Contributed by Konrád Siegler and Tamás Simon
What is work-out?
Instead of initiating enforcement proceedings, foreclosing on the security, or conducting judicially controlled insolvency proceedings, an alternative way to deal with financially troubled companies is a privately agreed reorganization, often referred to as work-out.
The main benefit of such procedure is that the debtor avoids (or at least deters) being labeled insolvent, formally bankrupt or in liquidation, and at the same time it enables the debtor to engage in negotiating a way out of its financial difficulties with its main creditors.
Also, because of the constraints on the effectiveness of Hungarian bankruptcy proceedings described in this series, almost all successful insolvency reorganizations in Hungary are carried out as private work-outs.
One of the notable successful out-of court insolvency reorganizations in Hungary involved NABI Rt., a Hungarian bus maker with subsidiaries in the UK and the US. The restructuring was implemented in several stages over a period of approximately two years and was completed in 2006. The creditors included a number of banks, financial institutions and trade creditors, and their aggregate claims exceeded $100 million. The restructuring was in part facilitated because the lenders and the noteholders agreed to apply the principles of the London Approach (and not take unilateral enforcement actions), and, following the sale of the UK subsidiary and the subsequent sale of the US subsidiary and the assets in the Hungarian entity to a private equity investor, the restructuring resulted in an relatively favorable return of the claims of the creditors.
The risk of a private deal
Although the Hungarian Bankruptcy Code does not recognize (or regulate) such procedures, there are, in principle, no legal obstacles to the debtor and its main creditors (e.g., banks and bondholders) negotiating and agreeing in a private contract the details of a reorganization plan that aims to rescue the debtor from insolvency. At the same time, it should be noted that, as with any private contract, it binds only the contracting creditors. Accordingly, privately agreed reorganizations may be frustrated if the non-participating or non-consenting creditors formally initiate liquidation proceedings.
Further, workouts have a similar “new money problem” as debtors attempting to reorganize in bankruptcy. Financing generally is not made available by creditors due to risks of equitable subordination and the lack of exceptions to the “challengeable transactions” rules.
Need for further legislative developments
The authors believe that the Hungarian insolvency regime should facilitate and encourage more effective bankruptcy reorganizations and out-of-court work-outs, as well as reduce incentives to initiate judicial procedures. Further, the Hungarian Bankruptcy Code – which has been in force, albeit with countless amendments, for 20 years – is ripe for a legislative overhaul. Although there are rumors that a new code is being prepared, no official proposal has been announced yet. Before such code is enacted, unfortunately, bankruptcy practitioners will have to live with, and navigate in, the existing difficult framework.
The only notable recent developments in this area have been (i) the adoption by the Hungarian Banking Association of a recommendation for a self-regulating model for dealing with companies in financial distress in May 2010 and (ii) an amendment to the Hungarian Bankruptcy Code which became effective in August 2011.
The recommendations, commonly referred to as the “Budapest Principles” (corresponding to the London Approach), is a voluntary code of conduct – banks signing up to the code agree to consider on a case-by-case basis whether the principles could be applied to a debtor in a specific case. If the affected banks agree to apply the principles, then the debtor is given a reasonable standstill period, during which the consenting creditors refrain from taking action against the debtor in order to facilitate reaching an out-of-court restructuring agreement during the work-out process. The application of the principles, which are based on voluntary cooperation between the creditors and the debtor, is aimed at avoiding bankruptcy, liquidation or foreclosure proceedings. So far, nine Hungarian banks (including the three largest) have signed up to the code.
Although the adoption of the Budapest Principles is a useful initiative, it would be desirable that more banks sign up. Also, because the application of the principles should be approved by the creditors in each specific case (i.e, the principles are not binding), it will be important that legislation further strengthens the incentives to avoid judicial procedures (which so far have very rarely been successful) and rules that facilitate the preservation of debtors and business that experience only temporary financial difficulties.
As mentioned in this series, the amendment to the Hungarian Bankruptcy Code seems to have clarified the previously unclear position of those creditors who do not register their claims with the bankruptcy administrator within the statutory deadline, in that they cannot enforce their claims subsequently unless liquidation proceedings are opened against the debtor.
In addition, the amendment implemented certain special rules applicable to the bankruptcy and liquidation proceedings of the companies which the Hungarian Government declares, on a case-by-case basis, to be exceptionally significant from the perspective of the national economy. The bankruptcy administrator or liquidator of such companies is a special, state-owned entity – the Hitelintézeti Felszámoló Nonprofit Kft., which was originally set up to administer the insolvency proceedings of banks and other financial institutions – and the stated purpose of the new rules is to ensure that the proceedings against such companies are quicker, more transparent and conducted in a more unified manner.
Although no proceedings conducted under these special rules by Hitelintézeti Felszámoló Nonprofit Kft. have been reported to date, it would certainly be a welcome development if the transparency and integrity of the insolvency proceedings were strengthened.