Doing Business in Hungary

1. OVERVIEW

Hungary will shortly be an EU member country: together with the other 9 candidates, Hungary signed the Treaty of Accession on 16 April, 2003 in Athens. According to the Treaty of Accession Hungary accedes to the EU on May 1, 2004. As Hungary prepares itself for accession to the European Union, investors from all over the world are preparing to take advantage of the investment opportunities which Hungary provides.

The purpose of this article is to give a brief introduction to the legal environment potential and current investors find themselves operating in. It is intended to give a brief overview only and is not meant to be exhaustive. We have included updates in all the areas mentioned in this article for investors who are already familiar with the market conditions in Hungary, to take account of any changes which have recently taken place in these areas or that are issues which we have found, time and again, cause surprise to investors. Potential investors in Hungary should always seek detailed advice from local professional advisors before taking any action.

2. INTRODUCTION

In common with many other continental European countries, Hungary is a Civil law jurisdiction and its laws are codified in Acts such as Act IV of 1959 on the Civil Code ("Civil Code").

The principal impact of a codified system of laws is that provisions of the Civil Code may apply to an agreement, even if they are not mentioned specifically in the agreement. This has traditionally meant that agreements in Hungary are shorter than those in common law countries, such as the UK and US, because many "boilerplate" concepts and provisions are dealt with in the Civil Code. However, Western investors often find that the provisions in the Civil Code are too vague or general and that they would rather have more specific wording in the agreement. In any event, under a codified system of law, the specific contents of the agreement may not be all the provisions affecting the business deal.

Under Act CXLIV of 1997 on Business Associations (the "Companies Act") there are six different types of business entities through which investors may choose to operate. Of these, limited liability companies ("Kft.") and companies limited by shares ("Rt.") are the two most popular vehicles for investors. It is these types of entities, therefore, on which it is most useful to concentrate. Other forms of entities are a Union, a Joint Enterprise ("KV"), a Limited Partnership ("Bt.") and an Unlimited Partnership ("Kkt."). Alternatively, investors may choose to operate through a representative office or a branch.

A Kft. is a company limited by quotas or business shares (i.e. set sums of capital are invested by the members) and approximates most closely to a German GmbH. The nearest English equivalent is a private limited liability company. An Rt. is a company limited by shares and is more like an English PLC or a German AG.

Both a Kft. and an Rt. can be owned by a single person/member. In such a case, no formal general meetings need be held and the single owner may simply decide on all matters falling within its capacity without having to comply with the various formalities. However there are further regulations imposing an increased level of liability upon single owners of companies. Even though the single owner of a company has limited liability in general, this rule may be set aside and unlimited liability imposed upon the single owner, for example, if it is shown that the single owner carries on a business which has an adverse effect in the long-term upon the company and this fact is upheld by a court upon the claim of a creditor.

Quotas

A Kft. may have one or more quotaholders (members), who may include both foreign natural persons and foreign legal entities. Membership of a Kft. is evidenced by entering the names of members into a list of members which the directors of the Kft. are obliged to maintain under the Companies Act. Unless the specific provisions of the Kft.'s deed of association provide otherwise, the quotaholder's liability for the obligations of the Kft. is limited to the value of their quota.

It is important to note that quota in a Kft. are not the same as shares in an Rt..Each quota is indivisible (except with the consent of the Kft. itself), must be denominated in Hungarian Forints, divisible by 10,000 and may not be less than HUF 100,000. Voting and dividend rights can be set out in the deed of association, subject to the proviso that at least one vote must be allocated per stake of HUF 100,000. Unlike shares, it is difficult to take security over the quotas. This is often relevant when financing the company.

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Although both a Kft. and an Rt. offer limited liability, for many investors a Kft. is more attractive than an Rt. Some of the reasons include:

• a Kft. requires a lower minimum paid up initial capital. Only HUF three million need be paid to found a Kft., as opposed to a minimum capital of HUF twenty million for an Rt.;
• the procedures for calling a general meeting and taking corporate decisions are generally considered to be more flexible as regards a Kft. Thirty days' notice is required for calling a general meeting of the shareholders of a public Rt., including advertising in the press. In case of a closed Rt., however, only fifteen days' notice must be given by post and no public announcement is required. The same applies for the members' meeting of a Kft., which can be called on fifteen days' notice or, with the consent of all the members who have to be present, at even shorter notice. The members of a Kft. may also adopt certain resolutions, without convening a meeting, by using the written resolution procedure; and
• a Kft. has managing directors but no decision-making Board of Directors, which an Rt. does.

However, it may be more appropriate to found an Rt. for the following reasons:

• it is more suitable to take security over the shares of an Rt. (as shares may be evidenced by the issue of a share certificate). A quota (or business share) in a Kft. on the other hand is regarded as being a series of rights reflecting the proportion of the capital contributed by that member and is only evidenced in the books of the company and not in any physical form. As such, it is more difficult to pledge a quota interest as it is not represented by securities;
• the larger paid up capital of an Rt. can sometimes give it an advantage in raising finance in the local or international financial markets; and
• unless otherwise provided in the deed of association, the directors of an Rt. can be removed by a simple majority, whereas the directors of a Kft. may only be removed by a resolution supported by at least 75% of the quotaholders.

Directors' Responsibilities

General Information

The role of the managing director of a Kft. and member of the Board of Directors of an Rt. is regulated by the Companies Act. The managing director or Board member qualifies as an executive officer of a limited liability company. The managing director or Board member is entitled to represent the company before authorities and third persons and also to act and sign documents on behalf of the company. The signature rights can be individual or joint depending on the provisions of the articles of association of the company (or deed of foundation for an Rt.). The managing director or Board member may transfer his right of representation to employees in respect of particular issues. The managing director should be elected by the Members' Meeting (or shareholders' meeting for an Rt.) and his appointment can be withdrawn at any time by the same company body. The managing director can perform his obligations on the basis of an employment contract or a mandate agreement.

Company manager

The Companies Act also provides for the appointment of a "company manager". The main difference between the managing director or Board member and the company manager is that the company manager must be an employee and he should perform his tasks by following the instructions of the managing director(s). Otherwise the company manager also has the right to represent the company before authorities and third persons and to act and sign documents on behalf of the company. The signature rights - whether the company manager should sign individually or jointly - should be determined in the articles of association. The company manager cannot transfer his right of representation to employees.

As far as the liability of the company manager is concerned, the rules of Labour Code Act XXII of 1992 ("Labour Code") with special respect to the provisions applicable for executive officers should be applied because the company manager can only be an employee. Please note that only one company manager can be appointed by the company unless the company has branches or business sites in which case the company can have one company manager at each branch or business site if permitted by the articles of association. A further restriction should be applied for a Hungary off-shore company ("HOC"). In accordance with Section 4.28 of the Act on Corporate Taxation, it is a requirement that over 50% of the executive officers, the members of the supervisory board and the employees taken as a whole, should be Hungarian tax residents.

Other Types of Investment Entities

Representative offices

A registered representative office can be established by a foreign company to perform the usual liaison functions, including assisting with contract negotiations, advertising and exhibiting products and other forms of marketing, although it should not "carry on business". Such an office can be opened by way of registration with the Court of Registration. There are no capitalisation requirements. The documents which need to be filed with the Court of Registration to register a representative office are similar to those required for companies.

Branches

Foreign enterprises may establish branches in Hungary, which may carry out normal business activities. These must be registered with the Court of Registration similarly to companies. There is no express minimum capital requirement for branches, but the foreign mother company must provide assets to the branch in an amount which is sufficient for its operation and the settlement of its debts.

Draft Act T/3803 on Modifications to Act CXLIV of 1997 on Business Associations ("Companies Act") and Act CXLV of 1997 on the Register of Companies, Public Company Information and Court Registration Proceedings was passed as an Act on 23 June 2003. The main aim of the modifications was to harmonise Hungarian corporate law with EU law.

The new regulations will come into force on 1 January 2004 except for some regulations which will come into force on the date of Hungary's accession to the European Union (1 May 2004). According to the modifications of the Companies Act, Hungarian companies must modify their Articles of Association ("Articles") by 30 June 2004 to comply with the new requirements.

The new regulations will provide significant changes to the present regulations concerning mostly companies limited by shares. The main purpose of the modifications is to provide for increased transparency the operation of the company and to protect the registered capital of the company and the interests of creditors more efficiently.

The changes to the modified Companies Act will affect the following main areas of law from 1 January 2004:

• mergers and demergers;
• redeemable shares;
• convertible and subscription bonds;
• in kind contributions;
• related party contracts and payments to shareholders;
• treasury shares;
• take-over rules;
• financial assistance.

If it is not possible, or desirable, to set up a corporate presence in Hungary a foreign company may still wish to market its goods in the country. Usual methods of doing this include setting up a distribution network or appointing an agent or agents. Both of these methods of doing business are possible and are used in Hungary, as is the setting up of a franchise (a method of selling that has become more popular in recent years).

The agency relationship is subject to Sections 219-223 of the Civil Code. Under the Civil Code, agency is a personal relationship between two or more persons or persons and firms. The relationship may be established by contract, law, the deed of association of a company or by a judicial order. An agency relationship may be terminated by the express declaration or death of either party. An agency relationship may be expressly established by a declaration to the agent or to third parties by way of a power of attorney under Hungarian law. Unless the law requires personal performance, contracts may be concluded and legal declarations may be made by agents. The agent acquires rights and undertakes obligations on behalf of the principal who is generally bound by the acts of the agent. Third parties may assume that the power of attorney is valid until otherwise notified by the principal.

Foreign Trade Agency Agreements

Foreign trade agency agreements, where a Hungarian principal appoints a foreign agent to act on its behalf, form a special type of agency agreement. If such an agreement is made under Hungarian law it is governed by the Act No. CXVII of 2000 on the Commercial Representation Contract of Self-employed Commercial Agents ("Agency Act"). Under such a foreign trade agency agreement, the agent agrees to mediate foreign trade contracts on behalf of the principal, and to carry out marketing and promotional activities and other related matters. The agent must not conduct activities competing with those of the principal and must not provide agency services to rival third parties without the principal's prior consent.

The provisions of the Agency Act are of special importance for contracts with agents and applies to all contracts signed after 1 February 2001 which fall under the scope of it. From 1 January 2003 the Agency Act has applied to all contracts in force which fall under the scope of the Agency Act irrespective of when they were signed.

The Agency Act applies to contracts between a principal and an agent on a long term contractual basis which allow commercial agents to negotiate the sale and purchase of goods or other contracts relating to goods between the agent and other parties, including, in both cases, contracts which authorise agents to enter into contracts which the agents negotiated on their principal's behalf. The Agency Act also applies to contracts between principals and agents which relate to the negotiation of contracts between the agent and other parties for the provision of services, rights which confer economic benefits, contracts for the sale and purchase of securities, and stock exchange transactions.

Franchising and distribution agreements

In Hungary there are no specific regulations on franchising and distribution agreements (other than the competition law regulations explained below), which, in consequence and like many other contracts, are drafted and interpreted according to the Civil Code. The Civil Code provides general direction about how contracts should define the contracting parties and their relationships, the contractual terms and conditions, the means of implementing the contract and consequences of breaches. The following sections of the Civil Code are particularly applicable to a franchise agreement:

• Sections 86(3) and (4) provide the only definition in Hungarian law for the concept of know-how, an important element in a franchise system. Know-how is comprised of the definition of the system to be franchised and the description of the rights granted; and
• Section 4 defines the general criteria for executing the franchise agreement, for example displaying good faith, fairness and a commitment to co-operation. The parties must also display, beyond the notion of fairness and co-operation, diligence, attention and professional knowledge which must be periodically renewed. This section calls for contracting parties to fulfil moral obligations as well as legal ones.

Pursuant to Act LVII of 1996 on Prohibition of Unfair and Restrictive Market Practices ("Competition Act") both exclusive distribution agreements and franchise agreements are primarily unlawful unless certain exemptions apply. There are governmental decrees detailing the block exemptions in relation to both franchise agreements and exclusive distribution agreements. Provided that a franchise agreement or an exclusive distribution agreement is covered by the conditions of these decrees, it may be freely concluded without breaching the Competition Act.

5. TAXATION

Hungary operates a system of self-assessment, with tight filing deadlines. The information that must accompany tax filings is limited. However, the tax authorities will periodically perform detailed audits. Significant interest and penalty costs may arise in respect of under-declaration and late payments of tax. Hungarian taxes currently in force include corporate tax, personal income tax and value added tax (VAT). Customs and excise duties, social security contributions, transfer tax and local taxes levied at a municipal level may also give rise to significant cost.

Corporate tax system

A Hungarian resident company will be subject to corporate income tax on its world-wide income. A non-resident company will only be taxable on its Hungarian source income. The business year is normally the calendar year but as from 1 January 2001 subsidiaries of non-Hungarian entities may establish their business year according to the business year applied by the parent company if certain conditions are met. The base for corporate income tax is the pre-tax accounting profit adjusted by increasing and decreasing items set out in the law. Costs are generally tax deductible if they are incurred wholly and exclusively for business purposes. The corporate income tax rate is 18%.

Transfer pricing

In general, transfer pricing rules continue to become more stringent. The Act on Corporate Income Tax and Dividend Tax and the Act on Value Added Tax incorporate the arm's length principle and the former specifies the available methods for setting transfer prices and, in general, refers to the OECD's 1995 Transfer Pricing Guidelines. In July 2003 a new Ministry of Finance decree will be issued, setting out the documentation required for recording related party transactions. As from 1 January 2001, the portion of interest or royalty received from related parties, under a contract concluded or a security issued after 31 December 2000 which exceeds the fair market interest or royalty rate, qualifies as a dividend and is taxed accordingly.

If interest paid to related parties exceeds the amount of interest received from related parties 50% of the difference will not be tax deductible. At the same time, if interest received from related parties exceeds the amount of interest paid to related parties 50% of the difference will be tax exempt. Only companies subject to Hungarian corporate income tax will be affected by this measure. A company is not obliged to apply these rules if it gives written notification of this to all its related companies (that pay or receive interest, including non-Hungarian companies) within 30 days of the end of the relevant tax year. Where notification is given none of the relevant companies will be entitled to apply the rules.

Thin capitalisation

As from 1 January 2001, if the debts of a company are in total greater than three times the equity then the interest charged on the excess amount will not be deductible for tax purposes. The level of debt applicable for this purpose is the daily average amount of debt arising from loans, private debt securities and bills of exchange received from anyone but financial institutions recorded in the statutory accounts for the year in which the relevant interest is paid. The equity is the daily average amount of equity recorded in the year for which the relevant interest is paid.

Dividends

As from 1 January 2001, the Act on Corporate Income Tax and Dividend Tax provides a precise and extensive definition of dividends.

The Hungarian domestic rules applicable to dividend payments have been modified to bring them into line with the Parent/Subsidiary Directive of the EU; the new rules will be effective once Hungary joins the EU. Dividends paid by a company to its parent will be exempt from dividend tax if the parent company (i.e. a company with at least a 25% holding) has qualified as such for at least two years on the day of payment.

Mergers

The provisions of the Merger Directive of the EU are incorporated into Hungarian domestic law for domestic transactions from 1 January 2003, and from the date that Hungary joins the EU for cross-border transactions. Basically, there is the right to opt for a deferral of taxation upon the actual realisation of a gain. The official commentary highlights that, regarding share mergers, the requirement of obtaining the 'majority of the voting rights' in the target company can be satisfied by considering more than one concurrent transactions (i.e. the shares or business quotas of several previous minority holders can be acquired, if in total they represent the majority of the voting rights).

Off-shore Company Regime

Under Hungary's off-shore regime, off-shore companies ("HOCs") are only liable to corporate tax in Hungary at a rate of 3%. As from 1 January 2001, off-shore companies are obliged to pay tax in advance and must comply with the general top-up obligation.

Due to Hungay’s accession to the EU the HOC regime has been largely dismantled. As a consequence, HOCs may no longer be entered into the relevant registry of the Hungarian tax authority after 31 December 2002. If any person, who has not previously been a member or a related party of a HOC, obtains a majority interest (over 50%) in a HOC; or if the HOC is affected by a merger, then the Hungarian tax authority will delete the HOC from its registry. All special rules applicable to HOCs (e.g. the 3% corporate income tax rate) will cease to have effect from 1 January 2006.

Hungary has developed an extensive network of tax treaties with over fifty countries regarding withholding taxes. Most of Hungary's treaties closely follow the OECD model. A treaty will overrule Hungarian law to the extent that it provides for more beneficial tax treatment.

Personal Income Tax

Hungarian tax residents are subject to personal income tax on their world-wide income. They may, however, be exempted from taxation on foreign source income by tax treaties. Non-residents are only liable to tax on their Hungarian-source income. This includes income from employment performed in Hungary.

The ranges of personal income tax payable on the consolidated tax base have changed. As from 1 January 2003, the portion of annual income below HUF 650,000 is subject to 20% personal income tax, between HUF 650,001 and HUF 1,350,000 the rate of personal income tax is 30% and above HUF 1,350,001 the rate is 40%.

Capital gains arising from the sale of securities on the Hungarian stock exchange are now exempt from personal income tax, whereas previously they had been subject to a 20% capital gains tax. Once Hungary joins the EU, the same exemption will apply to capital gains arising from the sale of securities on any recognised stock exchange of a Member State.

Interest income is exempt from tax in the hands of individuals.

If an employee receives shares on advantageous terms because of the employment relationship, as a general rule with certain exceptions, such income is taxed as employment income at high progressive rates and is also subject to social security contributions. However, since 1 January 2003, the concept of "recognised share schemes" exists. The underlying principle of such schemes is that, if the employees or managers obtain securities under specified circumstances and hold them for a prescribed period, a tax liability in respect of such securities will only arise if the securities are later sold. Once the securities are sold in the market, the rules on capital gains will apply at the applicable rate (currently 20%). If the scheme fulfils all the prescribed requirements, the Hungarian Ministry of Finance will register the scheme and the beneficial tax treatment will be applicable. Shares subsequently sold on the Hungarian stock exchange under a recognised scheme will not benefit from the above described tax exemption.

Value Added Tax

Called the general turnover tax (ÁFA) in Hungarian, this is a conventional value added tax (VAT), based upon the framework of European Union directives. The standard rate of VAT is 25%, but a reduced rate of 12% applies to certain goods and services (for example public utilities, books and newspapers, food, agricultural products). There are some goods and services that are zero-rated, including certain pharmaceutical products and all exports. Imports are subject to VAT on a taxable base calculated as the sum of the customs value, plus customs duties, fees and consumption tax.

Certain transactions which are carried out in Hungary are exempt from VAT (for example the sale, rental and leasing of land, the rental of an apartment, postal services, financial services and legal services). Businesses providing these exempt services will not be able to recover input VAT in full. Small businesses can elect to be VAT e

Hungarian VAT laws will be further harmonised due to Hungary's accession to the EU. Once Hungary joins the EU, the terms 'product import' and 'product export' will cease to exist with regard to transactions involving other Member States. Hungary will need to implement the so-called 'intra-Community acquisition' and 'intra-Community supply' principles of the EU's VAT Directive

Other Taxes on Individuals and Corporations

• In addition to VAT, consumption tax is levied on certain goods. These goods include coffee, jewellery and passenger cars. Persons not subject to VAT cannot be liable for consumption tax. Consumption tax should be levied when goods are sold or imported for sale.
• From 1 January 1998, alcohol, tobacco and petrol products and from 1 August 2000 certain types of wine became subject to excise tax in place of the previous consumption tax.
• A local turnover tax can be levied by municipalities up to a maximum of 2% of net sales decreased by material costs and certain other costs.
• There is 10% transfer duty on real estate and certain other assets.
• As from 1 January 2003 a new form of tax, the so-called 'simplified business tax' was introduced. This allows small enterprises and private entrepreneurs to operate a simplified system of tax that replaces VAT, corporate and individual income tax.

Other taxes include a building tax, a tax on undeveloped plots, communal charges and a tourism tax. Compared to the items discussed in detail above, these taxes are of minor importance.

Hungary operates a registered land system, which generally is efficient and reliable, although it can be slow in updating changes to its records, especially in Budapest.

Act No. CXLI of 1997 on Land Registration (the "Land Registration Act") replaced the former Law-Decree (No. 31 of 1972) with effect from 1 January 2000. The Land Registration Act does not introduce an entirely new land registration system except that the former "uniform land registration regime" is from now on referred to as "computerised registration system" meaning that the original copies of real property registers do not (or not necessarily) appear as hard copies. It is worth noting that under the Land Registration Act public notaries must be modem-connected to the Land Registries and they are entitled to issue certified copies of property registers and law firms may have modem access as well.

Leases

Commercial leases in Hungary are not registrable at the Land Registry as they are considered under the Civil Code to consist only of contractual rights to use the land and premises of the owner. This also prevents such leases from being mortgageable.

Parties are relatively free to agree between them the form of the security which is the most suitable to a particular transaction. The terminology used in Hungary to describe the different classes of security may be alien to most Western investors but the concepts behind the new legislation and the manner of enforcement will not be.

Planning considerations

Planning is controlled by the local municipalities in each city. In Budapest there are currently twenty three local municipalities (based on the number of districts), plus the Budapest City Council, which is the body responsible for preparing the development plan for the city.

A general 10% rate of property transfer tax applies to real estate transactions in Hungary. From 1 January 2000, the transfer of a real estate into a holding company is charged at 10% of its value. However, the transfer of shares in a company which already holds real estate can be made to avoid such a charge.

Transfers and the grant of leases of land are exempt from VAT. Buildings and other constructions are subject to VAT on their sale however the sale of residential real estate is VAT exempt, except where the development is sold before construction is completed and the first sale after construction is to a third party. If the property comprises land as well as buildings, they must be separately invoiced to the purchaser due to the different VAT treatment applicable to each of them.

7. FINANCE AND BANKING

In general terms, the Hungarian "banking" scene is quite advanced and sophisticated. Most major Hungarian banks are owned by foreign parents (which have integrated their Hungarian banking subsidiary into their respective international network), with Hungary's largest bank, OTP Bank, being listed on the Budapest and London Stock Exchanges. There is significant competition between Hungarian banks, particularly for the business of the larger companies and also for the Hungarian subsidiaries of strong "international" parents. In some cases, this has led to very aggressive loan pricing. There is an active inter-bank market both for funds and for foreign exchange. The National Bank of Hungary operates as the central bank and sets interest rates and also a "target" rate of exchange for the forint against other currencies, with the forint being allowed to trade within a fifteen per cent (+/- 15%) "corridor" above and below that target rate.

Taking Security

Taking security is important to potential foreign investors, especially in project finance and real estate transactions. Protection of an investment is often sought by investing banks and by companies seeking to become involved as joint venture partners or as minority investors in Hungarian businesses.

There are a number of methods by which security may be taken under Hungarian law. The primary provisions in respect of such methods are contained in the Civil Code. The concept of taking security is wider under Hungarian law than is generally envisaged by Western investors and is generally consensual in nature, requiring an agreement between the parties (which is likely to be in addition to their agreement in respect of the underlying transaction). As a general rule, the security transaction will terminate if the underlying agreement falls away because such agreements are collateral to the underlying agreement.

Under the Civil Code, enforcing security generally requires a court order. The procedure for enforcing security in Hungary is governed by Act LIII. of 1994 on Execution by the Court, as amended. The following sections outline two recent changes regarding the new financial institutions act and mortgage law.

The modification of the Act CXII of 1996 on Credit Institutions and Financial Enterprises ("Banking Act")

During the last three years the Hungarian Parliament has accepted several amendments of the Banking Act. The modifications aim to set out provisions that are more detailed and precise for the Hungarian financial and capital markets, and to put the practical experience of previous years into a legal framework. The modifications also serve the purpose of facilitating Hungary's EU accession and the harmonisation of rules and regulations applicable to financial institutions. Regarding harmonisation, it should be noted that these modifications contain a number of provisions, which will only enter into force upon Hungary's EU accession.

Without setting out all the modifications in detail, generally it can be said that some of the most important and significant changes relate to the rules applicable to: finance sector groups of companies; "bank secrets"; the prudent operation of financial enterprises, the consolidated supervision of financial enterprises; the closing down of financial enterprises and credit institutions; and capital edequacy requirements.

Since 1 January 2003, financial institutions are entitled to outsource certain activities such as data management, data processing or data storage related to financial services subject to compliance with the relevant data protection regulations.

The regulations provide that the person carrying out the outsourced activities is entitled to use third parties, so long as in the event if the agreement between such person and such third party, (which needs to be approved by the Supervisory Authority of Financial Organisations ("PSZÁF")), ensures that the PSZÁF and the National Bank of Hungary have the right to monitor matters in connection with the outsourced activity.

The Hungarian Parliament has recently passed legislation amending the Banking Act and Act CXX of 2001 on Capital Markets (the "2001 Capital Markets Act"). Most of the amendments came into force on 1 July 2003 but certain provisions in relation to the powers of the Hungarian Financial Supervisory Authority (the "PSZÁF") will automatically come into force only upon Hungary's accession to the European Union. A substantial part of the amendments relates to the regulatory control of banking groups, investment enterprises and mixed activity holding companies. The new rules provide that if the controlling credit institution/investment enterprise and the controlled companies (including enterprises other than financial institutions) have their seats in different member states of the European Union, the supervisory authority of the controlling credit institution/investme0nt enterprise shall have the right to exercise "consolidated regulatory control" over the relevant entities.

Act No. XV of 2003 on Preventing and Impeding Money Laundering of the Republic of Hungary (the "Money Laundering Act")

The Money Laundering Act came into force on 16 June 2003 and it consolidates (and replaces) the current legislation prohibiting money laundering, i.e. Act No. XXIV of 1994 and Government Decree No. 299/2001 (XII. 27.) and has resulted in less ambiguous and more precise legislation.

The most important new and amended rules of the Money Laundering Act as follows:

• the scope of the Money Laundering Act has been broadened to cover institutions accepting postal money orders and receiving and delivering domestic and international postal orders;
• introduces more precise and detailed definitions and interpretations;
• sets out which authorities /organisations have the role of supervising each particular class of service provider;
• removes certain types of insurance transactions from the scope of the legislation;
• increases the number of persons who must identify themselves and the circumstances in which such identifications have to be made;
• provides that a person taking travellers cheques, negotiable securities, money market instruments and recorded delivery slips of international postal orders, amounting to or exceeding a value of HUF 1 million (approx. EUR 4,000), across the Hungarian national border, must notify the Hungarian customs authority of this fact;
• lays down the procedure that must be followed to report any information, fact or circumstance that suggests that money laundering may be taking place;
• provides detailed rules of how someone reporting suspected money laundering must co-operate with the National Police Headquarters and lays down the sanctions available to the National Police Headquarters for failure of a service provider to comply with such obligations; and
• sets out detailed provisions governing funds held by lawyers and public notaries.

The comprehensive regulation introduced by the Money Laundering Act fully harmonises Council Directive 91/308/EEC on the prevention of the use of financial systems for the purpose of money laundering and Directive 2001/97/EC amending the above Directive, into Hungarian law.

Mortgages and Pledges

Under Hungarian law several changes to the law of mortgages and pledges were introduced by the Act of CXXXVII of 2000. All lien agreements must be created in writing. A lien is a right over another's property created to protect contractual obligations and provide the means by which security may be enforced in priority to claims of other creditors. Generally, a lien may be granted over any type of asset, transferable right or claim, but no lien may be created over only part of an asset. The two main forms of lien are pledges and mortgages. The main difference between the two types is that "pledged" property must be deposited with the beneficiary/pledgee or a third party custodian, whereas the debtor/mortgagor may retain possession of the "mortgaged" property.

A mortgage may be created over specific assets and it is called a "Mortgage" if it is over real estate/land or over the whole share of ownership of real estate/land, or a "Fixed Charge" if it is over movable assets or over the whole share of ownership of assets. A mortgage can also be created over all the current and future assets of a mortgagor, which is called a "Floating Charge". Mortgages can also be created over business quotas (in Kft.'s) and over amounts held in bank accounts.

A mortgage over real estate/land must be filed with the appropriate Land Registry, i.e. the Land Registry which is relevant to the title being mortgaged. The priority ranking of a mortgage over real estate/land is based on the order in which the filing of the mortgage is received at the Land Registry. Mortgages over real estate/land rank in priority to every other type of lien. In Hungary, pledges and mortgages may be created by contract, by court order, by the order of other authorities, or by operation of the law.

A "Fixed Charge" or "Floating Charge" can only be validly created if it is in the form of a notarised deed, executed before a Hungarian Public Notary, who will then enter details of the relevant fixed and/or floating charge into the so-called "Register of Pledges" (a computerised registration system maintained by the Hungarian Public Notaries).

General background

The principal sources of legislation are the Labour Code and Act IV of 1991 on Job Assistance and Unemployment Benefits, which deal with redundancy issues. These are supplemented by a number of minor regulations issued by the Government or particular Ministries, together with other laws or regulations dealing with the taxation and social security position of employees and other related areas.

In addition to the various statutory provisions, a further source of regulation of the employment relationship is derived from collective agreements that may be in force between the employer(s) and any trade unions. The role of collective agreements and the considerations of employee representation will vary depending on the number of employees at a particular enterprise.

Application of the Labour Code

The Labour Code applies to all employment where work is carried out in the territory of Hungary. An employee of a foreign employer working in the Republic of Hungary through delegation or temporary transfer is not regarded as a Hungarian employee but certain basic rules of the Labour Code (minimum time for rest, conditions of safety at work, minimum wage etc.) apply in relation to foreign employees. The Labour Code contains detailed provisions relating to a variety of issues including, among others, the statutory rights of employees, the establishment of employment, the dismissal of employees, holidays and sick pay. Unless otherwise stated in an individual employment contract or collective agreement, the provisions of the Labour Code are deemed to apply.

Legal succession

Under the Labour Code the transfer and take-over of the employer's separate and organised group of material and non-material resources (e.g. business unit, plant, business, shop, site, workplace working hours) as prescribed in the collective agreement, are applicable to the legal successor employer, in respect of the employees affected by the legal succession for at least one year following the date of transfer.

The employment contract must be in writing and must specify, as a minimum the name of the parties, the employee's salary, the structure of the salary (i.e. basic salary and supplemental payments for working shifts, for instance), official tasks and place of work. In addition to the statutory minimum content of the employment agreement, in practice it is important to incorporate certain additional terms. The transfer and take-over of the employer's separate and organised group of material and non-material resources (e.g. business unit, plant, business, shop, site, workplace or a part of the foregoing) to an organisation or a person that is subject to effect of the Labour Code, for further operation or the resumption of operation, on the basis of an agreement, in particular, by means of sale, exchange, lease or by way of contribution of assets by acquiring a quota of a company qualifies as "legal successorship". In the event of legal succession, all employment-related rights and obligations will be transferred from the preceding legal employer to the legal successor employer at the time of the transfer. The predecessor is obliged to inform the successor about these rights and obligations, however, the employees' rights to enforce claims are not affected if the predecessor does not meet this obligation. In case of a transfer of business, the employees of the former employer must be transferred to the legal successor employer and the employment of the transferred employees will be continuous.

In the case of legal succession, if the former employer had a collective agreement, the work conditions (not including agreement should include a provision stating that the employer may vary the employee's place of work and to define the employee's job description in as wide a manner as possible, as these cannot subsequently be unilaterally amended. Furthermore, the individuals who may instruct and exercise employers rights over the employee should be named.

Unless otherwise provided, the employee will be employed for an indefinite period of time. Contracts for a definite period may not exceed five years. Even if, after expiry of an employment contract for a definite term, the parties agree upon a further definite term, the total duration of all the subsequent employment contracts for a definite term cannot exceed five years. The same parties may establish fixed-term employment repeatedly or extend the fixed-term employment if it is justified by the employer's rightful interest and it is not aimed at the impairment of the employee's rightful interest.

Employment contracts may stipulate in writing a trial period, the length of which is thirty days unless otherwise specified, subject to a statutory maximum of three months, and cannot be extended. During the trial period either party can terminate the employment with immediate effect without any obligation to provide reasons.

Working hours

Unless expressly agreed otherwise, working hours are eight hours a day, that is forty hours a week. It is possible to determine the working hours on a weekly or monthly basis. In any event, the working time may not exceed twelve hours in one day, and the weekly working hours cannot exceed 48 hours together with overtime.

Holidays

The basic paid holiday is twenty working days in a calendar year and this minimum may not be validly reduced. This must be increased in line with the employee's age and extra days are awarded on the basis of certain other factors.

The employment contract is automatically terminated upon the employee's death, the expiry of an employment contract for a definite term, and certain special events, which may be stipulated in the employment contract.

An employment contract for a definite period can only be terminated by mutual consent or by extraordinary notice; no ordinary notice may be given. There is a qualification to this rule: the employer may terminate an employment contract for a definite term subject to an obligation to pay to the employee his average earnings for a one year period, or if the outstanding term of the employment contract is less, then for such outstanding period.

Both the employee and the employer can terminate in writing an employment contract for an indefinite period by ordinary notice.

The employer must justify the dismissal, unless the employee has reached retirement age, has the right to retire before the official retirement age, or will receive a special pension. The justification must indicate the reason for the dismissal which must relate to the employee's abilities or his behaviour relating to the employment or the employer's operation, and must include a notice regarding remedies, and their time limits, available to the employee.

The period of ordinary notice must be at least thirty days, subject to longer periods stipulated in the contract, but cannot exceed one year. The thirty day notice period is prolonged depending on the duration of employment by the employer in question. If an employee is dismissed on ordinary notice, the employee must be exempted from performing work for half of the notice period.

The employer or the employee can terminate the employment with immediate effect if the other party wilfully or negligently violates his significant employment obligations or otherwise demonstrates behaviour which makes the retention of the employment impossible.

The right to terminate on extraordinary notice must be exercised within fifteen days of the day on which the individual entitled to exercise employment rights over the employee becomes aware of the reason for the termination, and within one year of the actual occurrence of such reason. If the employment rights over the employee are exercised by a body such as the Board of Directors, then the fifteen day deadline starts running on the date on which such body is expressly informed of the reason for the termination.

The dismissal of a certain number of employees due to a reason related to the employer's operation is subject to special rules. In the case of a group dismissal, the Labour Code prescribes various obligations for the employer to have consultations with the employees' representatives and to inform the employees and the labour office about the circumstances of the group dismissal.

Under Hungarian law there are two types of employees: ordinary employees and senior executives. By law, the head of the employer and his deputy are statutory senior executives. The employer may determine that other employees in important positions are to be treated as senior executives in certain circumstances. The provisions to be applied for the senior executives are less protective than the average provisions. In addition, the Labour Code imposes special non-competition rules on the senior executives. The employer must inform his employees of their categorisation as designated senior executives at the time the employment contract is concluded, as subsequent changes are subject to the agreement of the employee.

Foreign employees

The foreign employers' employees working in Hungary through delegation or temporary transfer are not regarded as Hungarian employees. However some provisions of the Labour Code setting out minimum rights must apply also to these foreign employees. Foreigners are considered as resident for tax purposes if their "place of abode" or "usual place of residence" is in Hungary. If this is the case, Hungarian tax is applicable on their world-wide income. If a foreign employee is employed by a Hungarian company, neither the employer nor the employee is required to make contributions to Hungarian social security, provided that provision has been made for the health insurance of the individual. The employee will require both a residence visa and a work permit unless he is a managing director of a company with several employees, in which case he will only require a residence visa.

Hungary, in line with most other countries, offers protection to intellectual property, although in some cases certain steps need to be taken to benefit from that protection.

Hungary is a signatory to the most of international Intellectual Property conventions and is a member of WIPO. Following the re-regulation of Hungarian Intellectual Property law in the ’90s, it is in compliance with the latest developments, in particular the relevant EU requirements.

Patents

Following discussions between Hungary and the United States on intellectual property, Act XXXIII of 1995 on the Protection of Inventions by Patents was passed and came into force on 1 January 1996. Any application for a patent must be filed with the Hungarian Patent Office. If the patent is granted then the protection is for twenty years from the filing date.

The granting of a patent gives protection to the holder against infringement. The Hungarian Patent Office acts through a tribunal of three members in proceedings of annulment, of negative findings, and in the course of the interpretation of a patent description. The courts may overturn a decision of the Patent Office. In all patent matters under the jurisdiction of the Hungarian Patent Office, a foreign person must commission a patent attorney or a lawyer resident in Hungary to represent him.

Besides the protection of patents and registered designs (dealt with below), Hungarian law offers protection to topographies, microorganisms and product prototypes.

Hungary is a signatory to, inter alia, the European Patent Convention, the Paris Convention, the Patent Cooperation Treaty and the Strasburg Agreement concerning the International Patent Classification.

Trade Marks and Geographical Indications

The principal source of protection for trademarks is Act XI of 1997 on the Protection of Trademarks and Geographical Indications. The basic principle is that trademarks must be registered to enjoy protection although this principle is mitigated somewhat by the position regarding well-known marks and exceptions to the "first-to-file" rule.

The registration of a trademark lasts for ten years, and is renewable for further ten-year periods without limitation. The holder of a trademark may exclusively use the trademark on those goods for which it is registered and may grant a license to others for the use of the mark. Foreign persons are required to authorise a patent attorney or lawyer resident in Hungary to represent them in all trademark matters falling under the jurisdiction of the Patent Office.

The protection of geographical indications is similar to the protection of trademarks, except for certain additional requirements relating to the origin of the goods concerned.

As mentioned, Hungary is a signatory to the Paris Convention and, further, to the WIPO Trademark Law Treaty, the Madrid Agreement concerning the International Registration of Marks and other related conventions.

The infringement of a trademark may qualify as a criminal offence.

Copyright

There is no need to make a filing to gain copyright protection for a work. Copyright is protected principally by the Civil Code and Act LXXVI of 1999 on Copyright. Copyright subsists in individual and original works although "original" is not defined. Copyright protection is due to the creator of a work, but it is also due to a rewriter, adapter, or translator of a work without injury to those rights due to the author of the original work. The author of the original work must be cited in all subsequent works based on the original work.

Unless otherwise agreed, the delivery of work to the creator's employer means that the economic rights are transferred to the employer as successor in title to the creator, if the creation of the work falls within the scope of the creator's employment. Also, the delivery of a work to the creator's employer is considered as an act of consent to the disclosure of the work to the public. The creator is entitled to a royalty if the employer licenses another person to use the work or transfer to another person the economic rights relating to the work.

One of the most important parts of the Copyright Act includes rules on software program creations. Interestingly, the creator's right to receive royalties if the employer licenses another person to use the work does not apply to software created by the creator in the course of his employment.

Copyright lasts for the lifetime of the author and for seventy years from the first day of the year following the death of the author.

The Copyright Act also protects neighboring (or related) rights, such as the rights of performers, rights of music publishers, rights of movie producers and rights of radio and television organizations. The principles of protection are similar to those of protection of authors; however, the time of protection is shorter.

New provisions of the Copyright Act, which took force on 1 January 2002, extend copyright protection to databases, which are defined as systematic collections of individual works or data. The copyright protection in a database is due to its creator ie. the person or entity who has initiated and paid for the compilation of the database. This is subject to the proviso that the creator of a database must be either a Hungarian private individual, a foreign individual with permanent residence in Hungary or a corporate entity registered in Hungary whose main place of business is Hungary. As for other types of work the consent of the creator of a database is required for the reproduction or use of a database.

Hungary is a member of the Berne Copyright Convention, the Universal Copyright Convention, the Montevideo Treaty and the Geneva Treaty concerning the Protection of Audio Recordings.

Infringement of copyright is a criminal offence.

Registered designs

With effect from 1 January 2002 Hungarian rules have been brought in line with the EU Directive on the legal protection of designs. Under the new regulations a "design" is defined as meaning "the appearance of the whole or part of a product resulting from the features of, in particular, the lines, contours, colors, shape, texture and/or materials of the product itself and/or its ornamentation".

A design may be protected only if it is new and has individual character. Upon registration with the Patent Office a design is protected by the design right for one or more periods of five years from the date of filing of the application. The right holder may have a term of protection renewed for a maximum of four periods of five years each, up to a total term of twenty five years from the date of filing.

The design right confers an exclusive right to prevent the making, offering, putting on the market, importing, exporting or using as a product or stocking such a product. There are special rules relating to designs created by employees.

Similarly to other intellectual property rights, registered designs are also protected by criminal law.

"Passing off" (unfair competition)

Under the Competition Act which came into force on 1 January 1997, it is prohibited to manufacture or place in the market, goods or services having the characteristics (such as appearance, packaging, markings (including the marking of origin) or description) with which the goods or services of a competitor are normally associated or to use names, markings or attributes of goods of such competitor, without the competitor's consent. This will give some protection to an unregistered trademark. However, it would be necessary to show that the goods being infringed are well recognised in the market and that the goods doing the infringing are sufficiently similar to cause confusion.

The offence of “passing of” may also qualify as a criminal offence.

E-commerce

Act CVIII of 2001 on E-Commerce ("E-Commerce Act") took force on 23 January 2002. The E-Commerce Act contains both general consumer protection regulations and rules relating to the specific functioning of electronic commerce such as the conclusion of contracts via the Internet and the sending of electronic advertisements.

Electronic signatures

Act XXXV of 2001 on electronic signatures ("Electronic Signatures Act") came into force on 1 September 2001 and its purpose was to implement into Hungarian law the provisions of the EU Directive on electronic signatures. Subject to certain exceptions, it is now not permitted to refuse acceptance of an electronic signature or electronic document solely on the basis that it is in electronic form. Furthermore, except in certain cases, if a particular document is required to be in writing by law, then this requirement is deemed to be met by incorporation into an electronic document provided that such document has been signed with a so-called "advanced electronic signature" (ie. a signature uniquely linked to the sender which is capable of identifying the signatory). The Act also introduces the concept of a "qualified electronic signature" which is to be certified by certain bodies authorised to provide such certification.

10. DISPUTE MECHANISMS, SETTLEMENT AND ARBITRATION

In Hungary there are four levels of Courts: Local Courts (municipal and district Courts), County Courts (including the Metropolitan Court), Court of Appeal and the Supreme Court. Each court has separate civil law and criminal law divisions. In a civil law case, a case may be initiated before a Local Court or before a County Court. In Local Court cases, the county or Metropolitan Court is the relevant court of appeal, whilst in other cases the Court of Appeal is the appellate body. In exceptional cases the parties may, jointly, appeal directly to the Supreme Court. In certain and very restricted cases, judicial review may be applied for at the Supreme Court against the final and binding decision.

As far as jurisdiction and competence of a Court is concerned, all lawsuits belong to the jurisdiction of Local Courts unless otherwise delegated to the sphere of authority of a County Court. The County Courts also have jurisdiction for actions in the sphere of property law if the value exceeds five million Hungarian Forints (with the exception of those concerning indemnification for expropriation), copyright actions, patent actions, actions for revision of a decision of a business association and actions for illegal utilisation of a registered trade name (name of a firm).

In international commercial disputes according to the newly modified Act regarding Conflicts of Law ("Conflict of Law Act"), Hungarian courts may now generally have jurisdiction in every case if the defendant’s registered office, place of business or representative office (or place of permanent residence or usual place of abode) is located in Hungary unless the Conflict of Law Act states the contrary. The Hungarian court also has jurisdiction if one of several defendants has a registered office in Hungary provided that the defendants will be co-defendants in the litigation or if the decision would apply to all the defendants regardless of their involvement in the proceedings. Defendants who do not have a registered office in Hungary may be party to proceedings before a Hungarian court if the defendant has property/assets in Hungary. The parties are free to agree upon jurisdiction with regard to employment and consumer agreements provided that the choice of jurisdiction:

• shall not result in actions brought against consumers or employees in any court other than courts where the consumer's or employee's permanent residence or place of abode is located; and
• shall not preclude consumers from bringing an action before the courts of the country where his place of residence or usual place of abode is located or employees from bringing an action before the court of the country where they usually work.

Hungary civil procedure follows the inquisitorial system, whereby the judge decides on questions of fact and law. The judge may also ask for the opinion of an expert. However, the judge has the power to evaluate the report of an expert. There is no jury system in Hungary, although, there are certain cases, albeit limited, when a professional judge sits in Court with two lay assessors (for example claims in Family law and in Employment law).

Costs of proceedings are all costs incurred either in or out of Court in relation to the practical and bona fide conduct of the parties. The Court should decide on costs of proceedings in its judgement or in any other ruling terminating the procedure. The defeated party must refund the costs of the prevailing party as determined by the Court taking into consideration the duly certified data provided. Costs may not be charged subsequently. Hungarian lawyers are not permitted to work on a contingency fee basis in litigation.

Enforcement of judgement

In Hungary, once a judgement has been made a party may seek its enforcement. The winning party may ask the Court for a charging order, or in special cases, the notary public may give such an order. Enforcement is effected by the executor of the competent Court. Alternatively, the winning party may use the Court judgement to commence bankruptcy or insolvency proceedings against the losing party if satisfaction of the judgement has not been obtained.

Enforcement of foreign decisions

There must be a Treaty or reciprocal arrangement between Hungary and another country for Hungarian courts to recognise and enforce foreign judgements. However, an exception to this rule, which is effective from 1 May 2001, is if the parties have agreed upon the place of jurisdiction where the judgement was issued then no Treaty or arrangement is necessary. However this exception only relates to general commercial contracts (for example it excludes guardianship or employment agreements). The recognition of a foreign judgement does not entail special recognition proceedings. However, interested parties may still request that the court establish special proceedings to decide whether or not the foreign decision can be recognised in Hungary.

Arbitration

Since litigation in Hungary can be time-consuming, many commercial contracts include provisions for arbitration as a means of resolving disputes. Hungary is a party to the 1958 New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards. As such, an arbitration award made (in accordance with the 1958 New York Convention) outside Hungary can be enforced directly in Hungary.

The rules of arbitration, including the relationship between the Court system and the arbitration system is governed by Act LXXI of 1994 on Arbitration. The Arbitration Act contains provisions on ad hoc arbitration and also on permanent institutional arbitration. The most popular permanent arbitration body is the Court of Arbitration attached to the Hungarian Chamber of Commerce and Industry.

Hungary has been at the forefront of the moves by Central and Eastern European countries to join the European Union ("EU"). Its Association Agreement with the EU was one of the first such agreements concluded between the EU and a Central-Eastern European countries in 1991, which entered into effect in 1994. On the basis of Hungary’s Accession Agreement, provisions have been made for the key regulations of EU law to be applied in relation to trade between the EU and Hungary, which set out a legal framework by which Hungary was able to meet the economic and political conditions for accession to the EU.

Hungary (together with the other 9 candidates) signed the Treaty of Accession on 16 April, 2003 in Athens. According to the Treaty of Accession Hungary accedes to the EU on May 1, 2004. Effective from that day all of the EU Treaty provisions and all the EU legislation will come into force in Hungary, except the ones for which interim measures has been granted by the Treaty of Accession.

Practically, the harmonisation of the national laws to the EU legal system has nearly been completed. The businesses shall integrate the usage of the new laws into their day-to-day operation. Several questions may arise in the course of the application of the new laws in practice, especially among the small and midsize enterprises. The challenge for such enterprises will be to learn how to adapt the modified legal framework and, moreover, how to make the best out of the new possibilities provided by the opening common market.

Ormai és Társai CMS Cameron McKenna

July 2003

The contents of this brochure are meant to give a brief overview only and are not meant to be exhaustive or to provide specific advice. If you have a specific problem or query, it is recommended that you take specific legal advice.