This article was originally published at Jogi Fórum
In the financial sector, acquiring significant influence is subject to regulatory approval. However, as part of the approval process, the supervisory authority not only investigates acquisitions of shareholdings that would give rise to active control, but also monitors owners with voting rights that give rise to negative control or even fall below that threshold. Nevertheless, it may happen that the votes of persons whose minority shareholding does not even reach the threshold required for approval will be decisive in a major decision of the supreme body.This is the case, for example, when the votes of the person(s) with the majority vote cannot be taken into account by virtue of the law [see, for example, Section 3:19(2) of the Civil Code]; in such cases, the decision is made by the minority vote. Thus, persons who have not been subject to prior official scrutiny, i.e., whose ownership background, expertise, or other qualities have not been verified by the supervisory authority, will have a decisive influence on the outcome of the decision. Thus, the legislative intent behind the prior authorization of acquisitions in the financial sector is not fully realized in all cases.
I. Introduction
The basic principle of the operation of business associations is the division of decision-making powers between the bodies of the company – essentially the supreme body consisting of the owners and the management.
Fundamental business and personnel decisions concerning the business association are made by the supreme body (members' meeting, general meeting) consisting of the founders who established the company and subsequent owners. In principle, all members of the business association are entitled to participate in decision-making (either in person or through a representative) [Civil Code, Section 3:110].
While in the case of so-called personal companies (e.g., limited partnership, general partnership, limited liability company), the law ensures that all members can participate in the decision-making of the supreme body, i.e., members cannot be deprived of their voting rights [Civil Code 3:143. §], in the case of so-called asset-pooling companies (e.g., public and private companies limited by shares), it is possible to restrict or exclude voting rights [Civil Code 3:231, 3:257].
However, in addition to general restrictions arising from potentially differing rights associated with shareholdings, the law also regulates special conditions and restrictions for certain companies engaged in specific activities with regard to participation in the decision-making of the supreme body and the exercise of voting rights. Compared to the general restrictions that may be laid down in the articles of association, these can be regarded as special conditions linked to a specific situation and person, as they apply to (prospective) shareholders/members who are or will be in a given situation. They are typically temporary, lasting until a given condition is fulfilled.
Such special conditions apply, among others, to certain institutions operating in the financial sector, such as financial institutions, investment firms, insurance companies, and certain investment fund managers. The rationale behind the regulation is that only persons who can reasonably be expected to act in the interests of the institution and promote its prudent operation when making ownership decisions should be allowed to exercise significant influence over the institution's operations.
II. Prior supervisory approval of persons influencing the operation of financial sector institutions
Pursuant to Act CCXXXVII of 2013 on Credit Institutions and Financial Enterprises (the CFA), permission must be sought from the competent supervisory authority, the Central Bank of Hungary (the Supervisory Authority or MNB)
- for the acquisition of a qualifying holding in a financial institution [i.e. a credit institution or financial enterprise – see Section 7(1) of the CFA], or
- for the acquisition of additional qualifying holding in a financial institution by which to reach the 20, 30 or 50 per cent limit, and
- members of a financial institution may enter into a contract regarding members’ shares or voting rights, or to secure advantages in excess of such rights only upon the Authority’s permission [Section 126 of the CFA].
A "qualifying holding" is a direct or indirect interest in an undertaking which represents at least 10% of the capital or voting rights, and/or which enables the exercise of significant influence over the management of that undertaking.
Any person with a qualifying holding in a financial institution shall satisfy the following requirements:
a) be independent of any influences which may endanger the financial institution’s sound, diligent and reliable (“prudent”) operation, and have good business reputation and the capacity to provide reliable and diligent guidance and control of the financial institution, furthermore transparency in business connections and ownership structure so as to allow the competent authority to exercise effective supervision over the financial institution [Section 125 of the CFA].
The CFA also sets out grounds for exclusion in relation to the acquisition of influence [Section 131 of the CFA], which cover circumstances that, if they arise in relation to a person (or even a member or senior officer of that person) seeking to acquire a qualifying holding in a financial institution, will result in the MNB not authorizing the acquisition of the controlling interest. These grounds for exclusion have been formulated in fairly general terms by the legislator, and the legislation and the cases constituting grounds for exclusion leave room for supervisory discretion, and further circumstances to be considered may also be subject to investigation in the course of examining individual cases.
In the event of failure to submit the required application for permission, rejection of the application, failure to comply with the required reporting obligation, or refusal to provide data, the Supervisory Authority may prohibit the exercise of voting rights until the relevant legal conditions are met [Section 133 of the CFA].
Furthermore, if the conditions for acquiring a qualifying holding no longer exist, the Supervisory Authority shall suspend the member's voting rights until the unlawful situation is remedied or ceases to exist, or until the conditions are evidenced again [Section 135(1) of the CFA].
Provisions essentially identical to those contained in the CFA can be found in Act CXXXVIII of 2007 on investment firms and commodity exchange service providers and the rules governing their activities (the ISA), Act CXX of 2001 on the Capital Market (the CMA), Act LXXXVIII of 2014 on insurance activities (the Insurance Act) and Act XVI of 2014 on collective investment forms and their managers, as well as on the amendment of certain financial laws (the Collective Investment Act).
It follows from the determination of the extent of the qualifying holding that prior supervisory approval is required not only for the exercise of voting rights in proportion of a simple majority (since even an influence of 10% of the voting rights is subject to approval), but also, in practice, for the level of influence required to block decisions (typically 50% minus 1 vote, or, in the case of decisions requiring a qualified majority, 25% minus 1 vote), the legislator considers it important to examine whether the person holding such a shareholding will be a suitable owner of the supervised institution in question.
III. Exclusion from voting based on the Civil Code
The meeting of the company's supreme decision-making body shall have a quorum if more than half of the votes that can be cast are represented by those entitled to vote.
If a member or founder is not eligible to vote on a particular matter, he or she shall be disregarded when determining the quorum for that decision (unless the articles of association provide otherwise) [Civil Code, Section 3:18(2)]. The quorum must be examined for each decision [Civil Code 3:18 (1)], and the result of this examination may therefore vary depending on whether there are members excluded from voting on a given issue and thus on the number of votes that can be cast.
Exclusion from voting may also result from financial sector regulations (bearing in mind that the MNB may suspend or temporarily prohibit the exercise of voting rights), but Section 3:19(2) of the Civil Code sets out general grounds for exclusion applicable to business associations. These include cases (e.g., point a), where the decision exempts the person concerned from liability, or point c), where the subject of the decision is the initiation of legal proceedings against the shareholder) where a potential conflict of interest between the member and the company seems easily identifiable.
Some of the cases referred to in Section 3:19(2) may also apply in situations where the member is affected by the outcome of the decision, but there is not necessarily a conflict between the interests of the company and those of the member concerned. (An analysis of the question of what can be considered to be in the interests of the company and to what extent the interests of the company can be separated from those of the owner(s) is beyond the scope of this paper, but it should be noted in parentheses that there is a considerable amount of literature on this subject.) A conflict between the interests of the owner and the company certainly arises when, as a result of the decision, a contract must be concluded with the member [case under point (b)] or with a company majority-owned by the member [case under point (c)]. This may occur, for example, in the event of legal succession, when the subject of the decision is, for example, a merger agreement to be concluded with the member concerned. In such cases, unless the application of the relevant rule has been excluded, the member with whom the merger agreement is to be concluded may not participate in the decision-making process (i.e., may not vote).
This means that only members who are not considered affected parties may participate in the decision-making process. In the above example, therefore, the merger can only take place if a sufficient majority of members who are not affected support the proposal. In a situation where the affected member has a share of more than 10% but less than 25% or 50%, this does not necessarily seem detrimental, but in the case of ownership ratios where the member excluded from voting holds more than 50% or even more than 75% of the votes, it may be disadvantageous. This is particularly true if the members who are not excluded from voting and thus make the decision are all persons who do not hold a qualifying holding in the votes, and therefore their persons and their influence in the institution have not been examined by the Supervisory Authority.
In such cases, the person(s) entitled to make (or at least prevent) a decision of fundamental importance to the institution are those in respect of whom the prudential guarantee controls required and deemed necessary by financial sector rules in relation to the management of a supervised institution do not apply. Therefore, in these decisions, the group of persons influencing the institution and the extent of their influence do not correspond to what is known to the Supervisory Authority and what the Supervisory Authority has found to be appropriate on the basis of previous investigations.
IV. Failure to take into account exclusion from voting in sectoral regulation
Sectoral legislation [e.g. Section 127(1) of the CFA] stipulate that, when determining the extent of a qualifying holding, voting rights shall be calculated on the basis of all shares to which voting rights are attached under the provisions of the company's articles of association, regardless of any restrictions on the exercise of voting rights.
This provision is fundamentally understandable, as neither the person seeking to acquire influence nor the Supervisory Authority can adapt to a dynamically changing situation (e.g., resulting from changes in the number of own shares).
In practice, it is also not feasible to require shareholders (who exceed the threshold only in special circumstances and only temporarily) to request supervisory approval to vote on issues on the agenda of the supreme body in which their shareholding suddenly and temporarily becomes a qualifying holding as a result of voting rights that differ from the general rule pursuant to Section 3:19(2) of the Civil Code. This could paralyze the operation of both the companies and the Supervisory Authority. It is understandable that sectoral rules do not impose such an obligation.
(It should be noted that, for example, the rules on company acquisitions applicable to public companies take into account situations where influence exceeding the level specified by law is acquired not as a direct result of the conduct of the person acquiring the influence, in which case the person with the increased influence is subject to a subsequent obligation to make an offer [See Section 68(2) of the CMA]. However, this case does not cover temporary shifts in voting rights arising only in connection with a specific decision, but rather situations where the shareholder's influence becomes permanently higher.
V. A possible solution – deviation from Section 3:19(2) of the Civil Code
Pursuant to Section 3:4(2) of the Civil Code, the members or founders of a legal entity may deviate from the rules of the Civil Code applicable to legal entities in their relations with each other and with the legal entity, as well as in the regulation of the organization and operation of the legal entity, with the exceptions set out in paragraph (3). Pursuant to Section 3:4(3), a deviation shall be considered a limitation if it clearly infringes upon the rights of the legal entity's creditors, employees, or minority members, or if it hinders the supervision of the legal entity's lawful operation.
The first question, therefore, is whether the exclusion or restriction of the applicability of Section 3:19(2) clearly violates the rights of the minority of members (or conflicts with any other obstacle specified in Section 3:4(3)), in which case the deviation would not be possible under Section 3:4(3)(b).
In this regard, legal practice is consistent: the rule set out in Section 3:19(2) of the Civil Code is dispositive, so deviation from it is possible. As explained in the "Comprehensive Commentary on Act V of 2013 on the Civil Code", "the Civil Code specifies certain cases in which a person who is otherwise entitled to vote may not exercise their voting rights. These are situations in which, due to personal interests, it cannot be expected that the member or founder will make a decision based solely on the interests of the legal entity, and therefore their participation in the vote would distort the result, and such votes would not be suitable for representing the will of the legal entity. […] The regulation of cases in which a member or founder may not exercise their voting rights aims to balance the relationship between the members or founders, or between a member or founder and the legal entity, and has no external effect. Therefore, if the members or founders can agree that voting rights may be exercised even when prohibited by the Civil Code, there is no reason to consider this agreement invalid."
This interpretation was confirmed by Assessment No. 25 of the National Conference of Civil Law College Heads held on 18–19 May 2015, which states that "the rule contained in Section 3:19(2) of the Civil Code is dispositive, and deviation is possible. The last two sentences of Section 3:19(3) only prescribe nullity in cases of deviation from the proportions necessary for decision-making or in matters requiring unanimity, not in cases of deviation from Section 3:19(2). Additional grounds for exclusion from voting not specified in this section may also be determined."
Therefore, if the aim is to ensure that persons authorized to acquire a qualifying holding under sectoral laws exercise influence over supervised institutions in all cases, or that decisions of the supreme body of the institution are made in accordance with the voting ratios resulting from the authorization of such persons to acquire holding, a possible solution is to deviate from Section 3:19(2) of the Civil Code by stipulating in the articles of association that certain specified cases shall not apply or shall apply to a limited extent to the decision-making of the supreme body.
If the founding document does not contain such an exclusionary or restrictive provision, the question may arise as to what decision can be made in this regard.
Since deviations from the rules contained in the Civil Code may only be made in the articles of association, the exclusion or restriction of the applicability of the provisions of Section 3:19(2) may only be effected by amending the articles of association.
Pursuant to the Civil Code, amendments to the articles of association – unless made by contract – shall be decided by the supreme body of the company by a majority of at least three quarters [Civil Code, Section 3:102(1)].
At the same time, according to Section 3:102(3), a unanimous decision by the supreme body is required if the amendment would adversely affect the rights of certain members or make their situation more burdensome. Members who do not otherwise have voting rights may also vote on this issue.
The question is therefore whether a decision to deviate from the provisions of Section 3:19(2) can be taken by a qualified majority or by unanimous decision. To decide this, it is necessary to examine whether the exclusion or restriction of the provisions of Section 3:19(2) would adversely affect the rights of individual members or make their situation more burdensome. The preliminary question is what rights individual members have and what their situation is when Section 3:19(2) applies.
Court practice is also not yet fully developed with regard to this issue.
According to one argument, the quasi-veto right that certain (small) shareholders gain as a result of the exclusion of the votes of shareholders who are excluded from voting (due to their increased relative voting ratio) is not a right to which the (small) shareholder in question is entitled, but always a possibility that depends on the given situation and voting ratios. In such a situation, neither the voting rights nor the (nominal) value of the votes of a shareholder change; the number of votes to which the shareholder is entitled remains the same, whether Section 3:19(2) applies or not. The fact that casting the same number of votes does not have the same consequences does not mean that this would adversely affect the shareholder's rights or that their position would become more burdensome.
However, there is a court ruling (see BDT2024. 4782) according to which members may decide only unanimously to deviate from the provisions of the Civil Code regarding the exclusion of a member of the company from participating in a given decision. According to the reasoning presented, "it is obvious that if all members can participate in the decision-making process, all members present can be counted when calculating the quorum, then the influence that minority members can exert on the decision is proportional to their voting rights. However, there may be situations where, due to the exclusion of the majority member from voting, the minority member is in a position to influence the decision and can decide on issues requiring a simple majority with his or her vote. […] There is no doubt that the [...] plaintiff's previous voting rights have not been revoked, and he may continue to exercise his 25 votes in the same manner as before. However, if the majority member is allowed to participate in the decision-making process in cases where he would otherwise be excluded under Section 3:19(2) of the Civil Code, and if he were excluded but had to be taken into account in calculating the quorum, the plaintiff would lose its existing right to decide in such a situation, i.e., the right to decide on the issue on the agenda." This court decision ruled that the minority member has a quasi-right to decide on the issue on the agenda in situations under Section 3:19(2) of the Civil Code. Questions may arise as to whether it was indeed the intention of the legislator that certain issues should be decided by the minority.
This approach is nuanced by the fact that the aforementioned Assessment 25 of the National Conference of Civil Law College Leaders held on 18-19 May 2015 also confirmed that Section 3:19(2) of the Civil Code allows for deviation, which provides the opportunity to specify further cases of exclusion from voting in the articles of association; according to the assessment, this is "a matter concerning the relationship between the members" which "provides not fewer but additional rights, that is why deviation is possible."
The question is therefore whether the potential influence that is not necessarily and permanently linked to the given share, but arises in an uncertain and occasional manner, the voting position of the minority member arising on a case-by-case basis under Section 3:19(2) of the Civil Code can be considered as a right of the given member (pursuant to Section 3:102(3) of the Civil Code) and thus, whether a deviation from the rule allowing for deviation within the meaning of the Civil Code would actually adversely affect the rights of the member in question.
If the answer to this question were yes, it would mean that any decision relating to the application of Section 3:19(2) of the Civil Code could only be made with the support of the minority, which would essentially give the minority a (temporary) veto right over the decision-making structure of the company.
In our opinion, it is reasonable to take into account the legislative intent behind the provisions of Section 3:19(2) of the Civil Code (i.e., the prevention of situations resulting in conflicts of interest) in a manner that is foreseeably justified and necessary in relation to the company concerned, but at the same time does not result in unnecessary distortion of control relationships – this may mean including specific, typical contractual subjects under the decision-making mechanism set out in Section 3:19(2), or even exempting pre-defined cases (such as the merger used as an example in this paper) from this regime.