Closer to market needs - recent amendments to the Hungarian insolvency regulation

The Hungarian Civil Code passed in 2014, prohibited the use of call option and security assignment of receivables for security purposes. This prohibition was lifted in 2016 in respect of non-consumer borrowers with the amendment of the Hungarian Civil Code. However, no other acts – such as the Hungarian Insolvency Act – have been aligned to this amendment of the Hungarian Civil Code.

Exercising a call option in liquidation proceedings was regarded as unreasonable by the market, because creditors were not able to set-off their claims against the purchase price (ie the creditor must pay the purchase price for the asset and its claims remained unsecured). Based on court practice, creditors secured by security assignment were not allowed to collect receivables from third party debtors after the commencement of the liquidation proceedings against the assignor. Claims secured by the security assignment remained unsecured in liquidation proceedings. The amendment of the Hungarian Insolvency Act improves these situations. Beneficiaries of the call option or security assignment will enjoy privileged positions in the liquidation proceeding (ie they will be treated on an equal rank as the mortgagees and pledgees) provided; that the call option or the security assignment was registered in the relevant register before the commencement of the liquidation proceedings. In turn, the amendment provides the opportunity for other creditors to challenge these security interests in the event that the beneficiary thereof does not settle the proceeds of the enforcement with the debtor in the required manner.

Also based on court practice, pledge over future receivables may have proved ineffective in a liquidation proceeding, as the pledge did not cover receivables that came into existence after the commencement of the liquidation proceeding (eg this court practice adversely affected real estate financings where the only liquid security interest might be the pledge over the tenants' rental payments). The amendment abolishes the short-lived court practice in relation to pledges over future receivables. Such pledges will cover all future receivables in case the underlying contract, from which such future receivables stem, already exists before the commencement of the liquidation proceedings.

Furthermore, the amendment abolishes the so called "50 % rule" regarding floating charges. This means that the recovery of the chargee is not capped at 50 % of the proceeds of the sale of the encumbered assets; the chargee may expect full recovery subject to certain deductions to cover the costs of the sale.

The amendment aims at enhancing the protection of the beneficiaries of the security interests by stipulating that part of the claim that remained unrecovered from the sale of the encumbered assets, due to the deduction of the costs of the sale, will still enjoy priority to the unsecured claims and may be recovered up to the amount of such deductions right after the costs of the liquidation. Should there still be any outstanding claim of the beneficiary; the remaining amount will be ranked pari passu with the unsecured claims.

In addition, the amendment enhances the position of the first ranking secured creditor by allowing set-off of its claim against the purchase price of the encumbered asset in case such creditor purchases that asset. This opportunity has been introduced only to the benefit of the first ranking secured creditor. The creditors in subsequent ranks – while they may purchase the encumbered asset – may not set-off their claims against the purchase price. The purchase price paid by the creditor in the subsequent rank will serve as the recovery amount of the first ranking creditor.

The amended regulation is now closer to market needs. From 1 July, the security interests (in particular, the call option, the security assignment and the pledge on future receivables) provide for more protection to the secured creditors in liquidation proceedings.