Hungary and the Hague Convention

Thursday, 05 November 2015
Dr Istvan Illes discusses how Hungary treats foreign trusts and how Hungarian trusts are treated abroad.

 

Key points

What is the issue? The newly formed Hungarian fiduciary asset management agreement (FAM) is a civil-law legal instrument designed to look and act like a common-law trust.

What does it mean for me? The FAM regime provides an opportunity to establish trusts in Hungary, and a basis for the recognition of foreign trusts.

What can I take away? Although legal recognition of foreign trusts seems to be secured, their tax treatment is more problematic in comparison to domestic trusts.

Hungary adopted a fully functioning trust regime in March 2014.1 Although the country has a well-established legal system based on civil law, Hungarian trusts offer most of the functionality of their common-law counterparts.2 As a civil-law jurisdiction, Hungary does not have equity jurisprudence, which meant the trust regime was not easy to introduce. Legislators had to find a way to design a legal instrument that is not a trust in the common-law sense (as under civil law it is impossible to separate the legal title and the beneficial title), but looks and acts like a trust and complies with the principles of the civil-law system. The result is the fiduciary asset management agreement (FAM).

Hungarian trusts are contracts

To incorporate trusts into the Hungarian legal system, the legislator looked for a familiar form, alighting on the French fiducie, which regulates trusts as contracts. Hungary embraced the contract idea and enacted the FAM, a contract-based trust regime with lots of extra-contractual features. A good example is the self-declaration trust, which can be established by means of a unilateral declaration in a notarial deed (instead of a contract). Importantly, especially for settlors, trustees and beneficiaries, the FAM did not replicate the fiducie’s rigid nature and instead offers a high degree of flexibility, as is expected from any traditional common-law trust.

As Hungarian trusts are essentially contracts, a few questions necessarily arise: how will Hungarian trusts (i.e. the FAM) be treated outside Hungary? Will it be considered a trust or an atypical contractual relationship? Without international recognition, the use of Hungarian trusts would be rather limited. Similarly, it is also interesting to consider how the Hungarian legal system recognises trusts created abroad.

Treatment of Hungarian trusts outside Hungary

The answer to the first question lies in the Hague Convention of 1 July 1985 on the Law Applicable to Trusts and on their Recognition (the Convention). Even though Hungary is not a signatory, the FAM regime qualifies as a trust in terms of article 2 of the Convention.

Article 2 of the Convention sets out the following criteria, which, if fulfilled, qualify the legal instrument as a trust for the purposes of the Convention:

  • assets are to be put under the control of the trustee to benefit the beneficiaries or for a specific purpose; 
  • assets are to constitute a separate fund; 
  • title is to be vested in the trustee;
  • the trustee has the power and duty to manage, employ or dispose of the assets; and finally
  • the trustee is accountable.

Trustee’s control

At the heart of the FAM is the transfer of property from the settlor to the FAM manager (i.e. the trustee). The legal relationship between the settlor and the transferred property terminates once the transfer is complete. The FAM manager has almost free rein to do whatever is necessary to the FAM assets. This includes everything that the owner of property could do. The only restriction that binds the FAM manager’s powers is their duty of loyalty towards the beneficiaries, which requires them to foster and enhance the beneficiaries’ interests throughout the management of the trust fund.

Hungarian trust fund is a separate fund

Under the FAM regime, the assets transferred to the trustee comprise a distinct fund within the trustee’s property. The fund is sealed off from the trustee’s personal property and any other funds the trustee manages. No personal creditors, spouse or heirs may raise claims against the trust fund. The creditors of the trust fund have, except in some extraordinary cases, no access to the trust assets.

Legal title vests in the trustee

The FAM manager as trustee not only exercises control over the trust fund, but has full legal title to it. Accordingly, all public registers indicate the trustee as the owner of the registered assets. Nevertheless, the trustee is obliged to disclose their trusteeship to anyone with whom they deal.

Power and duty to manage, employ and dispose of property

The full legal title of the FAM manager entails the power to manage, employ or dispose of the FAM property. If the FAM manager exercises these powers in breach of trust (e.g. contrary to the beneficiaries’ interests), the transaction remains valid vis-à-vis a bona fide third-party purchaser; however, the FAM manager will be liable for the loss that the FAM and, ultimately, the beneficiaries have suffered.

Trustee’s accountability

The FAM manager as trustee is accountable to the settlor and the beneficiaries and must report to them on a regular basis. In addition, the settlor or the beneficiaries may at any time request the trustee to give extraordinary reports. If the trustee fails to comply, or the reports indicate a breach of trust, the settlor or the beneficiaries may hold the trustee liable and also have the power to remove them from office.

Recognition under the Convention

Hungarian FAMs fulfil all the criteria for trusts under the Convention. Although Hungary is not yet a signatory to the Convention, member states have the right to recognise Hungarian trusts. This has relevance both in terms of trusts’ legal recognition and their tax treatment. Some uncertainty naturally might derive from Hungary’s signature to the Convention remaining pending, but the conditions for international recognition of Hungarian trusts are in place. Time will tell how this works out in practice.

Treatment of foreign trusts in Hungary

Not only is the recognition of Hungarian trusts abroad important, but the recognition of foreign trusts in Hungary is of equal, or even greater, significance. Even though there is no judicial practice relating to the recognition of non-Hungarian trusts in Hungary, the new trust regime provides a solid basis for the recognition of non-Hungarian trusts. According to Hungarian conflict-of-law rules, if a non-Hungarian trust were brought before a Hungarian court, it would have to analyse the legal framework of that particular trust and look for the most similar Hungarian legal instrument – i.e. the FAM. Due to the obvious similarities, the court would be encouraged to recognise the existence of the foreign trust.

The legal recognition of foreign trusts, therefore, seems to be secured under the current trust regime. The tax treatment, however, is more problematic. Prior to the introduction of the FAM regime, Hungarian nationals could set up foreign trusts in Hungary under the choice-of-law provisions of the Hungarian conflict-of-law rules. This method, however, was not applied, as the tax treatment of trusts had severely adverse consequences. Even after the enactment of the FAM regime, the relevant tax regulations did not change. Although Hungarian trusts now have separate and tax-neutral treatment, these provisions do not apply to foreign trusts. Foreign trusts are still not treated in the same way as Hungarian trusts under the current tax system.

Conclusion

The adoption of the FAM regime was a big step forward for Hungary, providing a flexible and effective wealth-management solution. However, until Hungary accedes to the Convention, while the recognition of foreign trusts is ensured, the tax treatment of foreign trusts will remain punitive. Nevertheless, the FAM regime offers a competitive, flexible and secure solution for Hungarians and non-Hungarians seeking to set up a trust in the country.

 

  • 1. ‘New ground for the trust concept’, STEP Journal, volume 21, issue 10
  • 2.  For a comparison of Hungarian and Anglo-American trusts, see Professor Charles E Rounds, Jr and Istvan Illes: ‘Is a Hungarian trust a clone of the Anglo-American trust or just a type of contract?: Parsing the asset-management provisions of the new Hungarian Civil Code’, in 6 Journal of International Commercial Law (2015)
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Dr Istvan Illes

Dr Istvan Illes is an Attorney at PwC, Hungary.

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