Hungary: Modifying the rules

Author: | Published: 1 Oct 2009
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By early October 2008, following the collapse of Lehman Brothers, all constituents of the Hungarian financial system experienced unprecedented turbulence. In response, the government and the National Bank of Hungary (NBH) introduced several measures in order to protect the financial sector from collapse and to minimise the impact of the economic recession.

These measures fall into the following categories:

  • Guarantees of bank debt by the state (introduced by Act CIV of 2008 on the strengthening of the financial intermediary system (bank bailout law));
  • Deposit guarantees by the state;
  • Special (monetary) assistance measures by the NBH;
  • Recapitalisation measures by the state (under the bank bailout law);
  • Financial support by international organisations (IMF, EU and World Bank);
  • Various economic stimulus packages by the state;
  • Development of legislation in critical areas (most prominently in the field of insolvency); and
  • Development (typically tightening) of regulations in the financial sector.

Bank bailout law

In December 2008 the Hungarian Parliament enacted the bank bailout law, which introduces a debt guarantee scheme and a recapitalisation scheme, together requiring the designation of HUF 600 billion (approximately €2 billion). These measures are available to Hungarian banks organised as corporations. This means that retail bank branches are not eligible to participate in the schemes under the bank bailout law.

The debt guarantee scheme is applied upon the request of an eligible bank and guarantees obligations based on loans and debt securities that are denominated in Euros, Hungarian forints or Swiss francs. Banks participating in the scheme are required to issue a special voting preference share in favour of the state. The preference share entitles the state to veto all major decisions put forward at the general meeting of the bank.

The recapitalisation scheme makes it possible for the state to inject capital into eligible banks (upon request) in consideration for a special voting preference share (offering identical rights to the share issued in the context of the debt guarantee scheme) and non-voting dividend preference shares. In the event of a recapitalisation transaction, the state appoints at least one person to both the board of directors and the supervisory board of the applicant bank.

Changes to insolvency proceedings

Act 51 of 2009 on the amendment of Act 49 of 1991 on bankruptcy and liquidation proceedings (Bankruptcy Act) and other related laws (Amending Act) were adopted by the Hungarian Parliament on June 8 2009. The Amending Act substantially modified the rules regulating bankruptcy and liquidation proceedings.

With some exceptions, the new provisions of the Amending Act came into force on September 1 2009, and apply to those insolvency proceedings that start after that date.

The Amending Act changed several deadlines in the course of bankruptcy and liquidation proceedings, which has resulted in a shortening of the length of the proceedings. In most (but not all) instances the time limits set out in calendar days have been converted to business days.

With one important exception, the intention to shorten the deadlines is actually not expected to result in any significant reduction of the relevant period (so the time limit of eight business days in practice may become two to three days shorter than the previously used time limit of 15 calendar days). The exception, where the reduction was significant, is the reduction of the deadline available in liquidation proceedings for the lodgement of creditors' claims from one year to 180 days.

As a significant procedural development, since September 1 2009 the county (metropolitan) court with competence on the basis of the registered seat of the debtor has exclusive jurisdiction over bankruptcy and liquidation proceedings. In addition, according to the Amending Act, as of July 1 2010 all communications between the court and the parties (other than individuals) will be conducted electronically.

Changes to bankruptcy proceedings

The most important objective of the recent amendment to the Bankruptcy Act was to harmonise the law with the demands of proceedings in practice and increase its ability to provide real bankruptcy protection for companies in distressed situations. The overhaul of the moratorium rules is the most significant tool and probably the most important change introduced by the Amending Act. As of September 1 2009, the court can order the immediate (and temporary) moratorium in its decree within one working day on the basis of the application of the debtor. By way of the immediate nature of the moratorium, its protective nature is ensured.

Following the ordering of the immediate and temporary moratorium, the court assesses the application. If the application is complete (or in the case of incomplete applications the missing documents have been supplemented), the court orders the normal moratorium. In principle, this moratorium ceases on the 0th hour of the business day following the 90th day from the publication of the respective court decree.

In the course of the negotiations with creditors, upon the request of the debtor the moratorium may be extended, but only with the consent of the creditors. With a view to protect the interests of the creditors, the aggregate duration of the moratorium (including any extension) may not exceed 365 days from the commencement date of the bankruptcy proceedings.

Except for certain payment obligations exhaustively set out by the Amending Act (taxes, salaries, health insurance fund contributions and so on), as a general principle from the commencement date of the bankruptcy proceedings the enforcement of monetary claims against the debtor is suspended and the debtor is not permitted to make any payments under any existing claims. Consequently, save for a limited number of exceptions as set out below, no security interests can be enforced during a moratorium. In addition, no set-off may be applied vis-a-vis debtors during a moratorium.

From the perspective of banks and financial institutions, there is a important new rule that provides that regarding the bank accounts of debtors, prompt collection orders cannot be submitted or enforced. Furthermore, money claims cannot be executed by the bank from the date when the debtor notifies the bank that it has submitted an application for bankruptcy proceedings.

The Amending Act introduced a provision whereby the contracts of the debtor cannot be rescinded or terminated by claiming that the debtor does not meet its payment obligations due to the moratorium. The debtor may only assume new obligations with the consent of the administrator and payments from the assets of the debtor may only be made with the countersignature of the administrator.

Enforcing a security deposit during moratorium

As described above, a general prohibition against enforcing security interests over the assets of the debtor applies during a moratorium. However, the Amending Act sets out limited instances when security deposits are enforceable and those exceptions correspond to the minimal requirements set out in Directive 2002/47/EC of the European Parliament and of the Council on financial collateral arrangements. For example, if both the depositor and the depositee are qualified as investment undertakings or credit institutions domiciled in an EEA Member State, the enforcement of the security deposit is possible during a moratorium.

Prohibition of payments during moratorium

Even before the effective date of the Amending Act, market players and commentators have raised serious concerns regarding the prohibition of payments during a moratorium.

It is regarded as problematic that the enforcement of close-out netting for financial arrangements (in particular derivatives developed on the basis of the International Swaps and Derivatives Association master agreement) is not regulated satisfactorily. The gist of the problem is that unlike the exception available for close-out netting arrangements in liquidation proceedings, no carve-out for close-out netting is provided among the exceptions to the general moratorium rules in bankruptcy proceedings.

Therefore, certain market participants are believed to be actively lobbying with the government for the inclusion of a specific exception benefiting close-out netting arrangements in bankruptcy proceedings.

Creditors' committee

The creditors may establish creditors' committees in the course of both bankruptcy and liquidation proceedings. Compared to the previously applicable rules, the Amending Act has retained the basic tasks and legal status of creditors' committees but introduced more detailed regulations.

The rules of formation differ in the event of bankruptcy and liquidation proceedings. However, the participation of one-third of all creditors (measured by the number of creditors) is required in both proceedings. In the context of bankruptcy proceedings, the creditors' committee may only be established if the creditors represented in the committee also hold at least half of the total votes that can be cast. Pursuant to the Amending Act, creditors have one vote for each HUF 100,000 of debt registered as acknowledged or undisputed. By contrast, in the event of liquidation proceedings, the creditors' committee may only be established if its members represent one-third of the claims of those creditors that are entitled to enter into a settlement agreement.

The Amending Act also allows for the committees to be comprised of at least three but not more than seven members. Pursuant to a newly introduced conflict of interests rule, the debtor or any person personally or organisationally linked to the owners or executives of the debtor, as well as any person whose claim arose within 180 days prior to the launch of the bankruptcy proceedings may not be a member of the creditors' committee.

Role of the administrator

The most important new task of an administrator is to register and classify the creditors' claims.

The Amending Act clarified that the administrator is required to approve the new commitments of the debtor (i.e. commitments made subsequently to the launch of the bankruptcy proceedings). In that context, the administrator may only approve commitments aiming to maintain the day-to-day operation of the debtor, reduce its losses or those that are made in preparation for the settlement agreement. The approval of the administrator to the granting of any additional security is also subject to the consent of the majority of the creditors with voting right.

While the book value of the debtor's assets has remained the basis for the administrator's fee, the Amending Act introduced a new method for calculating the fee. In addition, if a settlement is reached in bankruptcy proceedings, the administrator may also be entitled to a success fee.

Settlement in bankruptcy proceedings

The Amending Act has maintained the concept that the purpose of bankruptcy proceedings is to reach a settlement between the debtor and its creditors. In the framework of the settlement, the debtor enters into an agreement with its creditors on the conditions of the settlement of its debts. In addition, depending on the circumstances of the case, a settlement agreement may provide for the forgiveness of debt, restructuring, the granting of new securities or the conversion of debt to equity.

A settlement agreement may be agreed if the debtor receives the majority of the votes of the creditors with voting rights both in the secured and unsecured classes of creditors.

The agreed settlement agreement also applies to those creditors entitled to make an agreement who have not given their consent to entering into the agreement, or despite their notification, they did not participate in the negotiation or execution of the agreement. In addition, the settlement agreement also applies to creditors whose claims are disputed and in the case of disputed claims, the court may order that a provision be established in order to cover the claims once the disputes have been resolved. It is important to ensure that the settlement agreement does not differentiate within a particular class of creditors on the basis of whether a particular creditor approved or rejected the settlement.

Bankruptcy vs liquidation

Under the new rules, liquidation proceedings may only have priority over bankruptcy proceedings if the liquidation has already been ordered by a court decree of the first instance when the application for bankruptcy proceedings is received. In the absence of a court decree of the first instance ordering liquidation, the applications for liquidation do not prevent the launch and conduct of the bankruptcy proceedings. This is because the applications for liquidation are suspended by the court until the ordering of the bankruptcy proceedings (the normal moratorium) or such applications may be rejected or terminated by the court, as the case may be.

If no settlement is reached in the course of the bankruptcy proceedings or the settlement does not meet the requirements set out in the Bankruptcy Act, the court automatically turns the proceedings into liquidation proceedings without considering the existence or appropriateness of any applications for liquidation proceedings.

Changes to liquidation proceedings

In addition to the significant reduction of the period available for the lodgement of creditors' claims from one year to 180 days, the Amending Act introduced several changes to the procedural rules of the management of the claims as well.

The date of the lodgement of the creditors' claims affects the satisfaction of the claims, even if the lodgement has been made within the new limitation period of 180 days. Pursuant to the Amending Act, a pledgee, chargee or mortgagee (pledgee) may only enforce its claim prior to other creditors, under the terms of the pledge, charge or mortgage, if the pledgee lodged its claim within the notification period of 40 days and paid up the registration fee.

Importantly, while the pledged, charged or mortgaged asset may also be sold if the pledgee lodged its claim after the expiry of the period of 40 days (but, obviously, within the limitation period of 180 days), in such circumstances the proceeds from the sale of the asset must be held separately and the claim of the pledgee may only be satisfied under the general provisions. In other words, pledgees that miss the 40 days lodgement period will only be satisfied if there is sufficient coverage following the satisfaction of the statutorily defined preferred claims.

Enforcing security interests

The Amending Act kept the general rule whereby secured creditors rank ahead of the unsecured creditors in liquidation proceedings. Furthermore, with minor changes, the previously applicable mandatory order of satisfaction among secured creditors remains effective as well.

Accordingly, under the Amending Act the satisfaction of claims secured by a mortgage, a pledge or any charge other than a floating charge (the mortgages) enjoys priority over the satisfaction of (i) claims secured by floating charges; and (ii) unsecured claims, provided that such secured claims are duly registered by the liquidator.

The Amending Act created a new category for pending claims. Since September 1 2009, special payment mechanisms are applicable to such pending claims among claims secured by mortgages. Pursuant to the Amending Act, the term pending claims means claims where the creditor undertook conditional payment obligations in favour of the debtor, but those payment obligations have not yet materialised or become due.

So as of September 1 2009 the so-called hundred-percent rule is only applicable if the claim secured by mortgage does not qualify as a pending claim. The hundred-percent rule provides that (save for the reduction of the costs of purchase of the encumbered asset and the liquidation fee as set out by law) the total revenues arising from the sale of the asset over which a mortgage was established have to be exclusively used for the satisfaction of claims, provided that the mortgage was established over the charged asset prior to the commencement of the liquidation proceedings.

In the context of pending claims (save for the reduction of the costs of purchase of the encumbered asset and the liquidation fee as set out by law), the total revenues arising from the sale of the asset over which the mortgage was established have to be deposited at the court, provided that the mortgage was established over the charged asset prior to the commencement of the liquidation proceedings.

Liability of executive officers

In comparison to the previously applicable legislation, the rules pertaining to the liability of executives of companies subject to liquidation have become stricter under the Amending Act. The amount of the fine that can be imposed on executives increased to HUF 2 million when the executive fails to meet its obligations, meets its obligations late, gives incorrect information or does not cooperate with the liquidator.

The Amending Act extended the scope of the rule on the basis of which the court may oblige the executive to bear the costs incurred due to the failure to comply with his or her obligations, including the cost of involving an expert. Consequently, the debtor's member with majority control will be liable as a guarantor in relation to the payment of the fine and the costs.

Under the new sanction of disqualification, which is incorporated in the Companies Act, a former executive whose liability is established by the court on the basis of the above rule but who failed to comply with his or her payment obligation may not be an executive of any business association. The disqualification will cease after five years following the unsuccessful execution proceedings vis-a-vis the executive.

The related amendments of the Companies Act enable the company register to indicate whether the respective executive has been disqualified, including the commencement and termination date of the sanction. As of September 1 2009, in the course of the establishment of companies, executives have to declare whether they have been disqualified under the above sanction.

Duties of the liquidator

The liquidator has to notify its appointment to the financial institutions holding the accounts of the debtor without delay under the provisions of the Amending Act. The liquidator registers and classifies the claims already lodged in the bankruptcy proceedings immediately before the commencement of the liquidation proceedings. In addition, the Amending Act set out a more clear description of, inter alia, the accounting and taxation-related duties of the liquidator in connection with settlements during liquidation proceedings.

Positive development

The Amending Act signals a generally positive development and can be regarded as a milestone towards a more viable bankruptcy regime. This new regime appears to be more debtor-friendly than its predecessor. As a consequence, certain resentment can be expected on the creditors' side mostly on account of conflicting interests regarding the enforceability of security arrangements.

Nevertheless, the Hungarian economy may still be approaching a significant wave of insolvencies. It remains to be seen how the existing uncertainties can be eliminated by developing best practices. The reactions of courts to particular arrangements in an insolvency context may also substantially modify the practices of the various interested parties.

About the author

Csilla Andrékó has been Managing Partner of Andrékó Kinstellar Ügyvédi Iroda in Budapest since November 2008. Her main areas of practice include international banking work and capital market transactions including syndicated lending, project finance, structured trade finance, medium-term note programmes, bond and securities issues, restructuring, insolvency, refinancing and general financing regulation.

Csilla is a member of the Budapest Bar and Registered Foreign Adviser of the Law Society of England and Wales.
Contact information

Csilla Andrékó
Andrékó Kinstellar Ügyvédi Iroda

1054 Budapest, Széchenyi rkp. 3
Tel: +36 1 428 4400
Direct: +36 1 428 4404
Fax: +36 1 428 4444

About the author

Gábor  Antal is a managing associate at Andrékó Kinstellar Ügyvédi Iroda. His main areas of practice include deal structuring and the tax consequences of domestic and cross-border investments, mergers and acquisitions, restructuring, insolvency, distressed situations, financial instruments and structured products.

Gábor is a member of the Budapest Bar and the New York Bar and a licensed tax adviser in Hungary.
Contact information

Gábor Antal
Andrékó Kinstellar Ügyvédi Iroda

1054 Budapest, Széchenyi rkp. 3
Tel: +36 1 428 4400
Direct: +36 1 428 4435
Fax: +36 1 428 4444