The System of Legal Security Interests Securing Loans in Hungary – A Practical Guide for Lenders (Part II)

Who is this article for and why does it matter?

This article series is primarily intended for lenders, financial institutions, investment funds and financing decision-makers who rely on legal security interests when structuring loans, investments or complex financing transactions in Hungary.

A clear understanding of the Hungarian security interest regime is critical for lenders, as the actual value of collateral depends not on its label or theoretical strength, but on its proper legal creation, perfection, registration and enforceability. A well-structured security package can materially reduce credit risk and improve recovery prospects, while formal or structural deficiencies may significantly weaken, or even eliminate, the protective function of otherwise strong collateral.

In the first part of this series, we presented the foundations of the Hungarian security interest regime and discussed pledges and mortgages as the most prominent forms of collateral. In the present article, we focus on other significant security arrangements commonly used in financing transactions, including cash collateral (security deposits), assignments of receivables, joint and several suretyship and guarantees. We review their legal characteristics, advantages and typical use cases in lending practice.

You can find the first part of this series here: The System of Legal Security Interests Securing Loans in Hungary – A Practical Guide for Lenders (Part I)

2.2. Cash collateral (security deposit)

Cash collateral represents one of the strongest and, in practice, the most rapidly enforceable forms of collateral under Hungarian law. Its essence lies in the fact that the borrower, or a third party, places cash, securities or other liquid assets at the disposal of the lender. Cash collateral must be structured in such a way that the collateral is clearly identifiable and transferred out of the obligor’s control and into the control of the secured party or otherwise removed from the obligor’s unrestricted power of disposition.

In the case of dematerialized securities and bank account receivables, cash collateral may be created by a written agreement between the account holder, the account servicing institution and the secured party, or alternatively, solely in favor of the account servicing institution, by way of a security agreement concluded between the account holder and the account bank. Where the subject of the cash collateral consists of cash, bank account receivables, or publicly traded securities with a readily available market price, the secured party may, upon the opening of its right to satisfaction, acquire ownership of the collateral by unilateral declaration up to the amount of the secured claim. This mechanism corresponds to what is commonly referred to as the right of direct realization.

Following the exercise of the right of direct realization, the secured party is required to provide a written settlement to the grantor of the collateral without delay and to release any collateral exceeding the amount of the secured obligation.

2.3. Assignment of receivables

Under an assignment, the borrower transfers certain receivables to the lender, enabling the lender to receive payment directly from the account debtor. Under Hungarian law, two legal aspects are of particular relevance in this context.

• First, an assignment is valid even without prior notice to the account debtor. Second, until appropriate payment instructions are received, the account debtor may validly discharge its obligation by paying the original creditor.

• Assignments may also be structured for security purposes, in which case the security assignment becomes enforceable only upon the borrower’s breach of contract, typically non-payment. In the case of security assignments, this has two important practical consequences. On the one hand, the assignment agreement must contain a detailed notification mechanism specifying when, upon which triggering events and in what form the account debtor is to be notified of the assignment and instructed as to whom performance is due. On the other hand, the lender’s risk exposure should be mitigated by ensuring that the account debtor is notified in writing of the assignment no later than upon the occurrence of the borrower’s default.

2.4. Other forms of security

2.4.1. Joint and several suretyship

Suretyship is regulated in detail by the Hungarian Civil Code; in financing practice, joint and several suretyship is the predominant form. Under a joint and several suretyship, the surety is obliged, upon the lender’s demand, to perform as if it were itself the borrower. The lender is therefore not required to wait to determine whether the original borrower is able or willing to perform, but may immediately pursue claims against the surety and demand performance from it.

From an investor’s perspective, typical examples include parent company sureties for the obligations of subsidiaries or shareholder sureties in project finance structures.

2.4.2. Guarantee

A guarantee constitutes an independent undertaking. Its most common form in Hungary is the bank guarantee, although guarantees provided by parent companies in respect of the obligations of their subsidiaries are also encountered in practice. In the case of a guarantee, the guarantor, typically a bank, is obliged to pay the beneficiary upon the fulfilment of the conditions specified in the guarantee, irrespective of the underlying contractual relationship.
The Hungarian Civil Code regulates guarantees as a security instrument distinct from suretyship, a distinction that is particularly relevant in cross-border and international transactions.

3. Prohibition of fiduciary security arrangements

Hungarian law generally does not support the creation and use of security arrangements involving the transfer of ownership for security purposes. More precisely, Hungarian law contains a general prohibition on arrangements under which a lender acquires ownership of collateral provided by a consumer borrower. It should be noted, however, that this prohibition applies exclusively to contracts concluded with consumers. Security arrangements in transactions between business entities therefore fall outside the scope of this restriction and remain permissible under Hungarian law.

Combining security interests

In practice, it is common for lenders to rely on multiple forms of security simultaneously. A combined collateral structure enhances the stability of the security package and reduces the lender’s potential loss exposure. Hungarian law permits multiple security interests to be applied in parallel to secure the same claim. Typical combinations encountered in Hungarian lending practice include

• mortgages over real property combined with assignments of receivables,
• security interests over movable assets combined with cash collateral, and
• comprehensive structures combining mortgages, cash collateral and assignments of receivables.

Pledge or assignment – practical considerations

The selection of the appropriate security arrangement also depends on a number of practical considerations, which should be assessed in advance in order to determine the optimal structure:

• What is the subject of the security?

Where the collateral consists of specific tangible assets, a pledge or mortgage is typically the appropriate solution.

Where revenues or future cash flows constitute the primary source of repayment, an assignment of receivables is generally advisable.

• What is the borrower’s revenue-generating capacity?

The borrower’s revenue-generating capacity is also a relevant factor. Where the borrower has a stable customer base and long-term contractual relationships, assignments of receivables may provide effective security. By contrast, where revenues are uncertain or volatile, asset-based security interests, such as pledges or cash collateral, are generally more favorable from the lender’s perspective.

Following this overview of the operation and combinability of various security instruments, the next and final part of this series addresses how these security arrangements may be effectively enforced in practice. In particular, we examine the legal and administrative requirements of enforcement, the practical significance of priority and ranking, the enforcement process itself and potential pitfalls that lenders should be aware of.

How can we assist?

Our firm not only advises on the legal issues outlined above but also provides practical support in their implementation. Our expert team assists clients in the structuring, review and enforcement of security arrangements under Hungarian law, including the selection of appropriate collateral, the proper legal documentation thereof, and the handling of priority, registration and enforcement-related issues.

This article is provided for general informational purposes only, does not constitute legal advice, and should not be relied upon as a substitute for legal advice tailored to a specific transaction or factual circumstances.