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Directors’ Liability in Hungary

28-10-2014
 
Article by Ákos Menyhei
 

Although Hungary has not yet ratified The Hague Convention on Trust, the Hungarian International Private Law Act recognizes trusts as a foreign legal solution and directs one to apply the foreign regulation in legal disputes in the case of a lack of similar Hungarian solutions. In relation to the recognition of foreign trusts in Hungary, there is no known case and if there were it would have no bearing on other cases; nevertheless, some Hungarian lawyers use foreign trusts as participation owners in company structures. The recognition of trusts is uncertain in real estate ownership registration as well; therefore, the Hungarian practitioners try to avoid this kind of uncertainty by solving the problem firstly by registering a holding company owned by the trust, then secondly, acquiring the real estate by the holding company. The real challenge for the trusts is distribution in Hungary, as the current tax regime treats it as ‘other income’ and levies the flat rate of 16% personal income tax and 27% health insurance contribution, which is very disadvantageous compared to income from dividend distribution as that is exempted from the extra health insurance surcharge.
 
In March 2013, the Hungarian Parliament – though the Hungarian legal system is strongly influenced by the German legal system – implemented the trust to the Civil Code, which is far from the German legal approach, but very British. The regulation of trusts is part of the new Hungarian Civil Code, which after more than 20 years work will be in force from 15 March 2014. This legislative decision has opened a new dynamism to estate planning and protection practice, as the practitioners may start to use Hungary’s own estate planning tools, having the legal certainty of the trust’s recognition and treatment. The new challenge will be to find a good compromise to promote this estate-planning tool and provide fair taxation at a personal level upon distribution from the trust.
 
Due to the lack of judicial and practice precedence regarding the Hungarian trust, the main features of the framework can be summarized as follows without any reference to practice precedence. Time will decide whether this Anglo-Saxon legal phenomenon could be integrated to a Roman law based continental system. At least practitioners might say it is an interesting experiment; nevertheless there is a good chance indeed to find the new framework’s place in the continental European legal systems and provide an example to other continental countries.
 
The creation of the trust follows the classical rules as the framework requires a written trust deed – there is no distinction between the trust deed and trust settlement – which includes the appointment of the trustee, the identification of the settlor, the description of the managed assets and the ownership transfer. The definition of the trust provides that the ownership is transferred to the trustee for the benefit of the beneficiary. This regulatory approach is revolutionary new in the civil law based Hungarian legal regime, because it previously wasn’t possible to separate the ownership in such a way, therefore creating legal and equity owners.
 
The legal definition of the beneficiary provides that the settlor must determine the identity of the beneficiary, and the conditions of the commencement and termination of entitlement of beneficiary. The beneficiary may be described by the reference to the scope of the beneficiaries, providing power to the trustee to define the proportion of the beneficiaries creating possibilities to set up discretionary trusts as well.
 
The settlor may appoint the beneficiary, or the scope of beneficiaries, and dispose of the conditions for the managed assets’ distribution. The settlor may dispose that the managed assets must be transferred back to the settlor or to the settlor’s heirs or to a third person wholly or partially by the occurrence of any specified conditions, or after a specified period of time. Following the classical rules, the appointment of the trustee to be beneficiary is invalid. However, the settlor and the trustee may be the same person but in this case the trust must be created by irrevocable statement of the settlor registered in a public document. Creating a testamentary trust is possible as well. For the validity of the testamentary trust the acceptance of the appointment by the trustee is required. The trust may be created for a definite or an indefinite period of time but not longer then 50 years.
 
In creating legal certainty regarding the managed assets, there are strict rules for the separation of the managed assets from the trustee’s own assets. This separation provides rules in two directions as the managed assets must be separated from the personal assets of the trustee and other assets managed by the trustee, which shall be separately recorded and registered by the trustee. The regulation contains further detailed rules regarding the separation and its administration.
 
The rules of the managed assets’ protection are clear, aiming to provide legal guarantees for the complete asset separation, as the trustee’s spouse, registered partner, creditors, and the creditors of any other assets managed by the trustee cannot lay any claim against the assets held in the trust, and the managed assets do not belong to the inheritance of the trustee.
 
From a civil law perspective the rules of the beneficiary’s and its creditors’ claim are understandable and these rules follow the consistent asset separation created by the trust. The regulation of the beneficiary’s possible claims follows the classical trust examples as the beneficiary may request the trustee to distribute the managed assets and the profit in accordance with the trust deed. The beneficiary’s creditors may enforce a claim against the trust assets only after the due date of the assets’ or profits’ distribution for the beneficiary.
 
Creating a clear separation between the settlor’s and the beneficiary’s assets from a management and an administration perspective as well, the beneficiary and the settlor are not allowed to give any instructions to the trustee; nevertheless, the settlor and the beneficiary may control the activity of the trustee in respect of the trust.
 
An ancient Roman Law rule – bonus et diligens pater familias - has been implemented to the framework extending the trustee’s obligation as the trustee is obliged to protect the managed assets from the predictable immediate risks in compliance with commercial rationality. Moreover, in accordance with the fiduciary requirements of the trust, the trustee must act primarily for the benefit of the beneficiary’s interests. The trustee is liable as well for the managed assets’ damages caused by breaching the obligations towards the settlor or the beneficiary according to the general rules of liability for damages. The framework provides rules for the liability of the trustee towards third persons as well. First of all, the trustee is liable with the managed assets for the fulfillment of the obligations; secondly, the trustee has unlimited liability with its personal assets for the fulfillment of the claims obligating the managed assets, if they are not satisfied from the managed assets, and the third party could not, and did not need to know the commitment of the trustee spread beyond the managed assets.
 
The framework provides broad rights to the trustee disposing of the managed assets as the trustee has the rights to exercise the managed assets’ ownership to a large extent; however, the trustee is obliged to dispose of the managed assets according to the conditions and restrictions of the trust deed. Balancing between the trustee’s rights and the settlor’s and beneficiary’s interest, there are rules to protect the last two’s interest against the trustee’s breach of obligations.
 
Surely, the FATF – Financial Action Task Force - won’t be keen to realize that lawyers’ confidentiality obligation is extended to the trustees as well; nevertheless this legislative decision provides protection to confidential information in connection to the trust similar to attorneys’ broad obligations, as the trustee is obliged to keep confidential all information acquired in connection with the trust. This obligation is independent from the establishment of the trust and exists after the termination of the trust, as well. The obligation is relevant for two reasons. Firstly, the settlor and his or her successor may grant an exemption from trustee’s confidentiality. Secondly, in connection with the anti-money laundering rules, in the case of defined but limited scope of suspicious transactions the trustee is obliged to report the transaction to the competent authority.
 
The accounting and information providing rules protect the settlor’s and the beneficiary’s interest obligating the trustee to inform the settlor and the beneficiary about the managed assets upon their request, providing information about the actual and expected enrichment of the managed assets, properties of the managed assets, the value of the managed assets, and the commitments in connection with the managed assets. The trustee must keep appropriate accounting books about the managed assets.
 
The settlor may appoint more than one trustee simultaneously, providing the opportunity for team decision making, as in this case, the trustees must act and decide jointly. This solution provides the possibility to foreign settlors to appoint a local trustee and a trustee from his or her own jurisdiction, achieving a higher level of control and protection for the trust’s operation. In the case of joint trustees, their liability is joint and several for the decisions adopted jointly.
 
During the life of the settlor, his or her power regarding control of the trust remains intact as the settlor is entitled to recall the trustee by appointing simultaneously another trustee. However, if the settlor dies or its corporate existence is terminated and the managed assets have no other settlor, this right is transferred to the judicial system, providing stability and further control for the trust. In this case, the court is entitled to recall the trustee upon the request of the beneficiary by appointing simultaneously another trustee, if the trustee has breached the trust deed seriously. If more than one beneficiaries are entitled to exercise this right jointly, under the request of any of them the court is entitled to decide the termination of the trust or the appointment of the new trustee or both. The court is not allowed to appoint a person to be the trustee, if all the beneficiaries protest against the person.
 
The rules of the trust’s termination follow the direction to secure the distribution, in the case of expiration of the trust or termination of the trust contract. The trust must be deemed to be terminated if the managed assets run out; or if the expiration time passes or if the trustee terminates the trust with three-month notice. In the latter case, the trust is deemed to be terminated only if the managed assets have no trustee for more than three months, or if the settlor dies and the settlor was the sole beneficiary. Nevertheless, the trust does not expire if the settlor becomes the successor of the trustee, neither by the death or termination of corporate existence of the settlor, the trustee or the beneficiary.
 
In the case of termination of the trust, first of all, the trustee is obliged to inform the settlor and then provide an appropriate accounting of the managed assets. If the termination of the trust endangers the managed assets, the trustee is obligated take the necessary measures in connection with the managed assets to protect it.
 
The trustee is obligated to transfer the managed assets together with their obligations after the termination of the trust to the new trustee appointed by the settlor or in the absence of a trustee to the settlor. The same procedure is applicable in the case of the termination of corporate existence of the trustee. In the case of having more than one settlor, the settlors are entitled to the distributed assets in the proportion of their original contribution and they are liable in the same proportion for the obligations of the managed assets. The same rules are applicable in the case if the trust deed disposes due to the transfer of the assets in the form of succession of the trustee.
 
Last but not least, there are rules securing the trustees’ fee, providing that the trustee is entitled to satisfy the claims for fees or justified costs directly from the trust assets. The trustee may claim reasonable remuneration and costs, as well if the trustee carries out its activity free of charge.
 
Dr. Ákos Menyhei TEP
Managing partner of H&M Trust LLC and
Senior partner of H&M Legal – Hajdu and Menyhei Attorneys at Law
Chairman of STEP Hungary
 
H&M LEGAL
Ákos Menyhei
Petofi Sándor utca 11. IV/18
1052 Budapest
+36 1 318 1546