1. The concept of the trust in the new Hungarian Civil Code
Twenty-five years after the collapse of the socialist system in Hungary and joining the market economy system again, both the legislature power and experts agreed that Hungary must provide a legal solution in helping long-term family wealth preservation and estate planning in Hungary. Earlier, during the soviet occupation, the importance of the private wealth was marginal but from 1989 privatization created a dramatic change in private wealth. Nevertheless, neither the legislature power, nor professionals realized in time that the lack of local estate planning solutions would create a massive capital outward flow from Hungary. This tendency resulted in the ‘90’s offshore spree and created an unhealthy environment where the focus was on the agressive tax planning.
The Civil Code regulates the trust (in Hungarian: ‘bizalmi vagyonkezelési szerződés’) among the mandate-type contracts. The concept of this new type of legal instrument was drawn up on the basis of the English trust model. Although the Hungarian law is influenced by the German law, this legal framework is far from the rules of the German Treuhand but very English. Strong, current demand in the economy was postulated the introduction of trust on a legislative level . Since the transition, Hungarian investors have chosen legal regimes of other countries because the institution of the trust provided them with a better legal and economic solution. The Chief Codification Committee of the Civil Code implemented the trust into the contract law chapter emphasising; however, the decisive element of the instrument is the transfer of ownership, which is based on the trust-like model. Under the rules of the Civil Code, the trust is an in personam legal instrument that implicitly carries substantial in rem effects. The framework’s general concept is that the trust is a contractual arrangement between the settlor and the trustee and its validity is bound to a written contract or statement. It derives from this concept that the central figures of the trust are the settlor and the trustee and this conceptual emphasis goes through the supplementary rules, as well. The supplementary rules including several details of the licensed trustee activity are regulated in two separate pieces of legislation. Such details are regulated in Act XV of 2014 on Trustees and the Regulation of Their Activity , and in Government Decree No 87/2014 (III. 20.) on certain rules concerning the financial security of trustees’ undertakings.
2. General rules of the trust
Pursuant to Section 6:310(1) of the Civil Code, under the trust the trustee must manage the assets transferred into the trustee’s ownership by the settlor for the benefit of the beneficiary, for which the settlor is obliged to pay a fee. The trust assets may be tangible or intangible assets, rights and claims as well. From this general definition derives three determinative elements of the trust: for the creation of trust it is necessary to transfer the ownership of the asset from the settlor to the trustee; the trustee acts for the benefit of the beneficiary; therefore, the framework requires at least one beneficiary; nevertheless, the settlor remains the contracting party, consequently, the rights to modify or terminate the relationship remains in the settlor.
It must be noted first of all that the Trust Section’s rules are mainly dispositive; therefore, the settlor may differ from the rules with the exception of a few obligatory rules (any deviation is null and void). The obligatory rules are:
- The trust arrangement must be in writing;
- The trustee can’t be the sole beneficiary;
- The trust assets must be separated from the trustee’s own assets and other trust assets;
- The settlor and the beneficiary can’t instruct the trustee;
- The trust period cannot last longer than 50 years.
The above mentioned rules mean as well that the settlor has large extend of freedom to specify the content of the trust relationship, apply protector or other advisors, like investment board.
It is allowed to create several types of trust including testamentary or inter vivos, discretionary or non-discretionary. The purpose trust is not regulated as a typical legal arrangement, but with using appropriate schemes, a legal arrangement that resembles the English private or charity trust may also be achieved. The general concept of the trust framework is the revocable trust. It is controversial, whether it is possible to create an irrevocable trust, as the settlor may terminate the trust arrangement and this right may be limited but not excluded.
If the settlor and the trustee are one and the same person, the trust must be established by an irrevocable unilateral declaration of the settlor in a public instrument. A legal relationship of the trust settled by last will and testament is valid if the trustee accepts of his appointment to such position, under the terms set out in the testament. In the case of creating a trust by unilateral legal statement, which must be done in a public instrument, the same rules must be applied as mentioned above.
3. Rights of the settlor
The rights of the settlor extend to the appointment of the trustee, the determination of the transferred assets, the designation of the beneficiary, and the condition or time to become beneficiary. These rules are very similar to the three certainties principle in the Anglo-Saxon law. This, however, is a bilateral legal act, as it also requires the acceptance of the appointed trustee. Although the settlor defines the trust’s character, in practice the creation of the trust requires the involvement of the appointed trustee and its consent. Without clear determination of the asset management rules in the trust deed, the Civil Code’s general rule applicable that the trustee must act for the utmost benefit of the beneficiary. This rule is the governing element of the whole relationship and all and every condition of the trust deed must be examined and fulfil for the utmost benefit of the beneficiary. The settlor may determine other conditions of the trust as well, such as its duration, which is maximum 50 years, terms, the right of unilateral termination, remuneration of the trustee, appointment of additional trustees, regulation of the delegation of other contributors (for example a protector) and the beneficiary’s right for distribution. The settlor may reserve the right to remove the trustee, appoint a new trustee, replace the beneficiary, modify given parts of the settlor’s declaration and to determine or modify the duration of the trust. Although, the settlor has no rights to instruct the trustee, the settlor may specify the asset management guidelines in the trust deed. These guidelines provide the legal framework of the asset management.
The settlor may monitor the activity of the trustee but the expenses of such monitoring shall be borne by the settlor. It derives from the concept of asset separation that it is not allowed to the settlor to instruct the trustee. This rule provides independence for the trustee and higher responsibility, as well. The final legal instrument of the settlor to control the trustee’s activity is that settlor may remove the trustee at any time simultaneously appointing another trustee. This rule may seem simple; nevertheless, it carries an extra transfer of ownership as the current trustee holds the legal title of asset ownership; therefore, appointment of a new trustee must be in that legal form which fulfils the legal requirements of the transfer and registration of ownership.
The settlor must determine the identity of the beneficiary and the conditions of the commencements and termination of entitlement of beneficiary. The beneficiary may be described by the reference to the scope of the beneficiaries, providing power to the trustee to define the proportion of the beneficiaries creating a possibility to set up discretionary trust as well. The validity test of this rule is that the trustee always must be able to identify a beneficiary. Although the settlor transfers the right to select the beneficiary to the trustee using this opportunity; nevertheless, this does not mean that the trustee has unlimited rights to determine anyone as beneficiary. First, the settlor must determine the possible scope of beneficiaries and must provide guidelines how to select the beneficiary among options. Second, the settlor may delegate this power to its representative as well, appointing a protector, who is the settlor’s representative in the trust relationship; therefore, may practice the settlor’s rights.
The settlor may appoint the beneficiary or the scope of beneficiaries and dispose of the conditions of the managed assets’ distribution. The settlor may dispose that the managed assets must be transferred back to the settlor or to the settlor’s heirs or to a third person, wholly or partially by the occurrence of any specified conditions or after a specified period of time. The appointment of the trustee as sole beneficiary is null and void. However, the settlor and the trustee may be the same person but in this case the trust must be created in a public document by irrevocable statement of the settlor.
4. Rights and obligations of the trustee
The trust framework of the Civil Code is very liberal and does not limit the scope of persons who may act as a trustee. The general rule is that every person – legal or natural – having its ability to act may be a trustee. Nevertheless, the Trustees Act provides further rules in this area and distinguishes the licenced and non-licensed trustee activity. The Trustees Act completes the Civil Code’s relatively shortly list of the trustee’s rights and obligation; nevertheless the Code itself contains the most important one, an ancient Roman law rule – bonus et diligens pater familias. This rule has been implemented to the framework extending the trustee’s obligation, as the trustee is obliged to protect the trust assets from the predictable immediate risks in compliance with commercial rationality. Moreover, in accordance with the fiduciary requirements of the trust, the trustee must act primary for the benefit of the beneficiary’s interests.
On the other hand to fulfill this obligation, the trustee has the right to claim the registration of ownership and the possession of the trust asset after the conclusion of the trust deed. The trustee may force this right against anyone, including the settlor, as well.
Requirements towards and duties of the trustee
The framework provides broad rights to the trustee disposing the trust assets, as the trustee has the rights to exercise the trust assets’ ownership to a large extent; however, the trustee is obliged to dispose of the trust assets according to the conditions and restrictions of the trust deed. Balancing between the trustee’s rights and the settlor and beneficiary’s interest, there are rules to protect the former two’s interest against the trustee’s breach of obligations.
The Trustees Act provides further obligations for the activities of the licensed trustees. This act distinguishes licensed (professional) and non-licensed (ad hoc) trustees. If a trustee concludes at least two trust contracts annually or if the trustee’s fee excess of one per cent of the value of the trust asset, the service is classified business-like and such an activity may be carried out only with a licence issued by the National Bank of Hungary, prior to the start of such activity. Licensed trustee may be only a limited liability company or limited company by shares registered in Hungary or the branch – registered in Hungary – of an undertaking based in another contracting state of the Agreement on the European Economic Area.
The trust company may not carry out any other activity than trust asset management and its related services and its name must make reference to trust asset management. The trust company must fulfil strict human resource and infrastructure requirements to receive and maintain the licence of the National Bank of Hungary. The human resource conditions are the followings: the company must employ at least one person having master degree legal qualification and bar exam, one person having master degree economic qualification; moreover it must hire a statutory auditor, as well. The infrastructure requirements of a trust company are the followings: at least HUF seventy million registered capital, financial security which is equal to twenty per cent of the trust assets but minimum HUF seventy million and maximum 1500 million, office, website, internal Rules for accounting policy and accounting software, which fulfils the requirements of the separated trust asset accounting.
The trust company must duly perform its trust contracts in accordance with statutory requirements for the utmost benefit of the beneficiary, in particular. The trust company is obliged to inform the settlor about the risks of the contract defined by law, prior to the conclusion of the trust contract. In addition, the trust company must provide information in writing, on a monthly basis. If no changes are made to the original information, it is sufficient to make reference to such fact in subsequent information. The trust company is required to maintain records of the trust relationships to support the traceability of trust, administrative controls and administrative assessments of assets.
The trust relationship and the activity is essentially built on trust, particularly in relation to the selection of the trustee, that is, beyond their business relationship. The trust relationship between the settlor and the trustee is governed predominantly by aspects of the trust contract and underlining rules of the mandate contract and less by the general contracting rules of the Civil Code.
In important obligation that the trustee must avoid conflicts of interest, therefore it is not allowed to conclude contract for his or her own benefits. Moreover, one of the trustee’s main obligations is to manage the trust assets separately from his own and other trust assets.
If the trustee is authorised to designate the beneficiary under the trust deed, the trustee may have the right to determine the share of the beneficiary as well.
Due to the high degree of professional requirements arising from the fiduciary nature of the trust relationship, the trustee must act for the utmost benefit of the beneficiary. The trustee must protect the trust property against foreseeable risks in a commercially reasonable manner.
The management of the trust asset includes the exercise of rights arising from ownership, other rights and claims transferred to the trustee and the fulfilment of obligations arising therefrom. The trustee may dispose of the assets belonging to the trust assets under the conditions and within the limits sets out in the trust deed. If the trustee breaches his obligations and illicitly alienates trust asset to a third party, the settlor and beneficiary have the right to reclaim the alienated asset for the benefit of the trust assets, if the third party did not purchase the asset in good faith or for consideration. This rule is applicable as well, in the case of illicit encumbrance of the trust asset.
The trustee must keep confidential all facts, information and other data he or she becomes aware of during his or her office as trustee or in relation thereto. Such obligation is without prejudice to the establishment of the trusteeship and remains in effect after the termination of the trust. The settlor and his or her successors may grant exemption from the confidentiality obligation.
One of the basic obligations of the trustee is that the trustee must inform the settlor or the beneficiary about the actual situation of the trust assets upon their request. This obligation is independent whether the trustee is licenced professional or non-licensed trustee; nevertheless in the case of licensed trustee the information providing obligation is more regulated. Such information must cover in particular, the actual and foreseeable increase in the trust assets, the particular assets of the trust, their value and commitments charged to the trust assets. Upon request, the trustee must account for the trust assets and settle accounts with the settlor and beneficiary. Expenses incurred in connection with the provision of information and the payments of invoices are borne by the settlor and beneficiary.
The rights of the trustee are governed by the Civil Code and rules specified in the trust deed. The rights of use and disposition are also conferred on the trustee in the case of trust, that is, the trustee has the right to
- use and operate the trust asset,
- possess the managed asset, resort to protection of possession under the appropriate title,
- enjoy, that is, utilise the trust asset either by himself, or with the collaboration of a subcontractor or agent, if he is authorised to employ such third parties under the trust deed. This right in practice is limited in the trust deed.
- right of alienation (e.g. in the case of portfolio-type trust asset),
- right of encumbrance (establishment of e.g. lien on assets belonging to the asset),
- right of destruction, or rather, right of processing and use (e.g. en entire plant is entrusted, together with its raw materials, and these are processed in the regular manufacturing process)
- right to exercise membership or shareholder rights.
The due care and diligence trust management is generally applicable to trust relationship. If during the process of utilising the trust relationship, the parties do not specify yield rate but only the due care and diligence fulfilment of the trustee, the trustee is required to manage the trust asset with due care to ensure the satisfactory performance of the trust. If however, the trust deed specifies annual yield rate and profit, the trustee must fulfil them; therefore it is a higher risk for the trustee. In both cases the trustee’s remuneration may be linked to the annual yield performance of the trust. Due to the general prohibition of the instruction, the trustee may not be instructed how to fulfil its obligations. Nevertheless, the trust deed may provide guideline for the asset management or general prohibition of alienation of the trust assets or certain trust asset. In this case currently it is difficult to determine how the trustee can fulfil its obligation to ensure that the trust asset preserves its value in the case of changing circumstances. The authors believe that the general rule of the due care and diligence trust management is applicable in changing circumstances as well, even though there is a prohibition of alienation in the trust deed. In this case the trustee must measure the different consequences and make a decision keeping in mind the utmost benefit of the beneficiary. In complex cases an investment advisory board, having its part the beneficiary or some of them, may help this decision making process.
Last but not least, there are rules securing the trustees’ remuneration, providing that first of all the settlor must pay the contracted remuneration to the trustee; nevertheless, the trustee is entitled to satisfy the claims for remuneration or justified costs directly from the trust assets, if neither the settlor nor the beneficiary settle the trustee’s remuneration. The trustee may claim reasonable remuneration and costs as well, if the trustee carries out its activity free of charge. The remuneration of the trustee may be implemented under different scheme; therefore the contracting parties are free to determine the remuneration for the service.
5. Liability of the trustee
The trustee is liable toward the settlor and beneficiary for the breach of his obligations in accordance with general rules of liability for damages. If the trustee carries out his duties without consideration, rules of liability for damages are applicable to his breach of gratuitous contracts. The settlor and beneficiary may claim the management of any financial gain as part of the trust asset, which was realised through the trustee’s breach of his obligations arising from the trust.
The trustee is liable as well for the damages occurring in the trust assets caused by breaching the obligations towards the settlor or the beneficiary, according to the general rules of liability for damages. The framework provides rules for the liability of the trustee towards third persons, as well. First of all, the trustee is liable with the trust assets for the fulfillment of the obligations. Second, the trustee has unlimited liability with its personal assets for the fulfillment of the claims obligating the trust assets, if they are not satisfied from the trust assets and the third party could not and did not need to know the commitment of the trustee spread beyond the trust assets.
If the settlor appoints more than one trustee, the actions and decisions of the trustees are taken jointly. If the trustees are also liable with their own property for their commitments, they assume joint and several liability for joint decisions toward third parties. The co-trustees assume joint and several liability toward the settlor and beneficiary for the breach of obligations arising from the trust.
6. Legal status of the trust asset
The trust asset may be anything, which is allowed to be lawfully owned; cash, securities, intangible or tangible assets, rights or claims. Mutatis mutandis, goods which ownership or possession is prohibited cannot be part of the trust assets.
Section 6:312 of the Civil Code provides rules on the separation of the trust asset from the trustee’s own and other trust assets. The trust asset constitutes separated property from the trustee’s own assets and other trust assets managed by the same trustee. The trustee is obliged to record the trust asset separately from his own and other trust assets. The parties’ derogation from this rule is null and void. The recorded trust asset is deemed to fall within the scope of trust asset until proven otherwise. Any asset substituting the trust assets, insurance indemnities, damages or other value and profits thereon, constitutes part of the trust asset, whether recorded or not. Assets not recorded by the trustee as comprising part of the trust asset are deemed to be the private property of the trustee until proven otherwise.
The Trustees Act contains further detailed rules regarding the separation and administration. The most important among these rules that the trust is a separate and independent entity from the accounting perspective but it is not a legal person. Therefore, the trust asset must be separately accounted in HUF or EUR but these records, contrary to the corporate loss and profit statements, are not publicly accessible.
The transfer of assets from the settlor to the trust is tax-free, there is no hidden taxation or transfer duty. The trust’s income is taxed independently from the trustee’s other income. The trust is a Hungarian corporate taxpayer, whose registered seat must be maintained in Hungary. The trustee is obliged to file an annual return on behalf of the trust to the Inland Revenue Service. The trust’s annual income is taxed as corporation income with corporate income tax. Capital distribution is tax-free for Hungarian tax resident private individuals. In the case of a foreign tax resident individual beneficiary, the tax rules of beneficiary’s residence are applicable. The trust income distribution to private individuals is treated as dividend and it is taxed with 16% personal income tax in the case of a Hungarian tax resident individual. If the beneficiary is a foreign tax resident individual, withholding tax may be applicable but the Hungarian double tax treaty network may reduce it to zero. Hungarian tax resident companies may pay corporate income tax on capital distribution. In the case of a foreign entity, there is no withholding tax on capital distribution in Hungary. Hungarian tax resident companies receive the income distribution as tax-free dividend. If the beneficiary is a foreign corporation, there is no applicable withholding tax in Hungary.
The spouse, life partner, personal creditors of the trustee, and creditors of other trust assets managed by the trustee cannot lay claim to the assets of the trust asset. The trust asset does not constitute part of the trustee’s inheritance. The beneficiary and the settlor may take action against the spouse, life partner, personal creditors of the trustee, and creditors of other trust assets managed by the trustee, to secure the separation of the trust assets.