Coronavirus and certain corporate law issues

The pandemic and the related measures taken to restrict social contacts are challenging many businesses. In the Law_Point publication we highlight a special aspect of the situation: the liability of foreign managers of foreign parent companies under Hungarian law for certain acts and decisions relating to their Hungarian subsidiaries.

Indeed, if the restriction on the free movement of private individuals continues for a longer term, then executives must get prepared for temporary and significant – in some sectors even dramatic – changes in the business environment. Executives should also be prepared for making quick decisions in such situations.

Furthermore, in such a situation it is especially important for in-house lawyers to indicate to the management if management is entering a territory in which the decision-making process no longer falls under the rules of “business as usual” (e.g. by way of the application of a special feature of Hungarian corporate law and as a result of the possible liability under Hungarian law of the foreign parent company and its foreign directors having control and influence over a Hungarian subsidiary).

Why is this important in the context of the pandemic? Do the roles and responsibilities of corporate executives change during the pandemic?

Of course they do not. The roles and responsibilities of corporate executives remain unchanged, but what may change significantly is the way executives have to conduct the company’s business and the way they make decisions. Most importantly, the legal evaluation of the executives’ acts and decisions may also change significantly.

What are the most important potential shifts in the focus of corporate governance in the current crisis?

Above all, the crisis situation results in a number of atypical situations which normally do not arise in the ordinary course of business; these atypical situations can lead to extraordinary agenda items in the company’s life and in management meetings. Aforesaid may be particularly true if the Hungarian management of a Hungarian subsidiary (i) requests a decision from its foreign owners/shareholders on a transaction / case / measure of the Hungarian subsidiary, or (ii) the foreign owners/shareholders intend to give instructions and orders to the Hungarian management.

Are there any cases that can be specified?

Decisions and circumstances that significantly affect the pursuit of the core activity, the liquidity, or equity position of the Hungarian subsidiary are usually topics that may require the involvement of the foreign owners/shareholders.

The company’s corporate governance – including the preparatory phases of the decision-making process –takes place in accordance with a settled and detailed protocol used. To what extent does the current situation affect it?

The current situation does not mean that the applied corporate governance protocols need to be changed. What is however required is that the decisions of the owners/shareholders are prepared with a higher level of care. The reason for this is that, under Hungarian law, the decision of or the instruction from an owner/shareholder may give rise to the liability of the management of the foreign parent company in certain crisis-related situations.

What crisis situations are we talking about? What type of responsibility may be established?

If the Hungarian subsidiary gets into a situation in which it is threatened by insolvency, there is a shift in the general obligations of the management: instead of focusing solely on the interests of the company management now has to consider the interests of the creditors as well.

Most importantly, the above obligation does not apply only to the Hungarian managing directors of the Hungarian company. Anybody who has a decisive influence on the operations of the Hungarian subsidiary and participates in the decision-making process (i.e. persons considered “shadow director”) can be held liable. Based on this, even the management of the parent company can qualify as a shadow director and as such it can be held liable under the laws of Hungary.

What happens if the managing director disregards the interests of the creditors in such situation?

In this case, personal liability may arise, provided that the company goes into liquidation and the assets of the company are not sufficient to satisfy the claims of the creditors.

Who is considered to be a creditor?

Anyone who, in principle, can file a claim in a liquidation proceeding on the property under liquidation.

Our company has sufficient assets, a sound capital situation and high equity. Can insolvency threaten such a company at all?

Yes, it can. Hungarian corporate law regulates the solvency of a company based on the liquidity test and not on the basis of the assets or equity of the company. When determining if the company is threatened by insolvency, and if as a result the changed decision-making and liability provisions need to apply, only the company’s solvency is considered.

What steps do I need to take and how can I identify a situation threatening with insolvency?

It is difficult to provide you with a general answer, but, generally speaking, monitoring the cash flow situation and making continuous short-term cash flow plans and related forecasts is definitely advisable.

A more comprehensive and accurate answer can only be given based on a deeper understanding of the company’s business, its books and its position in its respective industry sector as the Hungarian judicial practice is rather pragmatic and makes decisions on a case-by-case basis.