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The preparation and adoption of the annual accounts each year is an important step in the operation of a company as it clearly shows the results of the previous financial year. Act V of 2013 on the Civil Code (“Civil Code“) provides for a number of capital requirements and the obligation to intervene to remedy them for the purposes of protection of creditors. In our article below, we will examine the possible cases of undercapitalization and the legal solutions available, focusing on the rules governing limited liability companies.
Cases of undercapitalization
The Civil Code defines four cases, when the members are obliged to intervene and provide additional necessary funds or decide on appropriate restructuring of the capital structure. These are, in summary, the following:
- the company’s equity capital has fallen below the minimum amount of registered capital laid down by law
- an LLC can be established with a minimum registered capital of HUF 3 million, therefore this case arises if the equity capital is less than HUF 3 million
- the company’s equity capital has fallen to half of the registered capital due to losses
- with regard to the case of undercapitalization above, this can only arise if the registered capital exceeds the minimum amount, so for example its amount is HUF 10 million. In this case the members shall intervene, when the equity capital is HUF 5 million, or less
- the company is threatened with insolvency or has stopped making payments
- threat of insolvency is a situation where the directors of a company foresee, or with reasonable diligence should foresee, that the entity will not be able to meet its obligations as they fall due
- the company’s assets do not cover its debts
- this is the case when the company’s debts (e.g. debt, loans from members, other claims against the company) exceed the company’s total assets.
Obligation to intervene
In the event of undercapitalization, the Civil Code imposes specific obligations on both the managing director and the members.
The managing director shall without delay convene the members’ meeting (sole member) or initiate the decision of the general meeting without holding a meeting in order to take the necessary measures.
Members shall then decide on a solution to the situation and the adopted measures shall be implemented within 3 months. If the undercapitalization is due to the fact that the company’s equity capital dropped to half of the registered capital due to losses, and the members are unable to eliminate this within 3 month, the company’s registered capital must be reduced.
Possible actions by members
Members can remedy the cases of undercapitalization in several ways, as follows:
- supplementary payment
- in the event of authorization in the articles of association, the general meeting may impose a supplementary payment obligation on the members to cover losses
- in addition to the authorization, the articles of association must specify the maximum amount of supplementary payment that members may be required to pay, as well as the frequency with which such payments may be imposed. If these conditions are not met, supplementary payment may not be made even with the support of the general meeting
- in connection with the supplementary payment, it must be stated that its amount does not increase the financial contribution of the members. The supplementary payment may only be used to cover losses and, as a general rule, any unused supplementary payment shall be returned to the members
- reduction of capital
- in this case the members reduce the registered capital of the company, which entails a reduction in the member(s)’ business quotas;
- it is important to note that this can only happen if the original registered capital exceeds the minimum value of the registered capital set by law, i.e. HUF 3 million
- to provide equity capital by other means
- it is clear that, compared to the previous measures, this is an open option, i.e. it is not possible to define in a taxonomy exactly what actions may be appropriate in this regard;
- such possible solution for example: granting/cancelling loan by the members, assumption of (intra-group) debt from the company. However, it is also important to consider the tax implications of these possibilities
- transformation, merger, division and dissolution without legal succession
- if the members do not decide on supplementary payment, reduction of the capital, provision of equity by other means, the members must decide on transformation, merger, division or dissolution without legal succession
- of course, there is no obstacle to members taking such a decision immediately, if they so wish and if their other conditions for such decision are met
Summary
As can be seen from the above, there are a number of options available to restore the limited liability company’s capital position. Which of these options is the most appropriate cannot be generally determined, as it is always necessary to look at the specific company, its characteristics and the underlying causes of undercapitalization on a case-by-case basis, and to identify which measures offer a real long-term solution.
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