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Solutions to capital-related issues

24 July 2014

The deadline for the publication of the reports prepared by companies with 31 December as their balance sheet date will expire on 31 May 2014. Prior to that deadline companies will have to decide on the approval of the report, which, if a capital-related issue exists, may entail further measures to be taken. This is attributable to several reasons. First, pursuant to Section 3:133(2) of Act V of 2013 (the Civil Code), if, based on its report under the Accounting Act, a business undertaking fails to have equity in an amount equal to the amount of the mandatory subscribed capital stipulated for the corporate form of the company for two complete consecutive business years, and the members of the company fail to take measures to ensure that the requisite amount of equity is available within three months from the approval of the second year’s report under the Accounting Act, the company is obliged to take a decision on its transformation into another business undertaking or terminate without legal succession within sixty days from the expiry of the above deadline.

Furthermore, pursuant to Section 3:189 of the Civil Code, a limited liability company must also convene a members’ meeting immediately if the company’s equity decreases to half of its subscribed capital due to losses. In addition to the above, under Section 3:270 of the Civil Code, companies limited by shares also have to convene a general meeting if the company’s equity drops to two-thirds of its share capital as a result of losses.

Furthermore, pursuant to Section 13 of the Civil Code, limited liability companies which are already operational or under registration or, in respect of which registration of a modification is in progress as at the effective date of the Civil Code and whose subscribed capital is below HUF 3 million are obliged to raise their subscribed capital to HUF 3 million set as a minimum capital requirement. Pursuant to Section 12 of the Civil Code, the companies concerned are obliged to supplement their capital concurrently with the first amendment to their memorandum of association. The deadline for that is 15 March 2016 for limited liability companies, which have to adopt an owner’s decision to that effect by that date at the latest. In a situation like this, one of the possible solutions is recapitalisation. Alternatively, companies may decide to change their corporate form and select one the capital requirement of which they can fulfil.

This newsletter addresses the issue of recapitalisation and possible other solutions for reaching the minimum requirement set for the statutory amount of equity in respect of limited liability companies. Our solutions provide help in terms of form rather than content.

  1. Capital increase by cash contribution

The most basic method of solving the issue of the minimum required capital is when the owners of a company decide to raise subscribed capital. In this case, the entire amount paid is registered as subscribed capital and is made available to the company with any obligation of repayment. As regards accounting, the statement of the amount as registered capital in the accounts falls due upon its registration by the Companies Court.

 

  1. Capital increase by share premium

In this case, owners decide on both a registered capital increase by cash contribution and an increase in the capital reserves. This method is suitable in the case of negative equity and can also help restore the equity-to-subscribed capital ratio.

 

  1. Additional payment

It is a scenario under which owners make the amount paid available to the company only temporarily. Additional payments may only be accounted on cash basis. The total amount of the additional payment is recognised against tied up reserves. However, the probability of using this as a solution to capital-related issues must be clearly indicated in the company’s founder resolution. Additional payments are charged to the parent company’s retained earnings, therefore, it is important to ensure that an additional payment does not give rise to a capital-related issue for the parent company.

 

  1. Reduction in the subscribed capital

Under this scenario, subscribed capital is reduced against the capital reserves or the retained earnings, in the course of which the amount of the company’s equity remains unchanged. Only its capital structure changes. Although this option does not resolve the issue of inadequate capital, it can be of great help with the restoration of the equity-to-subscribed capital ratio. When opting for this method, however, the minimum amount of subscribed capital should be borne in mind. Furthermore, a reduction in the subscribed capital may also lead to difficulty in securing bank loans.

 

  1. Capital increase by contribution in kind

This is a form of capital increase where the parent company makes its claims against the company available to the subsidiary as contribution in kind. Contributions in kind may range from a loan from the parent company to accounts payable to the parent company. Furthermore, a dividend payment obligation may also increase the company’ equity in the form of contribution in kind.

 

  1. Increase in the subscribed capital from the company’s own resources

Another possible solution for complying with the minimum capital requirement is when the company includes its capital reserves or retained earnings in the subscribed capital, i.e. its assets in excess of the subscribed capital. In this case, however, the company must ensure that after the resolution of its capital-related issue, the amount of the equity less tied up reserves and valuation reserves does not drop below the amount of the subscribed capital and that committed reserves are set aside in respect of the amount to be recapitalised in the period between the date of the resolution and that of the registration by the Companies Court.

 

  1. Value adjustments

If, in its accounting policy, the company decides to apply value adjustment and the book value of the assets available for valuation is substantially below the current market value, capital may be increased by value adjustment. By making adjustments to the current market value, the company uses its valuation reserves stated as part of its equity to increase the amount of its equity, thereby resolving the issue of the minimum amount of equity. If, however, the company decides to use this solution, it will also have to make value adjustments in the years following the current one, which entails having to make regular estimates.

 

  1. Liabilities to the owner

An indirect, albeit appropriate, solution to capital-related issues is when owners waive their claims from the company. Such debt relief is recognised as extraordinary income by the subsidiary. This solution both improves the current year’s profit and solves the issue of capital. However, this method does not work in the long run. The company has to find further solutions for permanently settling the issue of capital.

 

In the case of owners’ decisions it is important that the selected method be enshrined in a resolution lest claims as contributions in kind should qualify as claims waived or authorities should interpret supplementary payments as funds provided without any obligation of repayment.