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.

1
Act IV of 2006 on Com­pa­nies.