Ensuring capital adequacy

How to solve the capital situation of a limited liability company?

capital adequacy

All business organisations have to ensure their capital adequacy in Hungary in accordance with the Hungarian Civil Code. Yet what does capital adequacy mean? When is there a problem with capital adequacy? And what should be done about it? In this article, I discuss these issues in the context of limited liability companies.

The basic purpose of companies is to operate profitably, to make a profit.  However, changes in the economic environment or sudden, unexpected events affecting the company can result in losses for a given financial year.

When is there a problem with capital adequacy?

If the gains of previous years cover the losses of the reporting year, the company’s capital adequacy is not at risk. The scenario might be different, though, if the company previously paid out the profits of earlier years to the owners against the retained earnings, as a dividend. In such cases, even a smaller loss can cause headaches in terms of capital adequacy. The same issue may arise if a single loss exceeds the accumulated profit of previous years. With continuous losses, however, it is obvious that the company will sooner or later be unable to meet the statutory requirements without continuously ensuring its capital adequacy.

An issue with capital adequacy can arise if

  • the company’s equity has fallen to half of its share capital due to a loss; or
  • the company’s equity does not reach the registered capital prescribed for the given type of company in two complete and consecutive financial years.
What should be done in these cases?

If the company’s equity has fallen to half of its share capital following a loss, the managing director must immediately convene the members’ meeting or initiate the passing of a resolution without a meeting to take the necessary action. It is important for the owner to adopt a decision that ensures the company’s equity at least reaches the amount of its share capital. The relevant resolutions of the members’ meeting must be implemented within three months.

A capital situation can be resolved in various ways in Hungary, and below we will examine these one by one.

Additional capital contribution

The owner may only decide to make an additional capital contribution if the articles of association of the entity specifically provide for this as an option, and also include the conditions for this. In the absence of such provisions, making an additional capital contribution is not possible. If the owner would still like to opt for this, they first have to amend the articles of association.

The members’ meeting decides on the amount of the additional capital contribution and how to pay it, in line with the articles of association. This does not require any registration at the Court of Registration.

If the causes for the additional capital contribution no longer apply, the amount of the contribution must be paid back to the owner. The law does not specify the repayment rules in more detail, so the particular provisions for this should be given in the articles of association.

Capital increase

Since the company’s capital must at least be equal to its share capital according to the Hungarian Civil Code, it is important that the capital increase is made with a premium, i.e. the owner must provide the company with the assets in excess of the amount of the registered capital increase. As usual, this capital increase can be a cash or a non-cash contribution.

The capital increase must be registered at the Court of Registration.

Registered capital decrease

A company may decrease its registered capital to solve its capital adequacy problem if its registered capital exceeds the minimum requirements specified by law, and its equity also remains above this amount, despite the losses. The company may reduce its registered capital by transferring part of it to its retained earnings or capital reserve, with the proviso that, if its retained earnings are negative, the transfer must first be carried out to compensate for the negative retained earnings.

Any decrease in registered capital must be registered at the Court of Registration.

Change of company form

To restore capital adequacy, the company’s owner may decide to change the form of the company too. Naturally, the company form chosen should be such that the company is able to meet its capital requirements. Please note that changing the form of company qualifies as a transformation, and thus the general rules of transformations must be adhered to. Of course, finalising the process is also subject to registration at the Court of Registration. Due to the rules pertaining to transformations in Hungary, this can be considered the most time-consuming way of resolving capital issues.

What else can be done?

If these or other measures suitable for restoring the capital situation are not applicable, the owner must decide to terminate the company without succession.

The rules on capital adequacy explained in this article pertain to limited liability companies in Hungary. For companies limited by shares, the rules are different. Feel free to contact our experts if you need more detailed information. Also do not hesitate to contact us if we may be of assistance with any of the capital resolution methods included in our article, be it a transformation or a voluntary liquidation.

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