Corporate / M&A

Hungary: Limits on Contractual Freedom in the New Corporate Law

With the Hungarian corporate law now incorporated into the civil code, it remains to be seen whether ambitious and brave attorneys will step up to soften the rigid corporate law practice.

The new civil code

The Hungarian parliament has recently adopted a new civil code to replace the current code originally passed in 1959. With the new civil code now incorporating the previously stand-alone corporate law as well, scholars and practitioners alike are eagerly awaiting to see how the general civil law principle of contractual freedom will influence corporate law practice.

Mandatory nature of corporate law

In contrast to civil law, Hungarian corporate law has traditionally been rather rigid, applying largely mandatory rules, where deviation was only possible if the law itself expressly so allowed. “Supplementing” the law, that is agreeing on matters not expressly regulated, was also limited, only allowed if such provisions were “in compliance with the general aim of corporate law and the aim of the provisions relating to the specific corporate form” and “not in breach of bona fides”1. These general principles clearly left much room for interpretation, but a wide-ranging and definitive body of relevant court decisions never truly materialised.

Strict judicial supervision

A very important aspect of Hungarian corporate law practice is that, while registering and supervising corporate entities may appear as a mostly administrative task, in Hungary this competence has traditionally been entrusted to the court system. Instead of a technical review of the underlying documentation and more or less automatic registration of key corporate data, corporate documents are subject to discretionary scrutiny by individual judges. As clients generally expect registration of a corporate entity and the subsequent changes (eg, the appointment of a new managing director) to be a mere technicality where timing is of the essence, attorneys to this day are reluctant to engage in potentially lengthy disputes (appeals procedures) with registration judges. As a result, court decisions, even if overly restrictive or rigid in interpretation, are rarely challenged, and the limits of corporate law legislation and the shareholders’ freedom to regulate their internal relations have not been effectively tested.

New rules and principles

Shackled by self-imposed (in the interest of clients) conservatism, Hungarian corporate practitioners have been expecting the final draft of the new civil code with cautious optimism, ever since the new code was announced to incorporate corporate law rules. Applying the general civil law principle of contractual freedom to corporate law relations could have opened up the possibility to introduce into Hungarian corporate law documents creative and sophisticated solutions used all over the world, for example in joint venture structures and private equity investments.

Contractual freedom

The principle of contractual freedom introduced by the new civil code into corporate law theoretically places the emphasis on the parties’ (shareholders’) internal relations, instead of the more organisational approach of the earlier corporate law regime. Contractual freedom, as a basic civil law principle, “translates” into corporate law as freedom of establishment. Founders (shareholders) of a corporate entity may agree in the articles on provisions that deviate from the provisions of the civil code, except where deviation is expressly prohibited or if the deviation (i) manifestly adversely affected the interests of the corporate entity’s employees, creditors, or minority shareholders or (ii) hindered the effective supervision of the corporate entity.

Problems of interpretation

Certain scholars have already expressed doubts as to whether the new exceptions from the freedom of establishment will be easier to interpret in practice than the current regime. Potential adverse effects on the interests of employees, for example, could be particularly hard to judge at the time of initial registration. Furthermore, the interests of the affected “stakeholder” groups (employees, minority shareholders, creditors) could and will clash during the lifetime of a corporate entity. For example, giving wide-ranging rights to employee representatives in the supervisory board may not be in the best interests of the minority shareholders. Deadlock, shoot-out, or similar mechanisms can be beneficial for the creditors (as disputes among shareholders will not freeze decision-making and can ensure uninterrupted operations), but minority shareholders may view such provisions as detrimental for minority rights.

A conservative approach to prevail?

Obvious exceptions aside, the actual beneficial or detrimental effects of contractual provisions are usually best assessed in practice, under specific and actual circumstances. There is little in the current court practice to suggest that judges will adopt a more easy-going approach to structures not expressly or exhaustively regulated in law. As clients will not be likely to accept lengthy registration procedures in seemingly straightforward corporate matters, attorneys will also continue to favour immediate client interests dictated by time constraints and cost-efficiency over the drive to test and challenge the limits of interpretation by proposing and attempting to register innovative structures.

Even though basic principles of corporate law legislation will seemingly soften, the current conservative approach to drafting corporate documents is not likely to undergo a fundamental change.

Act IV of 2006 on Companies.