What is the difference between first charge and second charge?

Charge creation means the establishment of the lender’s right over specified assets of the borrower in order to recover principal 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 the holder of ‘First Charge’. If a Subsequent charge is created in favour of a different lender against the same assets on which the first charge already exists, the subsequent charge holder is called the holder of the second charge.

The second charge is also a legal charge that will rank behind the first charge. It means when the first charge is satisfied by the company, the second charge holder is automatically promoted as the first charge holder against the specified assets. Besides, when the first charge holder disposes of 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 the first charge holder. This is possible only when the first charge holder’s dues are fully liquidated.

The second charge is usually created on the land building, plant, and machinery of the borrower which are normally funded by a term lending institution(s) that will have the first charge over the property so acquired by the borrower under the term loan. The bank which releases working capital finance will have the first charge over working capital (stocks of raw material, work-in-progress, finished goods, and receivables) funded by it. Normally bank which finances the working capital limit would stipulate a condition that the company should offer collateral security by way of the creation of the second charge on the properties against which term lenders have the first charge.