Loss of equity can have serious consequences for companies in Hungary. Failure to solve the capital situation in time may lead to irreversible liquidation of the company. The main purpose of the legal provisions on equity situations is to protect creditors. However, companies must also fix their equity situation in their own interest. If a company applies for a loan, the credit institution may reject the application on the grounds of a loss of equity. Loss of equity can be a disadvantage if a company with loss of equity applies for a grant, or it may also be a disqualifying factor in public procurement tenders.

Why is a loss of equity dangerous?

Companies that do not take the necessary measures to fix their equity structure are putting their very existence at risk. The balance sheets in the published financial statements show immediately the structure of the company’s equity and make it possible to determine whether the company’s equity is insufficient or has become negative. In such a case, the Hungarian Court of Registration will require the representative of the company to explain what he / she has done to remedy or eliminate the equity deficit. The fact that the equity problem form has been solved must be certified by the company’s representative. Otherwise, the Hungarian Court of Registration, exercising its supervisory rights, will initiate the liquidation of the company, which cannot be reversed.

If, due to loss, the company’s equity has been reduced to half of its registered capital, the decisions of the general meeting, convened without delay, must be implemented within three months. The latter rule of the Hungarian Civil Code is applicable to limited liability companies. In case of a company limited by shares, the law provides that in the event of a reduction of the equity to two thirds of its registered capital, the general meeting must be convened within eight days and its resolutions on fixing the equity structure must be implemented within three months.

If, based on the information contained in its financial statements under the Hungarian Act on Accounting, the company, for two consecutive full financial years

• does not have an amount of equity corresponding to the registered capital required for its legal form,
• and the members (shareholders) of the company fail to provide the necessary equity within three months of the adoption of the second year’s financial statements under the Hungarian Act on Accounting,

the company must decide within 60 days of the expiry of the deadline to transform to another company form or must make provision for liquidation without legal succession.

What are the possible solutions to a loss of equity?

We have already written about ensuring capital adequacy, but it is good to review and update your knowledge every year.

Additional capital contribution

The loss of equity can be solved by paying an additional capital contribution, which must be placed in the allocated reserve at the same time as the transfer of cash or assets. In this way the loss of equity is reduced or even eliminated. An additional capital contribution may be paid by the owners if they have undertaken to do so and if such a provision is included in the articles of association. The exact amount of the additional capital contribution must be recorded in a members’ resolution.

The provisions of the Hungarian Civil Code allow for the possibility of making an additional capital contribution not only in cash but also by transferring tangible assets, materials or a member’s loan as a receivable.

Capital increase

Equity problems may also be solved by a registered capital increase combined with an increase in the capital reserve. The increase in registered capital and capital reserve must be entered in the books on the date of registration of the increase in registered capital with the Hungarian Court of Registration. This reduces or eliminates the loss of equity.

Increase in capital from a shareholder’s loan or in-kind contribution

Capital situation may be settled either by a capital increase from a shareholder’s loan or by way of an in-kind contribution. In both cases, it is also advisable to increase the capital reserve at the same time as increasing the registered capital.

Change of company form

A transformation can also be a solution to overcome a loss of equity. A limited liability company (Kft.) with loss of equity can be transformed into a limited partnership (Bt.).

Merger, fusion

The loss of equity in a group of companies with the same ownership can also be solved by a merger or fusion. This requires that the positive retained earnings of one company are larger than the negative retained earnings of the other. If the combined retained earnings of the companies remain negative, the positive retained earnings can also be secured by revaluation, by increasing the capital reserve in conjunction with an increase in registered capital, or by transferring registered capital to the retained earnings. In the transformation process, i.e. a merger, more than two companies may be involved. In this case, the retained earnings of the company resulting from the merger or fusion must be positive.

Forgiving shareholder’s loan

The capital situation can also be solved by forgiving shareholder’s loan. The amount forgiven, which is recorded as other income, is included in equity in the profit and loss account, thereby increasing the value of equity. This reduces or even eliminates the loss of equity. Forgiving a liability booked in the course of the year is included in other income until the year-end closing and is only included in the balance sheet profit or loss and thus in equity at the balance sheet date, thus reducing or eliminating the loss of equity.

However, a tax liability arises on the liability forgiven. The corporate tax base cannot be reduced by the amount recognised in the tax year because of the liability waived by the original holder. The maximum burden of the waived liability is due to the gift duty that came into force on 1 January 2008, which can be as high as 18%.

Exemptions from the gift duty are provided for in the Hungarian law on duties. Also the acquisition of a claim by way of a gift between business entities, including debt forgiveness and debt assumption. Consequently, no duty is payable on a forgiven shareholder’s loan if the forgiving owner is a company.

Forgiving approved dividends

The loss of equity can also be solved by forgiving approved dividend, which is paid directly to equity on the date of the waiver.

Application of upwards revaluation

When the upwards revaluation is recorded, the source of the upwards revaluation is recorded as a valuation reserve, which increases the value of equity. This may reduce or eliminate the equity deficit.

The possibility of applying an upwards revaluation can only be recorded at the balance sheet date and must be included in the accounting policy and certified by an auditor. The amount of the upwards revaluation should be determined by reference to the market value at the date of the preparation of the balance sheet as defined in the accounting policy, rather than at the balance sheet date.

Once the upwards revaluation has been entered in the books, the assets concerned are shown in the books at market value. The amount of the upwards revaluation is reviewed annually upon the preparation of the balance sheet, with the result that its value increases, decreases or may not change. This may result in a change in the value of the equity and hence impacts the volume of the loss of equity.

Decrease in registered capital

A reduction in registered capital may be made by placing it in the retained earnings in order to reduce or eliminate the loss of equity. The decrease in registered capital and the increase in the retained earnings are recorded as of the date of registration with the Court of Registration.

The reduction of the share capital shall affect the members’ shareholdings in proportion to their share in the capital unless otherwise provided in the articles of association or in the resolution of the general meeting of members deciding on the reduction of the share capital.

When the share capital is reduced by a capital withdrawal, the amount of the assets in excess of the share capital shall also be taken into account in determining the amount to which the owner is entitled, in proportion to the share capital. At the same time as the share capital is reduced, a proportionate share of the other elements of the capital, such as the retained earnings, must be paid to the owner, which may give rise to a tax liability.

Assumption of intra-group debt or aid

Between related companies, one company may assume a liability from another company, which may have an indirect effect on equity.

If we can assist you in reviewing your options for resolving the loss of equity and quantifying the potential financial impact, please contact our accounting experts!

This article provides general information and does not constitute advice.