Chapter 8 Legal Aspects of Economic Reform in Eastern Europe
- Robert Effros
- Published Date:
- June 1994
8A. Property Relations and Foreign Banking Law in Poland
The Act Amending the Constitution of the Republic of Poland of December 29, 1989 introduced two new Articles, 5 and 6, as follows:
The Republic of Poland shall guarantee freedom of economic activity without any regard to the type of property; limitations of that freedom may be imposed by statutory law exclusively.
The Republic of Poland shall protect property and the right of succession and shall guarantee full protection of personal property. Expropriation shall be admissible exclusively for public purposes and with equitable indemnity.1
Thus, the system of command economy together with its follow-up, the system of differentiated treatment of various property types, collapsed. Many minor legislative corrections allowed the new principles to become partially effective. However, in order to erect a new system corresponding to the needs of a democratic society and market economy, massive organizational work needed to be performed. This paper describes the process of transformation in Poland. It is submitted that this process may have general application to countries undergoing analogous transformations.
The most important tasks requiring legislative intervention may be described as:
Re-uniformization of the treatment of property regardless of its type, which must be fully confirmed by civil law regulations. This calls for the reform not only of the law of property but also of the rules regarding contractual traffic.
Thorough adjustment of the property status of state land to the treatment of land as a transferable capital asset.
Development of a mature capital market and the proper adjustment of its institutional framework, as well as resurrection of certain forms of negotiable instruments, and the completion of the privatization of the state sector of the economy to bring about effective market relations.
These are the major tasks to be fulfilled in years to come. The general direction of the future development is, however, firmly settled.
State of the Property Law
Property of Land
Private property of land was still, at least formally, restricted by standards inherited from the 1944 agrarian reform and contained in the Civil Code. According to the bill amending the Civil Code, those and a number of other restrictions, characteristic of so-called socialist property relations, are to be abrogated. Within the respective area limits, however, natural persons are free to sell and purchase land.
Formerly, state ownership of land was concentrated in the hands of the state Treasury. Several old statutory regulations, however, were yet to be repealed:2
Disposing of the real property was reserved to the state’s local administration and permissible only in cases provided for by the law, pursuant to the established procedures;
State legal persons could not dispose of real property that was entrusted to them only for management purpose;
State land required for private housing or small industry purposes could not be sold but a specific transferable property right of “perpetual usufruct,” usually for 99 years, might be established thereon; and
The only instance in which the law allowed state land to be sold in full ownership was that of agricultural noncultivated reserves, which might be sold to farmers.
Capital Assets and Negotiable Instruments
One feature of the socialist property system was strict control over the preservation of the state’s economic prerogatives, extending to proclaiming invalid sales of state fixed assets even to other state units without government authorization. Although that principle as such had not yet been abolished, it was considerably relaxed: enterprises, by force of the State Enterprises Act (Art. 47),3 are free to sell their fixed assets to other state and socialized units, while the Government is authorized to determine conditions of such sales to other purchasers. (Land sales to foreign persons are discussed below.)
Previously, the Government granted enterprises a general authorization to sell to the private sector “superfluous” assets only. However, special statutory provisions were introduced in 1988 under which a state enterprise could be liquidated in order to either (1) transfer all its assets and good will to a company established for that purpose (in some instances this procedure has already been applied and the receiving companies were privately owned in part or even in whole) or (2) break up its assets and put them severally up for auction.4
Application of this legislation was temporarily suspended by the Government at the end of 1989. A special agency, the Office of the Government’s Delegate for Economic Restructuring, was established to prepare more detailed legislation for the full-scale privatization of state industry. A draft statute was accepted by the Government.
The right to acquire negotiable instruments representing financial capital has never been expressly restricted. One reason—a sufficient one—was that the state sector never thought of issuing such instruments before 1981. Easy access to plan-allotted bank credits provided sufficient financing. Since 1985, state enterprises have been authorized to issue credit securities (“debentures”), and some have already done so. A number of state credit securities were brought to the market in 1989.
Another type of negotiable instrument, to some extent already present on the market, are shares of companies “going public” under the provisions of the 1934 Commercial Code. The privatization program will greatly enhance the importance of these instruments.
The State, State Legal Persons, and Local Communities
The state is represented in civil law matters by the “theoretical” entity of the state Treasury (that is, in general, it has no structure separate from that of the administration). At least until privatization, the state remained the most important effective owner of capital in the country. Still, concerning the title to property, many changes have already been introduced. Since the beginning of 1989, all legal persons belonging to the state apparatus were granted, by an amendment to the Civil Code,5 capability of holding such title.
Before 1939 and after 1965 the legal nature of the rights of state legal persons—including state enterprises—was subject to constant dispute in civil law doctrine. One commentator wanted, in the “management” of state property by such entities, an exclusively administrative instrument; the other tended to treat it as a specific kind of civil law property right. As far as movable assets were concerned, the right of management was indeed capable of being transferred under contract. On the other hand, detailed provisions regarding state real property did not allow for any transfer of the land management right in the civil law traffic. The holder was, though, protected to some extent against the administration; except when the management was expressly granted for a specified time, it was practically irrevocable. Theoretically, even though holders were obliged to disclose and surrender to the administration any “superfluous” lot, they did not do so in practice. Rather, there developed a practice of “trading through the intermediary of administration.”
Formulation of the 1989 legislative innovation leaves a tremendously important question open, namely, whether the “managed property”—the state land or other assets—automatically becomes the given legal person’s property, or whether the given legal person can acquire such property only by a separate legislative grant or by purchase. The Government has, so far, held the latter; the opposing view has been strongly represented in legal writings and in the legislature. No matter which of the judicial constructions of the 1989 Civil Code amendment wins, passing the title to property from the state treasury to enterprises and public entities seems to be only a question of time.
Further deconcentration of public property will be brought about by the reform of the local administration system, whereby communities are given legal personality and the ability to hold property. The question of allotment of assets to those communities ought to be solved in the near future.
Nonresidents and Property Rights
The right of foreign legal and natural persons to acquire and possess capital assets in Poland is not, as a matter of principle, subject to restrictions other than those relating to Polish nationals. As Article 8 of the 1965 International Private Law Act sets forth: “Foreigners may have, in Poland, equal rights and obligations with Polish citizens, except when statutory law provides otherwise.”
One must note, however, one major exception, namely, foreign persons cannot acquire the right of land ownership without first obtaining the permission of the Minister of Internal Affairs. This rule is based on a pre-World War II statutory regulation, modified so that the notion of a foreign person includes companies in which at least 50 percent of its stock is foreign-owned.6 It is worth noting that the limitation is not subject to a widening interpretation; foreign persons may, without permission, acquire the right of usufruct, perpetual usufruct, or lease.
The rights of companies established on the grounds of the Economic Activity with Participation of Foreign Parties Act of December 23, 1988 (with later amendments) are specified under Article 28, Section 1, providing that state land may be given to companies: (1) in perpetual usufruct according to the principles specified in provisions governing state land management; and (2) in tenancy.
Section 2 of Article 28 provides that companies may purchase and lease land and other real estate not owned by the state, provided the law in force is observed.7
Perpetual Usufruct of Real Estate by a Company with Participation of a Foreign Party
The title to apply for perpetual usufruct of real estate is vested in both Polish citizens and foreign persons. Perpetual usufruct of land may be obtained by a company whose capital is in major part owned by a foreign party if the company obtains a positive decision of the appropriate local body of the state administration at the primary level. The period of perpetual usufruct may not be less than 40 years nor more than 99 years. According to the Council of Ministers’ order of September 16, 1985 on Particular Principles and Mode of Giving in Perpetual Usufruct and Sale of State Land, and Related Clearance and Management of Sold Real Estate, the land assigned to construction of utility buildings or living quarters or land with such buildings or quarters built on may be given in perpetual usufruct.
A petition lodged to the administrative body should include: (1) determination of location and area of the concerned plot; (2) designation of borders of the plot on the topographic map of the concerned real estate; and (3) reasons specifying assignment of the plot onto a definite aim, including relevant documents proving consistency of the intended construction or another planned utilization of the plot, together with the spatial development plan.
The positive decision on giving the plot into perpetual usufruct, made by the administrative body, constitutes the grounds for concluding a contract in the form of a notarial act.
Real Estate Lease by a Company with a Foreign Partner
Both state and private land may be leased. In the case of state land, the contract is concluded, in the name of the Treasury of the state, by a local body of state administration of primary level. Private land may be leased on contract concluded between a lessor and a lessee without any obligation to obtain the state body’s consent.8
Lease of land and buildings is accessible to all subjects, including companies with a foreign partner, without any limits for 10 years; in absence of a notice it is extended for subsequent three-year periods, in total not surpassing 16 years. The draft amendments to the Civil Code assume extension of the basic period to 20 years.
Purchase of Land and Buildings Not Owned by the Treasury of the State by a Company with a Foreign Partner
A company with a foreign partner may purchase land or buildings on condition of the Minister of Interior’s permission, which remains valid for one year.9 Permission is the condition for concluding a purchase-sales contract and for conveying the property to the buyer.
In certain cases, the local administrative body may exercise the right of preemption vested in it. However, exercise of that right should be expected exclusively in exceptional cases. Abrogation of provisions governing the right of preemption is being considered.
Establishment of Banks with Foreign Capital
The presence of foreign capital is considered to be desirable and beneficial to the national economy and the banking system of Poland. The opening of the Polish market to foreign banking is an important part of the market-oriented policy of the state and of its growing openness to the outside world. As a contracting party to the General Agreement on Tariffs and Trade (GATT), Poland took an active part in the Uruguay Round negotiations, including negotiations on liberalizing trade in services.
It is expected that while participating in the establishment of banks and opening banking offices in Poland, foreign capital will:
enable Poland to expand its international economic relations,
facilitate the creation of a financial infrastructure for foreign capital inflow,
promote growing competition in the banking sector,
spread modern bank management methods,
foster improvement of banking staff qualifications, and
contribute to the expansion of modern banking techniques.
Banking operations in Poland are regulated by the following statutes, both old and new:
The Banking Law Act of January 31, 1989,10
The National Bank of Poland Act of January 31, 1989,11
The Foreign Exchange Control Act of February 15, 1989,12 and
The Commercial Code of June 27, 1934.13
Article 80 of the 1989 Banking Law Act provides that banks “in a form of a joint-stock company can be established also by foreign persons or with participation of foreign capital.” Thus, both wholly foreign owned and mixed Polish-foreign joint-venture banks can be established. The Act further provides that banks with foreign capital may open branches or representative offices of foreign banks.
Banks in the Form of Joint-Stock Companies Established by Foreign Persons or with a Foreign Capital Share
According to the Banking Law, a bank may be established by at least three legal persons or ten natural persons. Establishment of a bank requires permission. A power to grant permission is vested in the President of the National Bank of Poland (Narodowy Bank Polski, NBP). On application of the interested parties, permission is given or refused by the President after consultation with the Council of Banks and in agreement with the Minister of Finance.
Permission to establish a bank may be granted when the following have been ensured:
(1) adequate own capital;
(2) premises and technical facilities; and
(3) managers with adequate professional background.
With respect to the bank’s own capital, the minimum capital, brought in by foreign persons, must amount to $6 million or its equivalent in other convertible currency. In the case of banks established jointly by Polish and foreign parties, the amount contributed cannot be less than Zl 14.2 billion. The said amount is adjusted according to the exchange rate fluctuations.
The fact that the chairman of a bank’s managing board shall, under the law, be appointed only after consultation with the President of the National Bank of Poland, is worth emphasizing. The positions of president, vice-president, and board member are considered managerial positions under the law. At least one Polish citizen must be a member of the bank’s managing board.
Premises and technical facilities must ensure the proper protection of assets accumulated at the bank.
Branch (Representative Office) of a Foreign Bank
To open a branch (representative office) of a foreign bank, permission is required from the Minister of Finance in agreement with the President of the National Bank of Poland. A representative office cannot perform banking operations reserved in the Banking Law to banks; that is, the activities of representative offices are basically confined to information and communication functions.
Regulations on Activities of Banks with Foreign Capital
A bank in the form of a joint-stock company established by foreign persons or with a foreign capital share is obligated to meet, in its activity, a number of specific requirements. Thus, such banks may employ foreigners as well as Polish citizens, provided that such foreigners are employed in agreement with binding regulations and on the terms agreed upon with the appropriate bodies of the state administration. The banks under consideration are also obligated to perform banking operations in agreement with the Banking Law and other provisions of the Polish law.
Banks with foreign capital are allowed to accept foreign exchange deposits from domestic persons on the terms agreed upon in contracts concluded with such persons and taking into consideration respective regulations in force. The Treasury of the State is not responsible for liabilities in this respect.
Banks with foreign capital are also allowed to place deposits with foreign banks up to the amount acquired abroad.
Banks with foreign capital are obligated to maintain foreign exchange reserves at the level determined by the President of the National Bank of Poland in agreement with the Minister of Finance. Performing both credit and deposit operations in zlotys is based upon the agreed-upon terms equal to those applied by domestic banks, but the Treasury of the State is not responsible for liabilities with respect to the accepted deposits in zlotys from domestic persons. However, the Treasury of the State may grant a guarantee or a warranty for the said liabilities.
It is worth emphasizing that the banks under consideration are obligated to maintain a zloty reserve with the National Bank of Poland, in accordance with the requirements binding domestic banks. Such banks are also subject to taxation according to the principles and rates applying to the domestic banks.
The bank’s profit after taxation constitutes the profit for distribution. Principles of profit distribution, and creation of own funds and their allocation, including principles of transfer abroad, are defined in the statutes; draft statutes are presented to the President of the National Bank of Poland, together with an application for permission to establish a bank.
Foreign banks and banks with foreign capital are, however, in virtue of law, entitled to transfer abroad annually at least 15 percent of their profits earned in domestic currency and 100 percent earned in foreign exchange.
A bank is obligated to apply uniform rules of accounting and interbank settlement as well as a typical plan of accounts. It is also obligated to prepare and submit to the National Bank of Poland information similar to that provided by domestic banks. A bank is obligated to carry on correspondence with domestic offices in the Polish language. Bank operations are subject to monitoring by the Polish financial authorities and to banking supervision exercised by the National Bank of Poland.
Procedure for Establishing a Bank with Foreign Capital
The procedure comprises: (1) steps preparatory to submission of an application for permission to establish a bank, and (2) submission and examination of an application referred to the above.
Preparatory steps aim at agreeing with the National Bank of Poland on a list of data that must be collected. The founders of a bank submit preliminary information on the foundation initiative, in particular: data concerning the founders; name and seat of the bank; anticipated date of commencing operation and the projected range of activities of the bank; and the paid-in capital.
The founders of a bank are guaranteed they will receive detailed information about preparation of the application and the necessary forms. They may seek advice on the contents of basic documents, particularly on drafts of the application, statutes, anticipated balance sheets, and profit and loss accounts. During the preparatory stage, the founders should prepare the premises and technical facilities as well as the staff for the future operation of the bank. If the application is complete and properly drawn up, a decision is made one month from the date of its receipt by the President of the National Bank of Poland.
A number of the legislative problems considered in this chapter have been addressed by the lawmaking processes. Important issues remaining to be addressed in Poland and other Central European countries include:
addressing the current budget deficit by central banks;
central banks’ guarantying the debts (liabilities) of a large number of big banks (for example, in Poland, 16 banks, which to a large extent are burdened with “bad credits” given to insolvent state-controlled enterprises);
supervising the settlement of accounts with other countries with a view toward the impact on the balance of trade and balance of payments;
supervising transactions in securities, treasury bonds, and other instruments traded on both the stock exchange and on the secondary market; and
controlling the money supply and determining a foreign exchange rate policy.
8B. Remarks on Legal Reforms
The present wave of economic reform in Eastern Europe began several years ago and, in the case of Hungary, more than a decade ago. Since then, the political upheaval of 1989 and the fall of socialism have accelerated the process. Nevertheless, the essential political changes of 1989 in Poland and Hungary, as well as the other central and eastern European countries like Czechoslovakia and the former German Democratic Republic (East Germany), have not been reflected in the fields of business law or banking law, even in Poland, where the creation of a new, post-socialist law seems to be the most advanced. Moreover, in Romania, Bulgaria, most of Yugoslavia, and Albania the lag between political development and economic and financial reform is even more marked.
Of all the items in the reform agenda, the most important problem to be solved in the countries concerned is transforming ownership: privatization. A year ago there was no privatization; there was a kind of ideological taboo. Post-socialist economies clearly must rid themselves of the domination, and sometimes monopoly, of state property and means of production. Privatization of state enterprises should pass up the stage of commercialization, and banking institutions must play a substantial role if privatization efforts are to succeed.
The other important problem is liberalization of the economy, with respect to domestic relationships and to joint ventures. It is noteworthy that joint ventures were introduced as a legal institution in the German Democratic Republic (GDR) and Czechoslovakia only after the collapse of the communist regimes. Legislation dating from 1988-89 is being changed, and facilities for foreign investment enlarged.
Reform relates also to financial instruments—bonds, notes, bills of exchange, and so forth—and to foreign exchange regulations. It requires harmonizing the law and the practice of the countries concerned with those of the west.
Finally, banking institutions themselves must be reformed, and new banks permitted to be set up, including joint banking ventures. Banking institutions have begun, even in the Soviet Union, to be active financial intermediaries instead of mere receivers, payers, and generally bookkeepers of the state.
Overview of Polish Economic Reform Programs
The Polish economic program instituted in early 1990 has as its first aim monetary stabilization. Inflation in 1989 was more than 1,000 percent. To stop inflation, a series of steps have been taken: price liberalization, subsidy cuts, credit tightening, higher interest rates, and abandonment of tax allowances and exemptions. Only a small part of this program required legislative implementation; these measures are in the sphere of economic policy. These reforms have to a large extent arrested inflation; by March 1990, inflation had dropped to 80 percent a year. Unfortunately, the rapid growth in food prices has led to a recession in agriculture and an unexpected general recession.
Under these circumstances, the Polish government needs to be more flexible than it appears capable of being. The bill on privatization and stabilization presented at the end of March 1990 to the parliament, which should have been a passage to the second stage of economic transformation, was for the most part unrelated to a market-oriented approach to economic reform. Instead, it relied on a traditional top-down bureaucratic reform. It gave the president of the state agency for ownership transformation almost dictatorial power to transform state enterprises into one-person Treasury joint-stock companies. Furthermore, it allowed the sale of shares in such companies without any evaluation of the given enterprise and without due process of law. Employees may buy shares—in some cases at a discount—but only individually; no employee stock ownership plans (ESOPs) are envisaged. Finally, the bill did nothing to ameliorate the concentration of power to transform state enterprises that was vested in government ministers in legislation passed between 1987 and 1989.
On April 17, 1990, another draft bill on privatization was made public that provided a greater extent for opportunities for privatization than did the government bill. For example, it provided for privatization without previous commercialization, and also allowed enterprises to be transformed to their local self-governing bodies. Privatization procedures may be initiated by any legal subject or by a foreign company; there is no gap between this privatization law and the joint venture law. Furthermore, the bill provided for due process of law in the field of privatization.
The draft bill distinguished between the decision to privatize a given enterprise and the implementation of that decision. The former would be entrusted to the Council of National Property, appointed by the parliament. The latter was proposed to be given to a special commercial type of institution—the National Property Fund—that would serve as a broker for the Treasury but also have the right, and competence, to undertake other financial activities, similar to an investment bank operating in the field of privatization.
This draft bill proposed to adapt the ESOP formula to a continental legal system by allowing privatization of a state enterprise if employees set up an employees’ ownership foundation. The foundation’s only purpose would be to pay the Treasury through the intermediary of the National Property Fund for shares, and then to transfer those shares to the employees. The foundation could operate through such diverse financial instruments as notes or company bonds. This mechanism would not be simply a revival of pre-socialist Polish law, but an attempt to introduce a form relatively new even in western business law. It was hoped these various draft bills would be combined, providing the best outcome for Poland. Such was the first decision of the parliamentary subcommittee charged with elaborating the final draft law. Nevertheless, the law, passed on July 13, 1990, was modeled more on the Government bill.
Overview of Hungarian Economic Reform Programs
The Hungarian reform program is in a way more advanced than the Polish one because it has begun to stress the importance of financial instruments. Although the Hungarians started their reform in 1968, they realized 20 years later that their economy was in crisis. Their experience proved that formal commercialization, formal transformation of a state enterprise into a joint-stock company owned by the state, does not change the essential nature of the economic system.
On April 6, 1990, a blue ribbon commission report to the Hungarian government recommended promoting entrepreneurship, that is start-ups of new private or genuinely corporate businesses and expansions of existing ones. It also recommended privatization of land, of all trades, of service establishments, and of workshops and other enterprises, permitting Hungarian citizens to buy equities in a “privileged” way with a special line of credit. Under such circumstances, the role of financial institution intermediaries would have expanded more rapidly than has actually been the case.
8C. The Evolution of the Legal Framework for Entrepreneurship in Hungary
FRANCIS A. GABOR
By the late 1980s, political and socioeconomic conditions in Hungary changed dramatically. A deepening economic crisis was the major moving force for a drastic political reform that led to the first free multiparty election in March 1990. The evolution of a constitutional democracy provided the foundation for sweeping socioeconomic changes in the framework of new constitutional amendments adopted by the 1989 Act.1 Article 9 of the new amendments adopted an historic compromise, stating that the economy will rely on a market economy where social ownership and private ownership are equal and receive equal protection and treatment.2
At the same time, the Hungarian Republic recognized and supported freedom of entrepreneurship and competition. These freedoms can only be restricted by an act of parliament having constitutional force and adopted by a qualified majority vote.3 Protection of property, whether private or social, owned by Hungarian or foreign citizens, receives equal and special constitutional protection in Article 13 of the Constitutional Amendments. Article 13 allows taking of property by the state only in exceptional cases for a public interest, which is determined by “legal acts.” Authorized taking of property must also be accompanied by complete, unconditional, and immediate compensation.4 This constitutional safeguard is fully consistent with general international law as recognized by a majority of western nations. Based on this constitutional foundation, a wide range of legislation has evolved since 1988, establishing a solid legal framework for entrepreneurship in an emerging free enterprise system.
Act VI of 1988 on Economic Association: A Synopsis
In October of 1988, the parliament adopted the Code of Economic Association, which entered into force on January 1, 1989.5 In 339 articles it provides the first comprehensive codification of the subject governing all types of economic organizations for Hungarian citizens and legal persons as well as foreigners. It is remarkable that only the highest source in the Hungarian legal system, the act of parliament, can be applied to its implementation.
The key question is, what was the purpose of the Hungarian legislature in codifying legal relationships that were still in a relatively embryonic stage? Obviously, the modernization of company law was badly needed. Most of the joint ventures with foreign equity participation as well as fully foreign owned companies had to rely on such antiquated legal sources as the 1875 Commercial Code6 to establish corporations and on 1935 legislation for creating limited liability companies.7 The outdated pre-socialist legislation could not play an effective role in modern conditions. The codification is based essentially on academic comparative law study because the legislature could not rely on actual experiences in Hungary. In other words, the law is ahead of the contemporary socioeconomic conditions for business organizations. The new company code, therefore, can fulfill an effective function for social engineering. This legislation can stimulate actual changes in the economic environment by creating and building a framework for these socioeconomic changes.
This code obviously has to be put in the context of the ongoing economic reform movement since 1968. The introduction of the new economic mechanism in 1968 did not lead to effective creation of a market economy. It is true that the central planning system was replaced by a financial regulatory system and that fluctuations within the economy have continued until recent years. In the mid-1980s the introduction of self-government in state-owned enterprises created the first framework for acceleration of the reform. This experiment was not successful because it created opportunities for abuse, which then triggered the return of administrative control of the market and competition. Overall, the lack of macroeconomic institutions prevented the effective evolution of micro-economic reform.
The need for radical changes and an expansion of the reform movement became obvious after 1987. The deepening economic crisis created pressure for the immediate implementation of political reform. The Constitutional Amendments, setting forth the foundation of the new socioeconomic structure, and the first free election provided the political consensus for the new structures.8
The new company code is the basic institution of the implementation of this stage of the reform, contributing to the creation of a functioning capital market. The creation of the stock market, for instance, is a product of this legislation.9 This legislation is intended to lead to the creation of capital markets, which will contribute to the establishment of unified free markets, including those of goods, capital, and labor, thereby restoring the fundamental structure of a free enterprise market economy.
Another important feature of the Code of Economic Association relates to the elimination of the administrative concession system. All newly formed associations are registered at the First Court of Registry. This court, however, can consider only the legality of the association, not its economic feasibility or external legal factors. Furthermore, state administrative functions are separated from the microeconomic environment in the evolution of this modern framework for entrepreneurship.
The new company code offers a wide variety of organizational forms in its seven chapters: General Provisions, Common Rules Relating to All Economic Associations, Unlimited and Deposit Partnerships, Unions, Joint Enterprises, Limited Liability Companies, and Companies Limited by Shares.10
Following the civil law tradition, most of the rules of the code are dispositive and therefore controlled by the parties with selected exceptions. Particularly, limited-by-share companies are generally governed by mandatory (cogens) rules for the protection of the public interest. Although from the standpoint of limited legal liability only the limited liability companies and the limited-by-share companies (next to unions and joint enterprises) have the status of legal personality, economic associations can be treated as autonomous legal entities. As a result, these economic associations can acquire property and conclude contracts under their own names. They can bring legal actions to protect their interest, and actions may be brought against them.
Attracting foreign working capital investment into the Hungarian and foreign-owned economic associations is a significant legislative purpose of this Act. The recently enacted Foreign Investment Code,11 coupled with this Act, effectively eliminated bureaucratic restrictions on the establishment and operation of foreign affiliate companies. Foreign owners do not need any governmental permit if their ownership interest is less than 50 percent. If the foreign investor has majority or full ownership, a joint permit from the Minister of Finance and the Minister of Trade is required; if the request for a permit is not rejected within 90 days, it is considered granted. The Act also provides a wide range of safeguards for the full protection of foreign investors.12
It is noteworthy that the Act attempts to preserve the socialist character of large enterprises by limiting the number of employees to 500 in economic associations that are fully owned by natural (private) persons.13 The limitation, however, is not applicable to entities that are under majority or full foreign ownership and/or control.
Finally, the Act in some respects draws on the principles of self-governing enterprises. The Act requires employee representation and participation on the supervisory board in every joint enterprise, limited liability, and limited-by-shares company with more than 200 full-time workers. The supervisory board fulfills a limited monitoring function on the management of the enterprise. This solution, however, is a definite contraction from the principle of codetermination, since only one-third of the members of the supervisory board are elected by the employees from among themselves.14
The code offers a menu of organizational forms. The prospective entrepreneur must perform a careful cost-benefit analysis for the proper selection. Any natural or legal person can establish a general or limited (deposit) partnership without legally designating a minimum level of contribution. These are ideal forms for smaller-scale ventures. The lack of legal personality creates an unlimited, joint, and several liability for all general partners, while in the case of limited partnership the outside partners (limited partners) are responsible only for the value of their investment; they do not ever have to contribute personal work or personal property.15
Members of a limited liability company are not liable for the obligations of the company, but are liable up to the value of their shares. This type of company has legal personality. It requires a minimum capital of Ft 1 million. Each share contribution has a value of no less than Ft 100,000. Medium-size companies prefer this form, and most joint ventures with foreign equity participation select this form of organization. A majority of the code provisions are dispositive and can be modified by the parties in the deed of association. The limited liability company has a unique legal construction that can be compared to the common law models of closely held corporations as well as to a limited partnership without any general partner.16
A limited-by-shares company is formed with registered capital consisting of shares of a predetermined number and face value. The shareholder’s liability is limited to the face value of the shares. Otherwise, the shareholder has no liability for the obligations of the company. The registered capital must be at least Ft 10 million, and paid-in capital at start up must be at least 30 percent of the registered capital and no less than Ft 5 million. Complex and cogens rules govern the operation of this type of economic association. These rules are comparable to the legal framework of the U.S. publicly held corporation. Obviously, this form is feasible only for large-scale enterprises, and therefore a large number of self-governing state enterprises have been transformed into limited-by-shares companies.17
Act XIII of 1989 on Transformation of Economic Organizations and Economic Associations
The Transformation Act was adopted as a technical supplemental statute to the Act on Economic Associations for the purpose of stimulating the metamorphosis of state-owned enterprises into different forms of business associations.18 It is, however, not a comprehensive privatization statute because it does not cover the critical questions of valuation and management of the state property.
Transformation under the Act essentially means that social economic organizations (state-owned enterprises and cooperatives), without being totally liquidated, are converted into a selected form of economic association. This new association will be the general legal successor of the transformed organizations.
Eventually, the Code of Economic Associations will be an effective vehicle and a moving force for the next stage of reform of ownership of the means of production. Article 9 of the Constitutional Amendments already recognizes the constitutional equality of social and private ownership. The company code makes a major contribution to implementation of this principle. While state enterprises and cooperatives will still be governed by their own statutes, there has been an emerging movement under the new Act on Transformation.19 Most of the state enterprises under self-management and cooperatives have a well-defined interest in transforming into one of the more desirable forms of economic association, such as limited companies or limited-by-shares companies. Although this process is a natural evolution, it is not mandated under the code.
Emerging Legal Framework for Ownership Reform
Many large and medium-size enterprises underwent transformation in 1989-90. Simultaneously, ad hoc privatizations were also increasing. A majority of the decisions for transformation were made by qualified voting of the collective bodies (councils and general assemblies) in self-governing enterprises. The employees and the management have not developed even a long-term property interest in the assets of the enterprise. Thus, self-interest of the collective bodies and the management prevailed. Quite often assets were grossly undervalued, and the new company was quickly sold to foreign investors below its fair market value.20
The escalating ad hoc privatization without adequate legal framework led to a problem of damage to the national wealth. As a result, in February of 1990, parliament adopted two acts regulating privatization; both entered into force on March 1, 1990.
The first Act provides an organizational framework by setting up the institution of the State Property Trustee,21 controlled by the parliament and supervised directly by a newly created State Office of Accountability. As a legal person financed by the national budget, the trustee functions as manager and guardian of state property in the course of transformation, examining the valuation and selling of the property and reporting to the parliament.22
The trustee can intervene to protect the state’s interest by exercising limited veto power in ad hoc privatization transactions. This Act preserves the exclusive power of the parliament to establish the basic principles each year for the perimeters of ad hoc and regular course privatization.23
The second privatization measure—the Act on Protection of Property Trusted on State Enterprises24—provides the regulatory framework for privatization. The controlling legislative purpose is to prevent dishonest transactions in ad hoc privatization, which damage the national interest. Thus, all the contracts by state enterprises involving any transfer of real or movable property, means of production, or industrial property rights that in a given year amount to 10 percent of the enterprise balance sheet and exceed Ft 20 million have to be included in the transformation plan.25 This plan has to be approved by the State Property Trustee, who has three alternatives: (1) order a new property valuation at the state’s expense; (2) advertise a free competition for the given contract; or (3) if the contract would damage the interest of society or the national economy, prohibit the conclusion of the contract.26 The state enterprise does not have to report to the trustee if it undertakes an open competition and concludes a contract as a result of it.27 It is hoped that these two acts can steer the widespread privatization movement onto an orderly course.