Law & Numbers - News Legal

Hungarian rules for private equity investments become more flexible

18.02.2014 (Hungary)

Hungary’s new Civil Code will enter into force in March 2014. The new legislation will also amend the rules of company law. As opposed to the previous legislation, the new company law regulation will share the general permissive nature of civil law. As a result, with a few exceptions, members of a company will now have the possibility to derogate from the statutory rules and regulate their legal relationship at their own discretion. In addition to this conceptual innovation, the new Civil Code will also introduce a wide range of new options available to the shareholders.

Capital contributions – new rules of divisibility

The currently effective rules set forth that the minimum capital contribution of a member of a limited liability company (kft.) must be at least HUF 100,000 and each capital contribution must be divisible by HUF 10,000. This rule proved to cause major difficulties in setting up fine-tuned ownership ratios within a kft. or upon the elaboration of employee option plans.

The new Civil Code eliminates the rule of divisibility and though it still sets forth that the minimum amount of a capital contribution shall be at least HUF 100,000, the parties will be able to deviate from this limitation. As a consequence, the parties will not be forced to elect other company forms just in order to mitigate the problem of the minimum amount and divisibility of capital contributions in limited liability companies.

Companies limited by shares – types of shares are not restricted anymore

The currently effective Companies’ Act provides an exhaustive list of preferential rights that can be attached to the shares of a company limited by shares. Investors that wished to create additional preferences needed to transform the target company into a limited liability company or to regulate these rights contractually only.

Although the new Civil Code still defines the various rights that can be attached to preference shares, due to the permissive nature of the new law the parties are able to introduce additional types of shares not yet regulated by the legislation. There is only one obligation: the exact rules and rights attached to these shares must be set out in the statutes.

Shortage of funds? Supplementary capital is the solution!

The so-called supplementary capital (‘pótbefizetés’ in Hungarian) has been a really flexible form of funding as it combines the benefits of capital and loan financing while it can be ordered by a simple decision of the supreme body of the company – thus its administrative costs are low. It is also a desirable option since it does not trigger any interest payment obligation.
The current Companies Act limits, however, the applicability of supplementary capital in numerous ways. It can be used by limited liability companies only and only for the purpose of covering losses. Also, it must be repaid when the company generates profits, and the contribution can be provided in the form of cash only.

The new Civil Code enables the parties to derogate from all these limitations. For instance, also a company limited by shares will be able to order for the payment of a supplementary capital and the contribution can also cover cash-flow problems, not only losses. This will allow supplementary capital to play a greater role in the course of investments.

Organisational structure – flexible options

The new Civil Code eliminates the strict rules defining the scope of competences of the various organisational bodies of a company. The new provisions enable the parties to delegate certain decisions to other corporate organs or officers of the company. Also, investors will now be able to create other organisational bodies than the ones named in the Civil Code and confer them with decision-making competence.

There has been a continuous demand by foreign investors that the management of limited liability companies is carried out by a board, rather than by individual managing directors as set forth by the laws. From March the creation of a decision making body will also be available to limited liability companies due to the permissive nature of the new Civil Code.

Executive officers: revised regulations, conceptual changes

Based on the effective rules only individuals can serve as managing directors of foreign companies. From March, the management of a company may be conducted by companies as well, which may lead to changes in the management structure of numerous company groups.

As it has been highlighted by recent press news, the liability of the executive officers will be extended. From March, an executive officer will be liable jointly and severally with the company itself for any damage caused to third parties when acting in his/her official capacity. It is important to note that this rule will not apply to contractual liability: should a company breach a contract the executive will not be held liable for the loss caused by the breach towards the other contracting party. In any case, however, this new concept will enhance the risk borne by executive officers and will probably give higher significance to liability insurances. Also, it may lead to the increase of transactional costs.

Call options – the provisions of shareholders’ agreements to be revised

It is common practice in private equity transactions that the investors are granted the option to purchase the shareholding of other members, if the other party fails to perform certain contractual obligations.

The new Civil Code will restrict the applicability of such right. Based on the new legislation, option rights designated to act as a security of a financial claims are considered void. While the aim of the new Civil Code is to prohibit the call option if it is designated to secure a monetary claim, it is a question whether such prohibition could also apply in the case the shareholder fails to meet its contractual obligations.

On the other hand, the Civil Code lifts some of the restrictions the parties need to face when designing a call option. Most importantly, the term of a call option will not, any longer, be limited in five years.

Operational rules – one step forward, two steps back

The new Civil Code contains several provisions that will change the day-to-day operation of companies. Some of the rules make the operation more flexible. For example, members will be entitled to resolve in writing in all such matters that fall within the competence of the general meeting. Further, in the future, no specific provision needs to be inserted into the articles to enable the company to pay interim dividend, i.e. interim dividends can be paid automatically.

On the other hand, some other provisions will create discomfort to investors. In the future, at least three days will need to elapse between the original members’ meeting and the members’ meeting reconvened due to the lack of quorum (in the current, somewhat questionable, practice reconvened meetings are often held within just minutes following the originally convened meeting). The new Civil Code also eliminates the possibility of the members to pay interim dividends on the basis of a balance sheet not older than six months: the new rules require the preparation of an interim balance sheet upon the declaration of each interim dividend payment.

Summary

The new Civil Code will completely re-write the legal background, in which Hungarian companies operate. In some cases it will bring new possibilities or encourage parties to tailor their legal matters to their own needs. From other aspects, companies and their executives will need to act with increased care or even to change their daily corporate legal routine. It is certain that the interpretation of some of the new rules will raise debates and hence both the courts and law practitioners will face many new challenges from March.





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