After the crisis, the number of financing transactions in Hungary (especially acquisition and project financing) radically dropped. Since that time the situation has changed again, and in the past four to five years the banking sector has come alive again and the appetite of banks for financing (especially for acquisition finance) has started to increase. Such increase was partly because of the financing programme introduced by the National Bank of Hungary (NBH) in June 2013, which aimed to help small- and medium-sized enterprises and offered a 2.5 per cent fixed interest rate on 10-year loans.
In Hungary, acquisition finance is typically made via bank loans. The composition (i.e., domestic, international or both) and the number of banks strongly depends on the size of the assets to be acquired and the volume of the transaction. The bigger the deal, the more probable it is that the financing banks are from an international background.
Note or bond issuance is used for foreign financiers and for high-volume transactions.
Other financing instruments (super senior revolving credit facilities, second lien loans, mezzanine loans, PIK loans/bonds, etc.) are not very common in Hungary, and are usually used if the transaction is a cross-border acquisition and one or more of the subsidiaries of the target company is Hungarian.
II REGULATORY AND TAX MATTERS
i Licensing requirements
According to Act CCXXXVII of 2013 on Credit Institutions and Financial Enterprises (the Banking Act), providing loans regularly ('in a business-like manner') is a licensable activity in Hungary, except for group financing2 provided by an entity that is not a financial enterprise. However, the Banking Act expressly provides a definition for group financing,3 and consequently not all types of group financing fall within the scope of this exception.
As stated above, debt finance may only be provided by:
- financial institutions incorporated in Hungary, holding a licence issued by the NBH; or
- any financial institution that is not incorporated in Hungary and that has duly passported its foreign licence to Hungary by way of a branch office or as a cross-border activity.
It is important to note that a licence is only required if the granting of loans is pursued as a business activity.4 The NBH issued various (non-binding) guidelines in respect of the interpretation of 'business activity', each of which emphasise that the three elements of such definition (i.e., regularity; for compensation; and without individual negotiation) shall be taken into consideration jointly. In other words, if any of such three elements is missing, the respective financial service probably cannot be considered as being provided as a business activity. Usually one-off lending does not trigger the licensing requirement in Hungary.
Notwithstanding, given that such guidelines are non-binding and each and every case is different, for non-bank lenders it is advisable to request a separate guideline from the NBH for the respective transaction.
No special rules or regulations with respect to anti-corruption and money laundering are applicable to acquisition finance; in this case, the general rules shall be complied with.
Banks, however, shall take into consideration international sanctions that might have an effect on the lending. Also, internal policies of the banks may prescribe that certain activities (in particular gambling, production of weapons, etc.) or offshore companies cannot be financed.
iii Other regulatory concerns
For M&A transactions using a share deal, the following regulatory issues shall be considered:
Financial assistance issues
Financial assistance rules that are currently applicable in case of the acquisition and financing of public companies limited by shares (for further details see Section III).
Competition law issues
In accordance with Hungarian competition laws, concentration of companies shall be notified to the Hungarian Competition Authority (HCA) in order to obtain consent from HCA to this concentration if the combined net turnover of all groups of companies involved, and the net turnover of the companies controlled jointly by members of the groups of companies involved with other companies of the previous financial year, exceeded 15 billion forints, and among the groups of companies involved there are at least two groups with net turnover of 1 billion forints, or more in the previous year together with the net turnover of companies controlled by members of the same group jointly with other companies.
An acquisition of regulated entities (financial institutions, insurance companies, investment firms, energy providers, etc.) is subject to the consent of sectoral authorities in addition to the consent of the HCA. In particular, in the financial sector, in order to acquire 10 per cent or more of the direct or indirect ownership in a financial institution, the NBH's prior consent is required to such acquisition. The same applies for insurance companies and investment firms. In case of natural gas companies, the prior approval of the Hungarian Energy and Public Utilities Office shall be required for the acquisition of control of more than 25, 50 or 75 per cent of the voting rights in such a natural gas company, and for the exercise of the rights associated therewith. For electricity companies, the prior approval of the Hungarian Energy and Public Utilities Office shall be required for the acquisition of control of more than 25, 50 or 75 per cent of the voting rights in such an electricity company, and for the exercise of the rights associated therewith.
iv Overview of tax issues
Where acquisition financing is concerned, limitations on interest deduction and debt push-down are the most relevant issues that investors usually face when evaluating the Hungarian tax implications of loan financing.
Interest deduction limitation rules
As of 1 January 2019, Hungary implemented the interest limitation rules set out in Council Directive (EU) 2016/1164 of 12 July 2016 (ATAD) laying down rules against tax avoidance practices that directly affect the functioning of the internal market, which, in essence, replace the thin-capitalisation rules.5
According to Act LXXXI of 1996 on the Corporate Income Tax and Dividend Tax Act (the Act on CIT), the excess financing costs, that is, the amount of the net financing costs exceeding the higher of the following increases the pre-tax profit: (1) 30 per cent of the EBITDA; or (2) the statutory threshold of 939.81 million forints.6 Inter alia, the following items should be taken into account as financing costs: interest expenses, also, any costs and expenses equivalent to interest in economic terms, as well as costs and expenses incurred in connection with the raising of finance.7 The amount of the net financing costs is equal to the aforementioned financing costs less interest income and other economically equivalent taxable income.8
If the taxpayer is a member of a consolidated group for financial accounting purposes, then it may deduct the net financing costs from its CIT base in an amount equal to ratio of the net financing costs of the group vis-à-vis third-parties over the EBITDA of the group multiplied by the EBITDA of the taxpayer.9
The unused interest deduction capacity can be carried forward, namely the amount can be used to reduce the excess financing costs in the subsequent tax year or years, but this reduction cannot exceed the amount of the excess financing costs.10 The interest deduction capacity of a given tax year is 30 per cent of the pertaining EBITDA less the net financing costs incurred for that tax year.11
If the CIT base was increased in accordance with the above, the CIT base can be reduced by up to the amount of the increase in the subsequent tax year or years; however, its amount may not exceed the interest deduction capacity calculated for the tax year in which such reduction is applied.12
The interest deduction limitation does not apply to taxpayers that, based on the relevant financial regulatory legislation, qualify as financial institutions, investment enterprises, alternative investment funds, the management companies of undertakings for collective investment in transferable securities, insurance companies or reinsurance companies.13
Furthermore, if the taxpayer is a member of a consolidated group for financial accounting purposes and it can demonstrate that the ratio of its average equity over its average total assets is equal to or higher than the equivalent ratio of the group, then it does not have to apply the interest deduction limitation rule.14
Withholding tax on interest
There is no Hungarian withholding tax on interest paid to domestic or foreign entities. However, interest paid to private individuals should be subject to a Hungarian withholding tax at 15 per cent. Tax treaties may override Hungarian domestic law with respect to the withholding tax on interest.
Transfer pricing considerations
Transfer pricing rules should apply if the acquisition financing takes place by means of an intercompany loan. This means that the interest rate applied on intercompany loans should be at arm's length in order to avoid any transfer pricing adjustments. Under Hungarian transfer pricing rules, downward transfer pricing adjustments can be made only if:
- the other contracting party is either a domestic entity or a foreign company (except for a controlled foreign company) that is subject to corporate income tax in its state of residence; and
- a declaration is issued by this other party indicating the amount of difference.
In recent years, the Hungarian tax authority has paid more attention to transfer pricing of intercompany loans used for financing acquisitions, and attempts to challenge interest rates applied or even the business rationale of taking out such intercompany loans instead of an equity contribution.
Big picture issues in terms of achieving deductibility of interest expense against operating income in Hungary
Corporate restructuring and debt push-down schemes have always been a focus of Hungarian tax authority investigations. However, in recent years, the tax authority has put even more emphasis on auditing debt push-down structures carried out by means of a merger between the acquiring entity and the target company. During these audits, even if the requirements under the thin capitalisation rules were fully met, the tax authority tried to challenge the deductibility of interest expenses by the Hungarian taxpayer by claiming that the transaction was aimed at eroding the Hungarian tax base without having any genuine business purpose.
In the tax authority's practice, interest expenses are usually regarded as deductible for corporate income tax purposes by the legal successor in the case of upstream mergers, while in the case of downstream mergers, the tax authority's practice seems to be more restrictive. In such cases, the tax office usually does not accept the deduction of interest relating to the acquisition loan by the successor, arguing that the debt push-down would result in the acquired company paying the expenses of its own acquisition.
As regards jurisprudence, the Hungarian courts mostly revoke the tax authority's resolutions by rejecting the arguments that the tax office makes against debt push-down structures, ruling in these cases that the tax authority has not been able to prove that the debt push-down structures in question were abusive and had no business substance. Nevertheless, in spite of the favourable case law, it would still be wise to seek a binding ruling from the Ministry for National Economy to confirm the deductibility of the interest expenses.
III SECURITY AND GUARANTEES
On 15 March 2014, Act V of 2013 on the Civil Code of Hungary (the Civil Code) entered into force in Hungary; therefore Act IV of 1959 on the Civil Code of Republic of Hungary (the Old Civil Code) was repealed. The Civil Code has introduced numerous novelties in respect of the permitted security structures and guarantees (i.e., security agents; all asset pledges; different types of sureties, etc.) and demolished some instruments that were commonly used on the market in the past (floating charge, etc.). These changes had a great effect on the legal practice and caused some very challenging times in the first year after the introduction of Civil Code. However, the legislative authority deflected most critics and amended the Civil Code in order to reflect the market practice.
As a general principle, provisions set out in the Civil Code in respect of the pledges and mortgages are mandatory rules; as such, rights are handled as in rem rights in the Hungarian legal system, and no deviation is allowed by the contracting parties unless the Civil Code provides an explicit possibility thereto.
Applicability of the Old Civil Code and Civil Code
As some types of security interests under the Old Civil Code have been demolished by the Civil Code, the general principle for the scope of the two is that any security interest established before the entry into force of the Civil Code shall be governed by the Old Civil Code (except where the contracting parties have agreed otherwise).15
Based on the above, before providing any loan to a borrower, the lender shall examine the old pledge register maintained by the Hungarian Chamber of Notaries16 as still valid and existing quota pledges, floating charges, pledges over movables and pledges identified by description can be registered therein.
Common security interests
The Civil Code provides several options for securing claims.
In general, to establish a valid security interest, a title instrument and an act of perfection (i.e., an act of publicity) are required.
Title instruments include:
- movable pledge agreement, account pledge agreement, receivables pledge agreement, pledge over IP rights (including trade marks) agreement, quota or share pledge agreement, pledge on assets identified by detailed description (floating charge) and real estate mortgage agreement;17 and
- guarantee agreement and surety agreement.18
Depending on the security interest, the act of perfection may be one or more of the following:
- the registration of the security with the respective registry;
- notification on the creation of the relevant pledge;
- the transfer of the respective collateral to the secured party; or
- notarisation of the agreement.
Regarding a guarantee or surety (personal security interests), the act of perfection is the signing of the security agreement.
Ranking of pledges and mortgages
The rank of a real estate mortgage, pledge on movables, account pledge, receivables pledge, pledge over IP rights, pledge on assets identified by detailed description and a quota or share pledge is determined by the time of registration. The applications are considered in the order of their submission.
The ranking can only be modified with the consent of all interested parties, and the new ranking must be registered with the relevant registry.
Common in rem security interests
|Asset||Security||Perfection under the Civil Code||Registration requirement before 15 March 2014|
|Movables||Pledge||Registration with the collateral registry* or, in case of certain movable assets such as aircraft and ships, IP rights with the separate specialist registry||Registration with the pledge registry or, in case of certain movable assets such as aircraft and ships, IP rights with the separate special registry|
|Account||Pledge||Registration with the collateral registry||Registration was not a requirement|
|Receivables||Pledge||Registration with the collateral registry||Registration was not a requirement, although the parties could describe the receivables and register them in the pledge registry|
|Quota||Pledge||Registration with the companies registry||Registration with the companies registry or pledge registry|
|Share||Pledge||Registration with the collateral registry||Registration was not a requirement|
|Assets identified by detailed description||Pledge||Registration with the collateral registry||This type of pledge did not exist under the Old Civil Code. The floating charge, which was a similar instrument, was registered in the pledge registry|
|Real estate||Mortgage||Registration with the land registry||Registration with the land registry|
* Act CCXXI of 2013 on the Collateral Registry.
Availability of a floating charge
Hungarian law recognises a floating charge in the form of a pledge over assets identified by detailed description. The pledge also extends to future assets, without any amendment of the underlying security document. However, those assets cannot be subject to such pledges that are recorded in separate special registries, and in case of which the pledge, charge or mortgage shall also be registered in such separate special registry (e.g., real estates, quotas, IP rights, aircraft, ships, etc.).
Trust and parallel debt issues
The creditors may appoint one of themselves or a third party to be their collateral agent. The appointment shall not be included in the pledge agreement, but could be made in a separate document.
The collateral agent must be registered in the relevant registries as security holder. Following registration, only the collateral agent is entitled to enforce the security on behalf of the other creditors.
Availability of private sale and its main conditions
|Security interest||Accessory||Private sale|
|Receivables pledge||Yes||Yes, although not used in practice|
|Quota or share pledge||Yes||Yes|
|Pledge on assets identified by detailed description||Yes||Yes|
|Real estate mortgage||Yes||Yes|
In order to avoid lengthy court procedures, it is recommended to incorporate the security agreements into a notarial deed. As a matter of Hungarian law, a notary public is entitled to issue an enforcement writ upon the request of the beneficiary if the claim to be enforced was incorporated into a notarial deed that shall contain:
- a commitment for performance and consideration, or a unilateral commitment;
- the names of the obligee and the obligor;
- the subject matter, quantity (amount) and legal grounds of the obligation; and
- the manner and deadline of performance.19
If the aforementioned conditions are met, the enforcement against the debtor can be started without any court procedures.
ii Financial assistance
As of 15 March 2014, the former financial assistance rules are not applicable in respect of limited liability companies and private companies limited by shares.
Regarding public companies, financial assistance is not restricted if the following conditions are met:
- financial assistance is provided at fair market conditions on an arm's-length basis;
- financial assistance is provided from funds that could be distributed to the companies' shareholders as a dividend; and
- the company's shareholders' meeting, based on the proposal of the board of directors, has given its consent to the contemplated measure through a decision passed with at least a three-quarters majority.
IV PRIORITY OF CLAIMS
i Commencement of liquidation
Regarding the Hungarian legal system, the priority of claims in an insolvency scenario is regulated by the Act XLIX of 1991 on Bankruptcy Proceedings and Liquidation Proceedings (BPA).
As a first step, the insolvency of the debtor shall be declared by the competent court, which shall also order the commencement of the liquidation procedure.
The opening of liquidation proceedings becomes effective as of the date they are published in the Company Gazette,20 a publicly available online platform. As of this date:
- companies subject to liquidation proceedings are identified by the use of the affix 'under liquidation' after the company name;
- the court appoints a liquidator, who becomes the sole representative of the debtor company and is responsible for conducting the entire liquidation proceedings;
- the directors cease to have management power over the debtor company;
- all assets of the debtor fall within the scope of liquidation assets;
- any enforcement procedure conducted against any asset of the debtor terminates; and
- any claim against the debtor may only be satisfied in the framework of the liquidation proceedings.
ii Priority of claims
If the super-priority nature of a loan is only contractually agreed between the parties, it will not be acknowledged by the liquidator. By virtue of law, in a liquidation procedure secured loans have priority over unsecured loans, and in respect of secured loans (if those are secured by the same security asset) the ranking of the security interest is relevant as to the priority of those loans.
If the super-priority loan is secured by the same security asset and at the same rank as another secured loan, the claims of the creditor of the super-priority loan and the creditor of the other secured loan will be satisfied pro rata from the proceeds of the liquidation procedure.
In accordance with the BPA, creditors' claims are ranked in the following order of priority:
- cost of liquidation (e.g., salaries of employees, costs of sales);
- claims secured by pledges and established before the commencement date of liquidation proceedings;
- alimony claims, life annuity payment claims and compensation benefits to private individuals;
- other claims of private individuals not originating from economic activities (e.g., damages, warranty claims);
- taxes and other public dues as well as public utility charges;
- other claims (e.g., any unsecured claims);
- default interest and late charges, as well as surcharges, penalties and similar debts; and
- claims held by the shareholder or any member of the management.21
However, claims that are secured will enjoy priority in satisfaction irrespective of the order above.
iii Effectiveness of contractual subordination
Contractual subordination is not regulated and may not be binding on insolvency officers. However, outside of an insolvency scenario, the parties are entitled to assign or transfer or change their creditor ranks by contractual arrangement. This arrangement might be enforceable, provided that no bankruptcy liquidation or other insolvency procedures will be commenced against the debtor.
iv Subordination by operation of law
According to Section 57 of the BPA, shareholder loans are subordinated to other indebtedness in the context of insolvency by operation of law.
i Choice of law
As a matter of Hungarian law, in respect of contractual aspects, the Rome I Regulation22 and regarding the non-contractual obligations, the Rome II Regulation23 shall be applicable for the choice of foreign law by a Hungarian entity. Notwithstanding the above, there are various specific exclusions that fall within the scope of Rome I, for example, contractual obligations arising under bills of exchange, cheques and promissory notes and other negotiable instruments, provided that the obligations under such other negotiable instruments shall not be subject to Rome I Regulation, but shall be governed by the mandatory national law. The Rome I Regulation also excludes arbitration agreements and agreements on choice of court, and certain company matters. These exclusions should be considered in detail when determining whether Rome I applies to a particular matter. As a result of the applicability of the Rome I Regulation, the particular contractual obligation should not have a link to its governing law.
As regards the final and binding judgments in civil and commercial matters provided by any court of another EU Member State in respect of a Hungarian entity, the Brussels Ia Regulation24 applies, and, therefore, these judgments will be enforceable in Hungary.
Regarding final judgments given outside the EU, if there is not a bilateral agreement between Hungary and the country of the court where such judgment was given, the enforceability will not be automatic and the Hungarian courts may decide to re-examine the merits of the case before declaring the enforceability of such judgment.
Hungary acceded to the 1958 New York Convention25 in 1962.26 As a consequence thereof, the arbitration awards issued in any other contracting state are enforceable in Hungary subject to certain limited defences.
VI ACQUISITIONS OF PUBLIC COMPANIES
When acquiring a public company, with regard to financing of the acquisition and providing security to the financing, financial assistance rules shall be taken into consideration (see Section III).
Any acquisition of the ownership interest in a public company is subject to a takeover bid (which shall be approved by the NBH in advance) if the acquisition covers more than:
- 25 per cent of the shares of a public company and neither of the other shareholders holds more than 10 per cent of the shares; or
- 33 per cent of the shares of a public company.
The takeover bid shall include, among other things, the composition of the consideration of shares – namely, it shall indicate whether the purchase price will be partially financed, although details of such financing shall not be disclosed.
If a potential buyer acquires 75 per cent or more of the ownership interest in a public company, the other shareholders are entitled to sell to such potential buyer their shares at a price determined in the takeover bid.
VII THE YEAR IN REVIEW
In order to accelerate the economy, the Budapest Stock Exchange (BSE) launched a special platform (Xtend) for small- and medium-sized companies that have the potential to grow into large companies (and, therefore, enter into the main board of the BSE) and could attract more private equity investors. Although Xtend was available form 2017, more companies started to express their interest to enter into Xtend from this year.
The Hungarian financing market is picking up pace in terms of financing. Banks have sold most of their non-performing loan portfolios in the past couple of years, and are ready for fresh financing.
The most emerging sectors are the manufacturing and energy sector (in particular the renewable energy sector), in which investors (both financial and professional) have expressed interest.
As a result of Regulation (EU) 2015/848 of the European Parliament and of the Council of 20 May 2015 on insolvency proceedings, the BPA was amended by the Act XLIX of 2017.
1 Melinda Pelikán and János Pásztor are senior associates and László Lovas and Bence Kálmán are associates at Wolf Theiss Faludi Erős Attorneys at Law.
2 Section 5(2) of the Banking Act.
3 Section 6(1), point 11 of the Banking Act: 'group financing' shall mean a financial arrangement between a parent company and its subsidiary or between subsidiaries that is carried out collectively to ensure liquidity.
4 Section 6(1), point 116 of the Banking Act: 'business activity' shall mean gainful (for-profit) economic activities performed on a regular basis for compensation, involving the conclusion of deals that have not been individually negotiated.
5 However, according to Section 29/A(73) of the Act on CIT, as a general rule, the thin-capitalisation rules remain applicable to agreements concluded before 17 June 2016 under which financing expenses (defined above) are incurred.
6 Section 8(1)(j) of the Act on CIT.
7 Point 50 of Section 4 of the Act on CIT.
8 Point 51 of Section 4 of the Act on CIT.
9 Section 8(5)(a) of the Act on CIT.
10 Section 8(1)(j) of the Act on CIT.
11 Point 56 of Section 4 of the Act on CIT.
12 Section 7(1)(ny) of the Act on CIT.
13 Section 8(1)(j) of the Act on CIT.
14 Section 8(5)(b) of the Act on CIT.
15 Act CLXXVII of 2013 on the issues related to the entry into force of the Civil Code.
16 Law Decree No. 11 of 1960.
17 Chapter XXI of the Civil Code.
18 Chapter LX and LCI of Civil Code.
19 Section 23/C of Act LIII of 1994 on Judicial Enforcement.
20 Section 28 of the BPA.
21 Section 57 of the BPA.
22 Regulation (EC) No. 593/2008 of the European Parliament and of the Council of 17 June 2008 on the law applicable to contractual obligations (Rome I).
23 Regulation (EC) No. 864/2007 of the European Parliament and of the Council of 11 July 2007 on the law applicable to non-contractual obligations (Rome II).
24 Regulation (EU) No. 1215/2012 of the European Parliament and of the Council of 12 December 2012 on jurisdiction and the recognition and enforcement of judgments in civil and commercial matters.
25 Convention on the Recognition and Enforcement of Foreign Arbitral Awards.
26 Law Decree No. 25 of 1962 on the Convention on the Recognition and Enforcement of Foreign Arbitral Awards of 10 June 1958.