, if any, for the debenture holders.

(5) The deed containing the charge or a duly verified copy thereof.
(6) Particulars as to the amount or rate percent of the commission discount or allowance paid or made in connection with debentures. [Section 129]

Following points shall be noted in this regard: (a) Failure to file particulars of such charge with the Registrar of Companies shall not affect the validity of the debentures issued. (b) Debentures may itself contain a charge or give a reference as to any other instrument in this regard. (c) The particulars of charge as given above shall be filed together with the deed containing the charge, or a copy of the deed verified in the prescribed manner, or if there is no such deed, one of the debentures of the series.

(d) The company shall file with the Registrar, particulars of the date and amount of each issue of debentures of series, if there is more than one, but failure to file such particulars shall not affect the validity of the debentures issued.
(e) Debentures must also be registered under the Indian Registration Act. (f) Section 133 requires that the company shall cause a copy of every certificate of registration given under section 132, to be endorsed on every debentur e or certificate of debenture stock which is issued by the company and the payment of which is secured by the charge so registered.

Charges requiring registration : A company must file within 30 days of creation of a charge with the Registrar complete details of the charge together with the instrument of charge or its verified copy in respect of certain charges. Otherwise the charge will be void. This does not mean that the creditors cannot recover their dues. It merely means that the benefit of the charged security will not be available to them. As per section 125(4), the following kinds of charges are mandatory and these charges needs to be registered with the Registrar of Companies: i.A charge for the purpose of securing any issue of any debentures ii.A floating charge iii.A charge on uncalled share capital iv.Charge on calls made but not paid v.A charge on any immovable property vi.A charge on ship vii.A charge on book debts of the company viii.A charge on goodwill or on patent or on license under the patent or on trademark or copyright or on the license under the copyright ix.A charge other than a pledge on any movable property of the company.

Effects of non-registration
Effects of Non-Registration: In case of non- filing and registration of these particulars the following consequences shall arise: all the charges covered under section 125(4) shall become void unless registered by the Registrar and when a charge becomes void under section 125, the money secured thereby shall immediately become payable by the company; the charge will be void as against the liquidator (in the event of the company being wound up) and against the creditors, if any, so far as the company is concerned, the charge will be good and it can be enforced so long as the company does not go into liquidation; the security becomes void but non-registration does not affect any contract or obligation of the company as to repayment of the money secured by the charge; the company, and every officer of the company or other person who is in default, shall be punishable with fine which may extend to Rs. 5,000 for every day during which the default continues [section 142(1)]. A further fine of Rs. 10,000 may also be imposed on the company and every officer of the company who is in default of any other requirements of the Act concerning registration of a charge created by company. [Section 142(2)]

If a mortgage or charge which requires registration is not registered, it does not mean that the transaction is altogether void or the debt not recoverable. The only consequence is that the security created by the mortgage or charge becomes void as against the liquidator and other creditors. The omission to register does not prejudice any contract or obligation for repayment of the money secured by the charge, and where the charge becomes void for want of registration, the money secured by it immediately becomes payable. Where an earlier charge and a subsequent charge have been created in succession in favour of the same charge holder, if, on account of non-registration or other cause, the later charge is or becomes void, the equitable doctrine of revival will apply so as to revive the earlier charge. Where a charge is void for non-registration, no right of lien can be claimed on the documents of title, as they were only ancillary to the charge and were delivered pursuant to the charge. The default is also punishable under section 142. Omission to registrar particulars of charge is required punishable with fine. A company or every officer of company is in default shall be liable to fine up to Rs 500 for each day of continuing default. A further fine of Rs. 1000 may be imposed on the company and every officer for other defaults relating to registration of charges. Wherever the terms and conditions or the extent of the operation of any registered charge is modified, the company is required to file the particulars of modification within 30days thereof with the Registrar of Companies.

Priorities of charges
As a general rule, a fixed charge will prevail over a floating charge, even where the fixed charge is granted subsequently to the floating charge. So too the preferential creditors in a winding up will rank before the floating charge. Thus, the basic order is, after fixed charges and the expenses of the liquidation, preferential debts, then the floating charges. Obviously, unsecured creditors rank after any floating charge. For ease reference, the above table demonstrates the said order. In view of above, a bank would normally prefer a fixed charge to a floating charge over the debtors assets. Yet, it is often difficult to draw a clear line between a fixed charge and a floating charge. As mentioned, whether a charge is fixed or floating depends on the degree of freedom the chargor is given to manage and deal with the charged assets both under the debenture and in practice. The greater the control exercised by the bank through the provisions in the debenture and the actual enforcement of those provisions, the greater the chance of the charge being regarded by the court as a fixed charge.

Receivers costs ( if any)

Fixed charge holder

Preferential creditor

Floating charge holder