A Q&A guide to Finance in Hungary. The Q&A gives a high level overview of the lending market, taking security over assets, special purpose vehicles in secured lending, quasi-security, guarantees, and loan agreements. It covers creation and registration requirements for security interests; problem assets over which security is difficult to grant; risk areas for lenders; structuring of debt agreements; enforcement of security interests and borrower insolvency; cross-border issues on loans; taxes; and proposals for reform.
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This article is part of the PLC multi-jurisdictional guide to finance. For a full list of contents visit www.practicallaw.com/finance-mjg.
In the last 12 months Hungary has seen a major downturn in lending activity. Banks have been reluctant to finance new projects and provide loans because of the level of distressed assets in their books and the lack of liquidity and capital support from their parent institutions (typically Austrian and Italian banks). Banks are struggling to comply with capital adequacy requirements and to survive the lack of liquidity on the interbank market.
The following are considered to be real estate in Hungary:
Vacant land.
Land with buildings.
Aircraft and ships.
Title to land is held at the Land Registry. Aircrafts and ships have their own registers.
Forms of security over real estate include the mortgage and the floating charge (see Question 3, Common forms of security). The most common form of security over real estate is the mortgage. A mortgage attaches to the particular real estate and takes priority over a floating charge. A floating charge takes effect over all of the borrower's assets.
A mortgage is created by a mortgage contract executed by the parties. It can take the form of a contract in writing countersigned by a lawyer, or in a notarial deed. It is perfected by registration in the Land Registry. The mortgage is then effective against third parties and enforceable against the borrower and third parties.
A floating charge must be created by a notarial deed, which has certain advantages on enforcement (see Question 20). The deed must be registered in the Register of Charges managed by the Notary Association.
Tangible movable property includes:
Machinery.
Inventory (trading stock).
Other movable assets over which title passes by taking possession.
Aircraft and ships are treated as real estate since title over aircraft and ships passes on registration of the new owner in the aircraft or ship registry (see Question 2, Real estate).
The most common forms of security are:
Liens over tangible assets. Liens (or possessory charges) require the lender to enter into possession of the tangible assets. A lien is easy to enforce and gives the lender priority over other creditors. If there are several charges, the person who possesses the tangible asset has priority.
Floating charges. A floating charge is a conditional pledge which is taken over assets or a class of assets. It is more practical for lenders such as banks than a lien, as the lender does not need to take possession of the tangible assets. Once a floating charge is registered, third parties are deemed to have knowledge of it, and therefore cannot take a lien.
In relation to liens, possession of the movable asset must be transferred to the lender.
Floating charges must take the form of a notarial deed and be registered in the Register of Charges managed by the Notary Association.
The most common form of security over printed shares and other securities is the security deposit of these instruments with the lender (or its security agent). In the case of dematerialised securities the securities account held by the depositary is usually blocked under a pledge or lien agreement.
Share certificates concerning registered shares are deposited with the lender. In relation to dematerialised securities, the parties enter into a pledge or lien agreement. No special formalities are required for this agreement. However, it is common practice for banks to use a notarial deed (see Question 20). There are no registration requirements.
The most common form of security is a pledge over claims and receivables. In practice, assignment (which is not technically a security but can be used as security) of claims and receivables is also widely used.
Pledges over claims and receivables are:
Created by a simple contract executed by the lender and the borrower.
Perfected by notifying the third party obligor (that is, the party required to meet obligations under the contact) of the creation of the pledge.
Assignment is created by the parties entering into an agreement. Notification of the obligor is required (otherwise the obligor can still discharge its debt by paying the original beneficiary).
There are no other special formalities or registration requirements. Banks often require borrowers to enter into a notarial deed, although there are no particular advantages to this.
The most common form of security is a lien over registered or unregistered intellectual property rights, such as patents, trade marks, copyright and designs.
The lien is created through a written agreement. In the case of registered intellectual property rights, such as trade marks and patents, the lien is registered at the relevant register. This notifies third parties of the security interest. In the case of unregistered intellectual formalities, there are no additional formalities required. A notarial deed may be advisable (see Question 20).
Future assets.
Fungible assets.
Other assets.
It is not possible to perfect a security over future land, buildings, aircraft, or ships because registration cannot be achieved due to the non-existence of title over these assets. Registration is necessary for a mortgage to exist (see Question 2, Formalities).
It is not possible to grant a perfected security over future movable assets since it is not possible for the lender to take possession over future assets, which is necessary to perfect a lien over movable assets (see Question 3, Formalities).
A floating charge, however, will cover assets that the debtor acquires after the creation and registration of the floating charge.
A floating charge can be taken over fungible assets, such as crops in a warehouse. A simple lien may also be practical, as the obligation of the debtor would be not to hold the same crop for the benefit of the lender but to hold a specified quantity of a certain quality available to the lender if there is an event of default.
Because a lien over movable assets requires that the lien holder be in possession of those assets, in many cases it is possible to challenge a lien agreement. This problem only arises for lenders who are not financial institutions, as banks will take a floating charge over assets, as they cannot take possession over tangible assets (see Question 3, Common forms of security).
Taking security over the shares of an SPV is used in Hungary but it is uncommon. Lenders mainly rely on taking direct security over the borrower's tangible and intangible assets. This is because direct security gives a first-ranking position to lenders over the proceeds of the secured assets in the case of insolvent liquidation (see Question 24). This does not apply to security taken over shares, which can be considered to be secondary to mortgages or liens which are primary (direct) security.
Sale and leaseback.
Factoring.
Hire purchase.
Retention of title.
Negative pledge.
Other structures.
Lenders do not generally use sale and leaseback in Hungary as security. The courts do not recharacterise it as a security interest.
Factoring is performed by financial companies (banks or special factoring companies) and requires a licence. Factoring is an assignment of accounts receivable and lenders do not use it as an alternative to security.
Hire purchase is a type of loan under which the buyer of an asset pays the asset's purchase price over a period of time. In Hungary, title over assets cannot pass in instalments, and therefore title is transferred at the start of the hire term. Therefore, hire purchase is not used as form of quasi-security in Hungary and there is no risk of it being recharacterised.
Retention of title is used in real estate transactions and is a common form of quasi-security in Hungary under which title over the real estate remains vested in the seller until payment of the purchase price. Retention of title is possible for all assets where title is passed by registration (see Question 2, Real estate). However, for movable assets, title passes when the buyer takes possession or control of the assets, and therefore retention of title cannot be used.
Negative pledges are used in Hungary in contractual documentation of banks. The practise has been imported from common law jurisdictions; it is not included in any Hungarian statute and the courts do not recognise it. Therefore, it is merely a contractual obligation, on which the courts will rule on a case-by-case basis depending on its actual wording. As it is a contractual obligation it cannot be enforced against the debtor by third parties, and will remain a breach of contract matter between the lender and borrower.
There are no other quasi-security structures which are common in Hungary.
The following are commonly used in Hungary:
Bank guarantees. Bank guarantees are created by a written unilateral declaration executed by the guarantor. It is an obligation which is independent to the underlying transaction or contract. As it is independent, the guarantor cannot use arguments on which the original debtor could rely to challenge the right of the beneficiary to seek payment.
Direct suretyships. Direct suretyships are commonly created by a contract between the beneficiary and the surety, without special formal requirements. In direct suretyship the beneficiary under the guarantee can claim under the suretyship without having to attempt to enforce its claim against the debtor first. This is in contrast to a simple suretyship, where the surety is entitled to withhold its payment until the beneficiary tries every legally possible way to enforce its claim against the debtor. In a direct suretyship, however, the guarantor can challenge the demand for payment on the basis of a defence on which the original debtor could rely.
Strict analysis of a bank guarantee is always advisable because sometimes bank guarantors try to word their guarantees to create a suretyship.
Financial assistance.
Corporate benefit.
Loans to directors.
Usury.
Hungary's regulation of financial assistance is lenient. Banks and other credit institutions can actively participate in financial assistance situations, by lending to the buyer for the purposes of the acquisition and taking security over the target's assets for the loan.
Corporate benefit rules do not apply and subsidiaries can provide upstream guarantees for their parent companies. Typically, the subsidiary will enter into a direct suretyship in favour of the lender (see Question 10).
Certain contracts of a fraudulent nature are void when they were entered into within a certain time limit before a petition for liquidation (Civil Code) (see Question 23). These contracts can include loans to directors, relatives of directors, and loans to controlled subsidiaries. If these loans are successfully challenged at court, they will be void against other creditors.
Usury is mentioned in section 202 of the Civil Code; it is a fraudulent act consisting of taking financial advantage of another party's situation. If a contract contains an element of usury, the contract is void. A petition can be brought before the court for annulment of that contract. In relation to company debtors (but not individual debtors) usury can only be invoked when the company was on the verge of insolvency when it entered into the contract with the lender. There is no time limit for challenges.
There are no other relevant rules.
It is currently unlikely that a lender would be liable under environmental laws in these circumstances.
Contractual subordination of debt is possible, but is only common in sophisticated financing transactions involving banks and multinational companies. It can be achieved by an inter-creditor agreement between senior, mezzanine and junior creditors. However, liquidators are not required to honor those agreements on a debtor's insolvency. These agreements can only affect the creditors involved, and cannot change the statutory order of distribution (see Question 24). In addition, the major creditors can agree to overrule the agreement in the insolvency procedure, by forcing a creditors' settlement on the insolvent company which can override a subordination agreement between smaller creditors.
Structural subordination can be achieved, for example, by certain lenders lending at a parent company level, while other lenders take direct security at the debtor company level. On the debtor's insolvency, the lenders that take direct security will receive repayment earlier than the lenders who lend at the parent company level.
Debt can be traded between creditors through assignment of the claim (see Question 5). The debt obligation can only be traded with the prior express consent of the party entitled to repayment. Assignment of the claim can be with or without recourse to the transferor of the claim. In the case of assignment with recourse, if the debtor defaults on the debt the assignor becomes a guarantor (simply suretyship) of the defaulted obligation and must pay to the assignee if the debtor cannot meet its payment obligation. Without recourse assignment means an assignment where the claim is transferred to the assignee and the assignor is completely released of the risk of the debtor's non-payment. Recourse must be expressly excluded.
To perfect the assignment, the debtor must be notified. On notification, the debtor is no longer required to pay the debt to the assignor but must pay the debt to the assignee.
Is an agency arrangement created under the law of another country recognised in your jurisdiction?
Can a facility agent enforce rights on behalf of the other syndicate lenders in the courts in your jurisdiction?
A security agent concept is not recognised, as such, under Hungarian law. However, the same result can be achieved by using ordinary agency principles. When there are a number of creditors, they can nominate an agent in a security agreement. The agent will act in its name when enforcing the security, and distribute the funds to the creditors in accordance with the agreement's sharing provisions. In the case of registered security such as a mortgage or floating charge the agent's name is entered in the relevant register. In that case, the agent and not the creditors will be considered to hold the legal right and the creditors will not be able to apply to court to remove the agent.
A similar agency agreement prepared under a law other than the Hungarian law will not be recognised or enforced and a facility agent cannot enforce rights on behalf of the other lenders in the Hungarian courts.
Is a trust created under the law of another country recognised in your jurisdiction?
Can a security trustee enforce its rights in the courts in your jurisdiction?
The trust concept is not recognised in Hungarian law. The Hungarian courts do not recognise a trust agreement created under the law of another country. Therefore, a security trustee cannot enforce its rights in Hungary as a trustee. However, the Hungarian courts will interpret a trust as an agency agreement, and the trustee will be recognised as an agent for the other creditors in accordance with the agreement's provisions (see Question 15).
A single security document is accepted but may be impractical because of the different registration authorities that could be involved (see Questions 2 and 3).
There are no rules on how loans should be documented for the loan to be enforceable.
On an event of default (for example, failure to make periodic payments as required by the loan) the creditor must notify the debtor of the default and give the debtor time to remedy its default. If the debtor fails to meet this deadline, the creditor can:
Request liquidation of the debtor from the court through a petition (see Question 21).
Depending on the security interest, either:
enforce its security immediately; or
bring legal proceedings against the debtor to enforce its security.
See Question 20.
Typically, lenders (such as banks) create security in the form of notarial deeds. This means that they can enforce security on an event of default without having to bring legal proceedings (see Question 19).
Assets are sold at public auctions. These are organised by the lenders, in many cases without the involvement of enforcement officers. If the agreement does not specify means of enforcement, the lender must go through court enforcement officers. The lending documentation will often entitle the lender to sell the secured assets themselves through an auction or direct sale.
There is a form of bankruptcy procedure that is available outside normal insolvency procedures. It grants the debtor a moratorium of 90 days from the start of the bankruptcy procedure, during which it must try to reach an agreement with its creditors. The agreement must be voted on by the creditors and approved by the court. During that moratorium, creditors cannot exercise any rights of set-off against the debtor, receive payments from the debtor's bank accounts, or enforce loans, guarantees or other security.
The creditors must vote on any proposed extension of the 90-day moratorium. If the majority of the creditors, including secured and unsecured creditors, vote in favour, the court grants a 180-day extension. If two-thirds vote in favour, the moratorium can become as long as one year. It cannot be extended past one year.
Creditors have votes in proportion to their claims, so that each HUF100,000 gives them one vote at the creditors meeting (as at 1 November 2010, US$1 was about HUF211).
Insolvency procedures are started by a petition for insolvency. Typically, by the time an insolvency procedure order becomes final (that is, when a court makes the appropriate order) and the liquidator takes over the management of the debtor company, lenders have already enforced their rights under the security interests, for example by selling mortgaged and pledged assets (see Question 20).
Once the insolvency order becomes final, creditors can only enforce their claims via the liquidator in the insolvency procedure. All other forms of enforcement (whether under loans, guarantees or security) cease to continue. However, assets that are secured by mortgages or pledges do not become part of the common pool of assets that are available for all creditors (see Question 24). Instead, they first go towards satisfying the claims of the security holder and any leftover value goes into the common pool.
Any creditor or the liquidator can apply to court to challenge a contract entered into by the debtor within one year from the start of the liquidation, if the contract is of a fraudulent nature (see Question 10, Loans to directors).
A contract is fraudulent if:
It was entered into within five years before, or after, the liquidation petition was filed (is usually much later).
Its purpose was to frustrate payment to creditors.
This is not an exclusive definition; the Civil Code provides for contracts which can be found to be void on other grounds (for example, transactions at an undervalue and transactions which gave undue preference). Different time limits apply; these contracts can be clawed back if they were entered into within two years, or in some cases 90 days, before the filing date of the liquidation petition.
Any contract can be challenged, whether a security agreement, bank guarantee, direct suretyship or a loan.
The secured creditors considered in Questions 2 to 6.
Statutory claims.
Unsecured creditors.
Subordinated creditors.
Once the liquidation procedure is completed, the debtor's remaining assets are distributed among the creditors in the following order:
Costs of liquidation (including salaries of employees).
Secured creditors (up to the value of the secured assets; if more than one security interest exists over an asset, the earlier security interest takes priority (see Question 25)).
Claims of individuals (other than companies).
Social security, pension fund, tax office, and state subsidy claims, and other claims.
Default interest on debt and fines for tax default.
Other unsecured creditors.
Security interests are ranked in the date of creation (qui prior in tempore potior in iure). If the first in time creditor's claim is fully satisfied and there is remaining value from the secured asset, the second in time creditor can seek payment of its claim. However, if no value remains after the first creditor has been repaid, the remaining secured creditors become unsecured creditors (see Question 24).
If a security interest has not been validly perfected (for example, was not properly registered) the security holder ranks among the unsecured creditors on the borrower's insolvency (see Question 24).
There are no restrictions on the making of loans by foreign lenders or granting of security or guarantees to foreign lenders.
There are no exchange control restrictions that restrict payments to a foreign lender.
Generally, security interests that concern assets located in Hungary are governed by Hungarian law. If the assets are in Hungary, the courts will not:
Recognise a security interest created under foreign law.
Apply a foreign choice of law clause in a security document.
Documentary taxes (for example, stamp duty).
Registration fees.
Notaries' fees.
There are no documentary taxes payable on the granting and enforcement of a loan, guarantee or security. Registration fees are nominal.
Notaries' fees, however, can amount to several thousands of US dollars. Notaries' fees are capped by law.
As most fees are nominal, there are no strategies to minimise their costs. There are no strategies to minimise notaries' fees.
Floating charges were introduced about ten years ago. Since then, there have been no significant proposals for reform. It is probable that the Civil Code will be revised in the next five years, and the concept of a trust introduced.
T +36 1 270 7430
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E bela.deri@deri.hu
W www.deri.hu
Qualified. Hungary, 1987
Areas of practice. Company law; accounting and tax law; banking and securities law; contract law.
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