Charge creation means the establishment of lender’s right over specified assets of the borrower in order to recover principle and interest in default from the borrower. The charge can be created against the same assets by more than one lender. The lender in whose favour charge is first created is called holder of ‘First Charge’. If Subsequent charge is created in favour of a different lender against the same assets on which first charge already exist, the subsequent charge holder is called as holder of the second charge.
The second charge is also a legal charge that will rank behind the first charge. It means when first charge is satisfied by the company, the second charge holder is automatically promoted as first charge holder against the specified assets. Besides, when first charge holder disposes off the assets charged in its favour in order to recover its dues from the borrower, the second charge holder is entitled to receive the residual value of the assets if any available in the hands of first charge holder. This is possible only when first charge holder’s dues are fully liquidated.
The second charge is usually created on land building, plant and machineries of the borrower which are normally funded by a term lending institution(s) that will have first charge over the property so acquired by the borrower under the term loan. The bank which releases working capital finance will have first charge over working capital (stocks of raw material, work-in progress, finished goods and receivables) funded by it. Normally bank which finances working capital limit would stipulate a condition that the company should offer collateral security by way of creation of second charge on the properties against which term lenders have the first charge.
Related articles (category loans and advances)
- Meaning of Pari-Passu charge
- Registration of charge against company’s assets: The process of creation, modification and satisfaction charge under Companies Act
- Consequences of registration and non-registration of charge under Companies act 2013
- Meaning of fixed charge, floating charge, and crystallization of charge
- Facility of ‘Condonation of delay in registration of charge’ under companies Act 2013
- Do you know that banks or FIs can register a charge if the borrower company fails?