Reform of the Hungarian Law of Security Rights in Movable Property

Author:Norbert Csizmazia
Position:Lecturer, Eötvös Loránd University

1. Introduction - 2. The reforms of 1996 and 2000 - 2.1. Validation of non-possessory charge over tangibles and establishment of a charges register - 2.2. Abolition of the notification requirement in case of a charge over receivables - 2.3. Departure from the principle of specificity - 2.4. Introduction of the enterprise charge - 2.5. Introduction of extrajudicial enforcement mechanisms - 2.6.... (see full summary)


Norbert Csizmazia1

Lecturer, Eötvös Loránd University

Reform of the Hungarian Law of Security Rights in Movable Property

1. Introduction

The Hungarian law of proprietary security rights - contained in the Civil Code 2 - has undergone two major reforms since the transition to a market economy, the first taking place in 1996 and the second in 20003. A third, minor revision of the Civil Code's provisions on security rights was undertaken in 2004, due to the transposition of the European directive on financial collateral arrangements4.

A third - or fourth, depending on one's view - reform is forthcoming, as Hungary is on the way to adopting a new civil code in the very near future. It was in 1998 that the Government decided to undertake a comprehensive re-codification of Hungarian civil law and set up a commission with the mandate of drafting a new code5. In co-operation with the Ministry of Justice, the commission, chaired by Professor Lajos Vékás, produced its draft in 2006 (known as the Commission Draft)6. The commission was about to finalise a second, revised draft, on the basis of the comments received, when the Ministry of Justice unexpectedly terminated its mandate in September 2007. The Ministry of Justice published a revised draft in October 2007 (referred to as the First Ministry Draft). Professor Vékás and a group of experts - many of whom also contributed to the Commission Draft from 2006 - published a draft in March 2008 (called the Expert Draft)7. Almost simultaneously, the Ministry of Justice published a new draft (the Second Ministry Draft)8. The Second Ministry Draft was again revised, and, on 28 May 2008, the Cabinet approved the final version of the draft, which was introduced to Parliament as the bill on the new civil code on 5 June 20089. The Government expects the bill to receive the approval of Parliament by the end of 2008 and enter into force in 2010, a full 50 years after the entry into force of the current Civil Code.

This article presents and evaluates the post-transition reform of Hungarian secured transactions law and examines the impact that the wholesale reform of Hungarian civil law will have on this body of law.

Two preliminary remarks need to be made:

First, the regime of proprietary security rights as regulated in the Civil Code applies without regard to the status of the debtor and the creditor; i.e., there is no separate set of rules for company security interests and security interests created by unincorporated businesses or individuals. Likewise, the transposition of the financial collateral directive into Hungarian law made the rules of the directive applicable to all financial collateral arrangements, without regard to the status of the debtor and the creditor. There is only one form of security right that is not available to all debtors: the enterprise charge, which can only be taken over the patrimony of a company or other legal person.

Second, it is important to note that, although this article focuses on security rights in movables, the division between the law relating to immovables (real property) and the law governing personal property is not as deep as in some other jurisdictions. The rules on real and personal property law can be found in the same book of the Civil Code (although there is a separate statute on the land register), with the rules on security rights in immovables and movables under the same title. Both the current Civil Code and the bill on the new civil code contain a considerable number of common rules applicable to all security rights, regardless of the movable or immovable nature of the collateral. Differentiation, where necessary, is made on the level of particular provisions.

2. The reforms of 1996 and 2000

The pre-transition Hungarian law of proprietary security rights focused on immovables10. The primary aim of the 1996 and 2000 reforms was to provide a legal framework by which movables can be utilised efficiently as collateral. The main source of inspiration for the reform was the Model Law of Secured Transactions (1994) elaborated by the European Bank for Reconstruction and Development (EBRD)11. It was on the basis of this Model Law that a charges register was established and two new types of charge were introduced into Hungarian law: the registered non-possessory charge over tangible (corporeal) movables and the 'enterprise charge'12. By introducing these forms of security interests, the Hungarian legislator borrowed concepts and ideas from North American and English law, albeit only indirectly, through the filter of the EBRD Model Law13.

Prior to the reforms, two types of charge were available in respect of tangible movables: the pledge and the so-called 'charge securing a bank loan'. The pledge requires transfer of possession to the creditor; therefore, it does not allow enterprises to raise financing against their equipment or inventory. The 'charge securing a bank loan' was free from this disadvantage. This special device was created by the socialist Civil Code of 195914. It could be created over tangible movables without transfer of possession to the creditor or any alternative form of publicity, but only to secure a bank loan. According to the Official Commentary to the 1959 Civil Code, the drafters' intention was to allow for the extension of bank credit against a shifting pool of assets, particularly against inventory15. With the development of the credit market and the switch to a two-tier banking system in 1987, this special form of charge became untenable: it amounted to positive discrimination in favour of the banks, and, more importantly, the lack of publicity discouraged even lending by banks as soon as commercial banks appeared on the playing field16.

Similarly, prior to the reforms, a charge over a receivable 17 required notification of the debtor and transfer of any document relating to the encumbered receivable to the creditor. Thus, future receivables were incapable of being used as collateral and the creation of a charge over a multitude of receivables was also cumbersome.

The pre-reform Hungarian law of secured transactions resembled very much the German law on pledges and hypothecs as codified in the German Civil Code of 1900. Apart from the exceptional 'charge securing a bank loan', non-possessory security interest could be granted exclusively over immovables.

There were two ways to overcome the rigidity of the system: to validate hidden security rights (i.e., fiduciary transfer of ownership and fiduciary assignment for purposes of security 18 ) or to introduce an alternative technique of publicity replacing dispossession (in case of tangibles) and notification of the debtor (in case of intangibles). German case law and practice went down the first road, thereby circumventing and displacing the rules of codified law. North American law illustrates the second option: the establishment of a public register of security rights in movables that fulfils the needs of both the debtor and the creditor. The creditor can file a record of the security right in the public register, thereby achieving third-party effectiveness and priority, whereas the debtor does not have to surrender possession of the encumbered assets to the creditor; that is, the encumbered assets are not withdrawn from the business of the debtor but continue to produce income from which the secured loan can be repaid. The great advantage of the North American approach is that it results in transparency and predictability: third parties (potential creditors) can discover any existing security rights through a search of the public register.

2.1. Validation of non-possessory charge over tangibles and establishment of a charges register

In 1996, the Hungarian legislator opted for the North American model: a grantor-indexed register of charges was established and non-possessory charge over tangibles - perfected 19 by registration instead of dispossession - validated.

In case of the non-possessory charge, the chargor (grantor) remains entitled to the possession, use, and enjoyment of the encumbered assets. The Civil Code does not expressly confer upon the chargor the power to dispose of the charged property in the ordinary course of business, but such power is to be inferred from the provision...

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