Hungary: Participation In Hungarian Privatization

Last Updated: 25 June 1997
1. MAIN CHARACTERS OF THE PRIVATIZATION IN HUNGARY

The year of 1992 was a milestone in the course of Hungarian Privatisation. The state-owned companies, as well as cooperatives were given the opportunity by legislation to get transformed into corporations. Now this transformation process have been completed, the state-owned companies have been transformed into mainly joint-stock corporations, but to limited liability companies as well. In 1995, with the coming into force of the Act On the Sale of State- Owned Entrepreneurial Assets, a new phase opened in the privatization. Now it is not transformational, but fully a privatization carried out by the sale of assets, which means that mainly company shares and stakes, but, to a smaller proportion, other assets such as estates, machinery, etc. are sold to market participants. The organization whose prime task is the sale of state-owned assets is the State Privatization and Holding Company Ltd ( APV Rt.), set up by the mentioned Act in 1995. Normally, a privatization contract is concluded in the form of a sales contract, in the case of which the consideration is cash , while in exceptional cases can the consideration be capital investment, assuming employment obligation, etc.

The property of state-owned assets can be acquired by almost all market participants, including all foreign persons: private persons and legal entities, even corporations owned fully or partly by foreign states or state budget-financed institutions.

2. THE SELLING PROCEDURES

APV Rt. is entitled to sell its assets directly, or through the institutions of the capital market: it can commission stockbroker firms to sell the assets, or can sell through investment funds. Furthermore, APV Rt. can charge the senior officials of the companies belonging to it with selling the assets, in order to fasten the procedure of privatization.

This latter technique is called simplified privatization. There is another kind of state-owned assets that the law defines as assets transferred to APV Rt. These assets also face privatization. The mentioned assets can be sold through processes of competition: through public or exclusive offer, through public auction, and through public bid. However, the law entitles APV Rt. to sell without competition, in exceptional cases described hereinafter.

2.1. Competition

2.1.1. Tenders

Competition that is open to public is normally the way of privatization in Hungary. Tenders are invited by APV Rt. or the appointed property seller. The announcement containing the main details of the company is published in two national newspapers, or, in one national newspaper, and one local newspaper published in the region where the head office of the company in question is located, furthermore, in the public information brochure of APV Rt. at least 30 days prior to the initial date set for the submission of the tender. The investors may get a detailed information brochure following the signature of the declaration of secrecy.

Exclusive tenders may only be invited in exceptional cases: when the circle of bidders can be determined in advance, the seller invites some bidders exclusively. However, in this case, the fact of the inquiry shall be published in the same way as in the case of public tenders.

2.1.2. Evaluation Of Bids

As a general rule, the sales contract shall be concluded with the party submitting the most favorable bid, considering all points of judgement. The following criteria shall be considered when evaluating bids:

  • increase in the efficiency of management, reduction of the shortage of capital in the economy, provision of capital increase required, acquisition of advanced techniques on international level, as well as management and marketing experience, preventing loss of markets and acquisition of new markets;
  • stimulation of economic restructuring, promotion of the rejuvenation of the organizational system of companies, reasonable decentralization of structures hindering competition and widening the sphere of participants in the market;
  • development of the domestic capital market, organized involvement of the domestic and international capital through investment funds and companies;
  • maintaining and strengthening the interest of foreign investors in privatization, with a particular regard to strategic (professional) investors;
  • support of the acquisition of assets by the domestic entrepreneurs, suppliers and raw material producers, with a particular regard to agriculture and the food industry; provision of domestic producers and industrial protection in accordance with international agreements;
  • maintenance of working places, creation of working places and enforcement of employees' social considerations;
  • promotion of acquisition of assets by employees and buy-out by managers;
  • maintenance of the operational ability of economic associations, use of privatization revenues, financial stability, development of the production structure and technology, reorganization, reduction of environmental losses and burdens, and increase in exports.

From among these considerations, APV Rt. or its representative shall indicate, in advance, in the course of advertising the privatization tender, the particular, individual considerations the realization of which is expected from the given privatization transaction.

In the case of purchases, the buyer can offer payment conditions for the settlement of the purchase price in ways that avoid prompt payment in cash. When such bids trying to obtain a so called preferential privatization technique, are compared with bids offering prompt payment, the evaluation shall take into account the revenues expected on the basis of their real market value (present value) at the time of the decision. In the case of bids of equal value, the bids of domestic investor(s) shall be granted preference.

2.2. Procedures Without Competition

Although competition is a main principle in privatization, there are cases in which techniques that are faster and cheaper are more rational:

  • in the case of the public sale of shares of the companies limited by shares established for the purpose of the management of portfolio packages, this is the case when the shares of such companies are publicly offered at the Stock Exchange, or in another way,
  • in the case of commissions given with regard to exclusive placement and sale at the Stock Exchange;
  • in the case of share exchanges;
  • in the case of making available company shares as non-cash contribution to specified economic associations and investment funds; these economic associations are established by APV Rt. for the purpose of promoting privatization,
  • if state assets are sold by APV Rt. to employees up to the preferential extent defined by law;
  • if APV Rt. (or its legal predecessor) granted an option for (an) external investor(s),
  • in other exceptional cases defined by law.

2.3. Selling Minority Shares

The minority shares remaining after the sale of majority shares, as a general rule, may be sold through auctions or public offerings, or by exclusive placement, because, according to international experience selling minority shares through competition is not rational, taking into account the exclusive rights of majority share-owners.

3. PREFERENTIAL PRIVATIZATION TECHNIQUES

3.1. The Techniques And Their General Rules

In the tender published, which is the most frequent way of selling, it shall be stated what preferential privatization techniques can be granted. There are two such techniques that may draw the attention of foreign investors: sale with payment by instalments, and sale with the reservation of ownership right (privatization lease). The law stipulates, that the tenders submitted by the application of these preferential privatization techniques may only be judged, if no valid bid reaching or exceeding the limit price fixed by APV Rt., aiming at the payment in cash of the total consideration within 60 days reckoned from the conclusion of the contract has been received. However, in some cases an application for a preferential technique may be granted the right of way, because in the course of the judgement of the tenders, and/or the individual bids, the obligations undertaken by the bidder in respect of reorganization, capital increase, technical development, restructuring and employment policy, income and social provision of employees, furthermore, in respect of reducing environmental damage or burdens shall be taken into consideration with special emphasis. The appropriate enforceability of such undertakings shall be facilitated by special guarantees necessarily stipulated in the sales contract. Naturally, if a bid promising payment in one lump-sum also corresponds to the special conditions mentioned here, it must be granted preference, for the disadvantage of bids applying for a longer period for the settlement of the purchase price.

3.1.1. Transfer Of Assets Without Pecuniary Compensation

APV Rt. may transfer the assets without any pecuniary compensation to the buyer who assumes the obligations mentioned in the above paragraph, with the stipulation of adequate guarantees. Also. if the handover takes place, in accordance with the Act, to a public foundation, public purpose foundation, public body, furthermore, to any other public purpose societies, which take over the performance of public duties defined in legal rules, and/or replace the undertaking of obligations by the budget, or , the 'free transfer' can take place in any other cases defined in the Annual Budget Act. As our privatization is based on selling, these transfers may only take place in exceptionally justified cases.

3.2. Sale With Payment By Instalment

Sale with payment by instalment is a sort of sale in which cash payment is delayed. In the case of such privatization contract the full ownership right of the asset shall pass to the buyer with the payment of the first instalment. The seller cannot reserve its ownership right, however, a contractual auxiliary obligation must be stipulated, or/and the seller can reserve shares or company positions that provide exclusive decision-making rights in the company.

The benefit to pay by instalments may be granted for a period of up to fifteen years. Upon the request of the buyer, a grace period may be established for the payment of instalments, with the exception of the first instalment. The grace period shall be at least one year, but cannot be more than three years. During this period only interests and a service charge shall be paid. The first instalment shall become due on the thirtieth day reckoned from the conclusion of the sales contract. The measure of the interest may not be less than 50% of the base rate of the central bank. The payment of instalments fulfilled by the buyer may be spent first on the service charge that has become due at the time of the settlement, secondly on the interest, and finally on the principal.

The buyer shall be entitled any time to honor its obligation to pay by instalments in one lump-sum in cash, or, during the period of the benefit to pay by instalments , the buyer shall have the right to speed up payment of instalments at any time.

In the case of a default on the payment of any of the instalments, the buyer shall lose the benefit to pay by instalments, and the full outstanding purchase price shall become due in one lump-sum. Should the buyer fail to observe the deadline for the payment as defined in the contract, it shall pay a default interest, calculated from the first day beyond the deadline, corresponding to twice the amount of the prevailing base rate of the central bank.

If the buyer fails to perform its payment obligation by the deadline, unless it pays the outstanding purchase price in one lump-sum within 15 days reckoned from the due date, the seller shall be entitled either to withdraw from the contract, or to terminate the contract by notice, according to its choice. The seller may withdraw from the contract even if a decrease in the value of the equity, calculated on the basis of the provisions of the Act on Accounting, exceeds 30% in the course of the term.

3.3. Sale With Reservation Of Ownership Right (Privatization Lease)

The central object of this technique is to provide the opportunity to sell corporations whose profitability is low, but which can turn profitable by efficient management and operation. The buyer provides the source for settling the purchase price from the surplus return on sale attained through the improvement of the company management.

There are three parties in such construction: the seller, here as lessor, the company, and the lessee. The relationship between the lessor and lessee is governed by the privatization lease contract. On the other hand, the relationship between the company and the lessee is governed by a contract of management-organization service, grounded on which the lessee receives a fee that must be spent on the payment of instalments. This is the most favorable character of the technique, that the buyer can extract the purchase price from the company itself. It is also beneficial, that the fee is accounted for at the company as extraordinary expenditure, thus it will be a writing-off tax allowance.

In order to reduce the risk to the seller, the buyer shall undertake a guarantee proportional to the fee, of a measure defined in the tender or in another way determined by the seller. Also beneficial is that this guarantee is just a small proportion of the assumed lease fee.

The seller transfers its company share also while reserving its ownership rights. In fact, this is a sales contract with the reservation of ownership, with a delay in the consignment of property rights. During the course of deferring, as mentioned earlier, the buyer provides management and organization services aimed at the reorganization of the company, on the basis of a separate contract. The period of the deferred alienation (hereinafter: term) may be 10 years at most, the concrete length of which shall be specified in the contract. By the payment of the full amount of the fee, the company share shall pass into the ownership of the buyer without separate compensation or separate agreement.

The lessee can react to the change in the entrepreneurial conditions in a flexible way. If the company's profitability is higher than expected, a higher fee for management service can be accounted for, thus, upon the decision of the lessee, the payment of instalments can be speeded up, or, afterwards, slowed down. The outstanding lease fee can be paid in one lump-sum, or instalments can be paid earlier, if there is an external source provided for the lessee.

Taking into account the significant benefits as to this construction, the buyer may only be a natural person. In the case of several buyers, their relationship among one another may be regulated by a separate civil law contract, which will not give legal entity to the community of buyers, and will not restrict their liabilities assumed in the lease contract towards third persons.

In each case, a public tender shall be invited for the sale of assets by privatization lease contract.

During the term, the equity of the company as shown in the balance-sheet certified by the auditor thereof may not decrease below the value specified in the contract.

In the case of failure of amortisation or loss of assets as defined before wards, or the absence of a certified balance-sheet, the seller shall be entitled to terminate the contract by notice with immediate effect, and to assert its right of disposal with regard to the guarantee.

In the case of termination by notice, the buyer may not assert any claim for assets concerning the company share or any other claim against the seller and/or the company, not even the already paid instalment of the lease fee shall be due back to the buyer.

3.4. Other Preferential Privatization Techniques

The law provides for the acquisition of state-owned assets through buy-outs by executives and employees of the company to be privatised, the benefits of employee's property acquisition, furthermore, a so called Existence Credit can be granted for domestic natural persons, and to corporations consisting of such persons. The term domestic person is not determined by citizenship, but by the legal rules regarding foreign exchange.

4. PROPERTY MANAGEMENT

4.1. General Rules

The first preference task of APV Rt. is the sale of state-owned assets. However, the sale of these assets is a long-term process, and if the assets cannot be sold, a proper management of the property temporarily remaining in the hand of the State should be provided. Should the sale of an asset have failed or if it can be established that the conditions for the alienation are temporarily unfavourable, APV Rt. shall be entitled to conclude property management contracts in the interest of the utilisation of the asset. The goal of property management is to maintain or reach the property value defined in the contract, or to attain an increase in assets through returns (dividends, profit-sharing). For the management of property, APV Rt. shall conclude contracts, the content of which the parties are free to establish, within the framework of the Act on Privatisation.

In the contracts aimed at property management, APV Rt. may transfer part or the whole of the proprietary entitlements due to it to the property manager. The extent of property rights transferred depends mainly on the type of the property management contract.

The fulfilment of the obligations undertaken in the contract concluded for the management of the property shall be ensured by auxiliary obligations that guarantee the contract and burden the own assets of the property manager (e.g. lien, security deposit, surety ship). The guarantees may also be applied jointly. No property management contract may be concluded with a party against whom liquidation proceedings are pending, and/or who has outstanding tax, customs duty or social insurance liabilities.

Before the conclusion of each contract, a tender must be invited. The contract may only be concluded with a person or an organization, who or which has adequate knowledge of the Hungarian privatization, economy, capital market , as well as business and finance regulations. The property manager shall fulfil its obligation with enhanced care and competency.

In case the proprietary entitlements over the assets are transferred, APV Rt. shall monitor the activity of the property manager on a regular basis. In the case of a serious breach of contract by the property manager, or if it hinders the controlling activity of APV Rt., APV Rt. may terminate the contract by notice with immediate effect.

4.2. Certain Types Of Property Management Contracts

4.2.1. Contract Of Agency

The most simple form of property management contracts regulate the management of properties whose profitability is doubtful, thus the goal can only be the preservation of their values. The contract is concluded in order to preserve the property's value or condition.

The property manager, as agent is entitled to a fee, but APV Rt. and the agent may agree that a specified portion of the returns on the property shall also be due to the property manager, because it is not excluded, that the corporation will have profit in spite of the unfavourable conditions.

4.2.2. Contract For Work, Labor And Material

In the case of profitable companies with good market positions a specified result can be required from the property manager. Thus APV Rt. concludes a contract for work, labor and material, which does not only require acting with due diligence, but establishes an obligation for providing result (specified returns, increase in property, avoiding specified decrease) from the side of the property manager. The contractor in consideration receives a remuneration stipulated in the contract.

In such a contract , the contractor shall exercise the proprietary rights over the asset, except for the right of alienation and encumbrance.

APV Rt. and the contractor may agree that APV Rt. cedes a portion of the returns to the contractor, however, the possibility thereof shall be referred to among the clauses governing the tender and in the contract.

4.2.3. Portfolio Property Management Contracts

In this case the contractor excersises the full property rights including the right of alienation, on the other hand assumes the obligation to attain the returns or increase in the assets specified in the contract. Within this framework, the contract may be aimed at the payment of a specified amount of cash or the acquisition of membership rights in other companies. The central point in this contract is that the increase in assets must not necessarily be in regard with the part of property consigned, but the contractor may sell it, exchange it, with the only obligation to return a property of higher value to APV Rt.

APV Rt. and the contracting party may agree on the apportionment of the returns or the increase in asset value; however, the possibility thereof shall be referred to among the clauses governing the tender and in the contract.

4.3. Privatisation On The Basis Of A Property Management Contract

The property manager can buy the assets it manages according to the regulations of law and the contract.

The information in this newsletter is correct to the best of our knowledge and belief at the time of going to public. It contains only basic information and specific advice should be sought, however, before investment and other decisions are made.

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