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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What are the conditions of a repurchase?

Own shares and own partnership shares are the company’s own equity investments repurchased (acquired) by the company itself.

The decision on the repurchase is always made by the supreme body, and is recorded in a members’ resolution in the case of limited liability companies. For companies limited by shares, the general meeting authorises the Board of Directors to acquire the own shares, but in exceptional cases – in the case of a transformation for example – prior authorisation may be disregarded.

In return for consideration, own shares and partnership shares may only be acquired if the conditions for payment of dividends are fulfilled at the company. Another condition for limited liability companies is that own shares and partnership shares may only be acquired from available assets in excess of the share capital, and that members must have paid their entire capital contribution. The regulation is similar in the case of companies limited by shares as well, as it is prohibited to acquire shares or partnership shares if the total nominal value/issue price has not yet been paid by the owners. The consideration for the own shares can be paid from the assets payable as a dividend.

Another important rule is in Hungary that membership rights related to the repurchased partnership shares may not be exercised, and the repurchased own shares do not provide shareholder rights, so when calculating the voting ratios, the relevant voting rights are deducted. Their share of the dividend must be distributed among the eligible members/shareholders.

Funds for repurchase, maximum repurchase

The funds for repurchasing own shares or partnership shares must be provided from the profit after tax and the disposable retained earnings recognised in the balance sheet or the interim balance sheet of the last financial year closed with financial statements, in a manner that ensures the equity reduced by the allocated reserve, the positive valuation reserve, and the repurchase value of the own shares does not fall below the amount of the registered capital. The data of the financial statements may be taken into account within six months of the reporting date.

The Civil Code in Hungary also stipulates a maximum limit for repurchasing own shares or partnership shares: For limited liability companies the capital contributions underlying the repurchased partnership shares may not exceed 50% of the share capital, while for companies limited by shares, repurchasing own shares or partnership shares is only possible up to 25% of the share capital.

Presentation in the financial statements

After the repurchase, an allocated reserve must be created from the retained earnings for the amount of the repurchase, which also sets the dividend payment limit. The repurchased own shares and partnership shares are recognised under securities in current assets in the balance sheet. The data related to their acquisition (reason for acquisition, number, nominal value, ratio to registered capital, amount of consideration paid) must be disclosed separately in the supplementary notes of the company.

Other rules in Hungary on repurchasing own shares or partnership shares

Own shares may not be acquired during a company establishment or an increase in capital, and when reducing capital, own shares must be withdrawn first. Neither single-person companies nor single-person companies limited by shares may acquire own partnership shares.

If a company limited by shares acted unlawfully during the repurchase process, it must withdraw the shares by reducing the share capital within one year of the acquisition. The company must sell the repurchased own partnership shares, give them to members free of charge or withdraw them within one year, and thereafter the allocated reserve can be reversed.

In the case of a sale, a gain between the selling price and the carrying value is recognised under other income from financial transactions, while any loss is recognised under other expenses on financial transactions.

In the case of a withdrawal, the registered capital  is reduced with an amount equivalent to the nominal value, while retained earnings are increased or decreased with the difference between the nominal value and the (carried) repurchase value, as applicable.

It follows that companies need to consider a number of things when repurchasing own shares or partnership shares. It is best to consult with an accountant and a lawyer before making the decision, to ensure everything is implemented in accordance with the rules. Feel free to contact us, the accounting advisers of WTS Klient Hungary will be happy to help.

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Registered capital, a basic element of equity

Looking at the equity components, registered capital (share capital) is one of the basic elements for financing operations. If this has not been paid, it is recognised in a separate row of the balance sheet: registered capital not yet paid.

The mandatory minimum amount of registered capital is regulated by law for certain business types, while the expected size of other capital elements also has to be taken into account when it is determined. Act V of 2013 on the Hungarian Civil Code includes important requirements regarding the measures that are necessary in the case of limited liability companies when equity falls compared to the registered capital. Accordingly, a managing director must convene the members’ meeting without delay to take the necessary measures if it comes to his/her knowledge that:

• the company’s equity has fallen to half of the share capital due to a loss;
• the company’s equity has fallen below the statutory minimum amount of share capital;
• insolvency is looming over the company or it has stopped making payments;
• or the company’s assets do not cover its debts.

In these cases the members have to make a decision on making supplementary contributions, providing equity totalling the amount of share capital in another way, or decreasing the share capital. For lack of all these, a decision must be made to transform, merge or separate the company, or terminate it without a legal successor. The relevant resolutions of the members’ meeting must be carried out within three months. If this does not happen the share capital has to be decreased.

Reserves

If capital falls, the amount of any supplementary capital contribution must be recognised as an increase in the allocated reserve. Supplementary contributions are regulated in the articles of association. Supplementary contributions that are not necessary to make up for the loss have to be repaid to the members on the list of members as of the date of repayment.

Shareholders can decide to settle the capital situation by increasing the capital reserve too; in this case the registered capital has to be increased, and the Court of Registration registers the amount based on the relevant members’ resolution. The amount put into the capital reserve can later be reduced by means of a capital decrease or rearrangement, and in the case of a capital decrease it must be ensured that all capital elements fall proportionally. The amount of the capital reserve can be transferred to offset any negative retained earnings if required.

In terms of the additional equity components, retained earnings show the accumulated earnings of previous years, which, provided equity is at an appropriate level and other conditions are also fulfilled, can be distributed as a dividend and used to increase registered capital.

The valuation reserve includes the valuation difference of assets at market value (valuation reserve for upwards revaluations) and the fair value reserve. Having such a reserve always needs contribution from an audit firm.

Profit after tax

Equity includes the profit after tax of the business for the reporting year, which, if the necessary conditions are met, can be distributed as a dividend to shareholders.

It is best to define the method for financing operations along with the elements and the amounts of equity when establishing the business, and to modify these during operations in light of the options allowed by Hungarian law. Taking appropriate measures ensures an optimal composition of equity, which will comply with statutory regulations, shareholders’ interests and provide protection for lenders. Should you need an expert for planning purposes, just contact the accounting consultants of WTS Klient Hungary.

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