Hungary: Leaving your MD to his own Devices is Never a Good Thing

Letting your MD fly high is not always a good thing

You have just found the most suitable managing director for your company. But before appointing him or her, there are some crucial factors you should consider in order to avoid unpleasant surprises.

Obviously, getting to know the new managing director may take time. Whenever you appoint anybody to a top position it carries some risk. Will the new managing director look out for the interests of the company or his own? Will he make economically justified decisions or help his friends? Will the company be more profitable or go bankrupt under his leadership?

Right under their noses

In our white collar crime practice we have encountered many ways in which managing directors steal company assets while the owners suspect nothing. By way of example, envisage the scenario where a managing director who uses the company to employ his own gardener, maid or his children’s private tutor, fakes these employment contracts – including golden parachute clauses so that these “employees” would receive huge lump sums upon their dismissal. Or imagine that a managing director enters into unnecessary and obviously overpriced contracts with companies owned by his friends in order to squeeze money out of the company. In addition, he employs specific employees (lawyer, bookkeeper, controlling manager, etc) to execute and then cover up the fraudulent acts, thus a whole team of white collar criminals live from the money of the company. In most cases, company owners only uncover these fraudulent acts after the managing director has been dismissed.

How can these situations be avoided? The fact is that all leading politicians and managing directors in most cases have one thing in common: sole, independent decision-making power over money. As such, the political method of checks and balances must be kept in mind when thinking about leading a company. It is therefore wise to establish an institutional system that helps prevent swindling, but does not interfere in day-to-day affairs. In business, these institutions include the establishment of a supervisory board or the appointment of a statutory auditor.

Supervisory board and statutory auditor

If the company has a supervisory board, it has access to all the company documents, accounting records and books, it may request information from any employee or directly from the managing director or managing directors, or it may inspect the company’s payment account, cash desk, securities portfolio, inventories or contracts, either by itself or have them inspected by an expert. Furthermore, the company may only adopt a decision concerning the financial report once in possession of a written report from the supervisory board in respect.

Apart from the above, if the supervisory board finds the managing director’s activity to be contrary to the law or the company’s deed of foundation, or that it otherwise infringes the company’s interests, the supervisory board has the right to convene a meeting of the company’s supreme body to discuss the issue and to make the necessary decisions. Under Hungarian law, it is legally impossible to bypass these rules.

Nevertheless, supervisory boards hardly ever fully apply regulations governing their practical application, as their establishment means more administration, while their power to control the management of the company is barely appreciated by company owners. Under the law, the establishment of a supervisory board is mostly optional but there are mandatory cases. The establishment of a supervisory board is mandatory for example when the annual average number of full-time employees employed by the company exceeds 200, and the works council has not relinquished employee participation in the supervisory board, in case of a public company limited by shares that does not use the one-tier system or in case of a public-benefit organisation, if its annual profit exceeds HUF 50 000 000 (approximately EUR 161 000).

While the supervisory board supervises the managing director’s decisions, the statutory auditor is a control mechanism over the company’s financial affairs. The statutory auditor is responsible for auditing the company’s books according to the relevant regulations and for providing an independent audit report to determine whether the company’s annual accounts are in conformity with the law and whether they provide a true and fair view of the company’s assets and liabilities, financial position and profits or losses. In practice, the importance of the statutory auditor is acknowledged more so than that of the supervisory board, but both bodies deserve more attention.

The appointment of any managing director will continue to be based on instinct and trust. However, it is better to avoid unpleasant surprises should these instincts be wrong and trust misplaced.

It is wise to establish an institutional system that helps prevent swindling, but does not interfere in day-to-day affairs? In business, these institutions include the establishment of a supervisory board or the appointment of a statutory auditor.

author: Alexandra Bognár