During the nearly 10 years of political and economic transformation In Hungary, the privatisation of the majority of state owned properties has created a market economy on the basis of a dominant private property structure. Large scale privatisation had practically been completed by 1997-98. The majority of nearly 2000 state owned or municipality owned enterprises were sold (these no longer fall under the responsibility of the state as an owner); 162 companies continue to work with majority state holding while in 102 companies the state is in a minority shareholder position (under 25%). In this short paper, I would like to summarise some thoughts, issues, and possibilities related to minority portfolio management in light of the current Hungarian legal regulations.

From a minority holder point of view, two aspects seem to be worthy of consideration: the options of the state for selling its property share, and the impact of the size of the portfolio on the operation of the company.

1. Selling of the minority portfolio

Considering exclusively from legal purposes the state is unlimited owner of the given share parcel or business share even in its minority position, the transfer thereof as a consequence of acts or legal rules in itself does not result in any kind of speciality, except for those described in the point 1.3. The Civil Code states one of the fundamental partial owner’s authorisations, the right of disposal which includes also the right in respect of transfer of the ownership right. Thus, it may be found that an owner having a holding of 1% in a given company is entitled to sell its property in the same way as the majority holder, is entitled in the same way to select the person of the buyer. Restriction may exist at the very most at identical level as for any owner (option right of the co-owners, agreement right of the closed share holding company in respect of transfer of the registered shares).

Even the seller’s responsibility of state does not differ from a privet owner, as the implied and right warranty system of the Civil Code does not make distinction in respect of the ownership percentage either.

You should face some limitation selling minority holding:

It is evident that for sale of the minority holding, certain such clauses which is normally applied by the state, but are unrealisable by the buyer as minority holder, because the involvement of its standpoint in a resolution is not guaranteed at the General Meeting (e.g. employment clause), are consequently qualified as invalid contractual provisions. Naturally the position when the buyer, together with the holding sold to it, exercises already a majority of the votes or when the voting right attached to the portion sold exceeds the holding calculated based on the par value and this provides a provision for decision, make exceptions for the above.

1.2 Specific selling procedure

Based on the Act on Privatisation, ("The state holding not exceeding 25% + 1 vote and not contributed to the privatisation portfolio may be offered by the owner, in a proportion of the assets, to the other members of the company or to the company, in this order of sequence ") the state has the possibility to carry out the sales by omitting the tender procedure.

1.3 Permanent state owned companies

The appendix of the Act on Privatisation provides a list of permanent state properties within the category of enterprising assets owned by the state. In the case of permanently state owned companies, the state holding has to reach a minimum 50%+1 vote. This act may also specify the minimum state holding level for exceptional cases with 25%+1 vote or for holdings with priority votes, i.e. „gold shares". In this latter case, the state held minority portfolio either cannot be sold or can only be sold subject to special Government decision.

Such a holding of a given company is considered as minority holding, for which the attached authorisations themselves do not provide or provide but in exceptional cases the operative direction over activity of the company or the possibility of participating in making of the decision mean the real position of deciding only in certain cases. This means that the minority holdings may and must be assessed not in themselves (strictly in quantitative terms), but together with the attached authorisations as a whole, mainly from legal and economic aspects.

2.1 From legal aspect:

The rights of the minority holder is ruled by the Act on Business Organisations (hereinafter as: Company Act). At the same time the respective provisions of the Act on Privatisation of 1995 shall also be taken into consideration. Under this Act, under minority holding we mean only holdings between 0% and 25% that do not provide an influence on the merits to the direction of the companies. For this reason, the holdings between 25% and 50% and the minority holdings between 0% and 25% shall be treated in a segregated way.

In quantitative terms, the Hungarian law attaches clear legal consequences to achievement of two minority holding limits, to that achieving 10% and that exceeding 25%.

The so-called minority protection provisions (e.g. convocation of the general meeting, possibility of Supervisory Board review, etc.) – authorisations that have rather a formal significance – are attached to the ownership of 10%. At the same time the ownership percentage achieving 25% + 1 vote holding is relevant in such matters referred to authority level of the general meeting, where the Company Act or the by-laws (Memorandum of Association) prescribe the qualified majority of the votes.

Based on the dispositivity principle, the Hungarian company law provides a great number of possibilities to the parties. Such possibilities include e.g. making the voting rights differing from the ownership percentage, providing different optional rights to the minority holding, implementing special share types, etc. The rights ordered to the „gold shares" of privatised Electric Companies provides a good illustration for these:

„At the General Assembly of companies, a positive vote from the priority share holder is needed for decisions on:

• reducing the capital of the company;
• issuing a new type of shares, or widening / narrowing the rights related to existing shares if this should have a negative or disadvantageous effect on the rights related to the priority share holder’s position;
• changing the main activities listed in company’s charter;
• the merger, split, transformation or final adjustment of the company;
• transferring a significant part of the main activity or operation of the company to another company (including subsidiaries);
• renouncing exclusive supplier rights in the public utility field specified in the company’s licence according to Act 48 of 1994 on the production, transport, and provision of electric energy (to be applied only in the case of utility company priority shares);
• nominating, electing, and recalling members of the Board of Directors and members of the Supervisory Board;
• dividend policy;
• development objectives.
• The priority shareholder is entitled to:
• request the Board of Directors in writing to convene a General Assembly;
• propose points for the agenda of the General Assembly to the Board of Directors in writing (with justification);
• request that the priority shares, anytime following a 5-year period after being issued, be withdrawn at a unit price of 10,000 HUF and destroyed;
• request that the priority rights attached to the shares be revoked.

 2.2 From economic aspect:

The economic content of the value of the minority holdings is fundamentally determined by the type and extent of the earning that the holder may rely on through the holding or alienation of the minority ownership percentage. In this respect partly the dividend generating capacity of the company and partly the marketability degree of the given shares or business shares have a substantial importance.

No economic problems in respect of minority holdings may be taken in themselves, but these may and must be investigated together with totality of the related authorisations. In general, a majority of the minority holdings are not included in the best qualified category, nevertheless they may be even appreciated which stands mainly for the company holdings sold to capital intensive professional investors.

3. To date experience of the Hungarian privatisation and State Holding Company (PSHC) with the minority holdings

The minority holdings of PSHC were originated decisively but not exclusively during the privatisation process in such a way, that the privatisation transactions covered only the majority holding of the companies.

During the first period of privatisation the holdings below 50% were equally considered as minority holdings and only on latest years begun a different approach on evaluation has only been adapted in the recent years.

The decisions in respect of sales of the minority holdings accelerated in 1996 and the submissions and resolutions dealing with sales of the minority holdings of PSHC at a more intensive rate were made at this date.

Meetings were held with the World Bank in 1996 on borrowing of EFSAL credit. The criteria system of EFSAL included the reqirement that PSHC should sell its minority holdings up to the end of 1997 if possible. Until the date when it alienates its minority holdings, PSHC would be required to behave as a passive shareholder. Furthermore the EFSAL conditions included that it would not apply a limit price for sale of the minority holdings, except for the cases when this is specifically prescribed by the law. This requirement forced PSHC to carry out on the one hand, a quicker privatisation of the minority holdings and to assure, on the other hand such an owner’s or more exactly privatiser’s behaviour, where accordance may be created between the passive share holding and the respective sections of the Company Act and Act on Privatisation. The below shall be taken into consideration for the behaviour as passive shareholder:

• PSHC may not disclaim its minority rights provided in the law in such cases when the Act on Privatisation prescribes a permanent state-owned minority holding (25% + 1 vote), considering that the purpose of the legislator was here just to create and maintain the possibility of an active minority behaviour.

• The Company Act states rules mandatory for the share holding companies. The Company Act divides the minority rights into two groups:
• the rights providing the so-called legality protection, which PSHC as minority holder, may not disclaim,
• the rights included in the authority level of the general meeting, where a three-quarter majority of the votes is required in the most cases. In such cases a passive shareholder’s behaviour means, that the state owner (in this case: PSHC) votes together with the majority holder.

On the practise of privatisation co-ordinance must be found between the principles drafted in the Act on Privatisation and the expectations. Decision was made for making of a privatisation portfolio package and for closed sales.

Reasons for the decision:

• acceleration of the privatisation for economic policy reasons in compliance with the expectation of the Government,
• the sales in portfolio packages allows to PSHC to sell many companies at the same time,
• such a scope of the companies may be so sold, for which the ownership percentage of PSHC does not make possible an effective intervention into operation of the company.

One of the forms of this is the development, creation and management of the strategy and framework of the so-called simplified privatisation. The rules of the simplified privatisation are included in the Act on Privatisation. During the simplified privatisation, PSHC announced decisively minority holdings, however not only the minority holdings, but also the majority owned small and medium sized companies below a certain limited equity and staff number were also involved in the same list of sales. Therefore, during the simplified privatisation, the state owned holdings of all such business organisations could be put into this category, where the equity of the business organisation did not exceed HUF 600 million (2,5 M EURO) and the staff number employed in full time did not exceed 500 persons.

The companies included in the list disclosed during the simplified privatisation have a heterogeneous composition, their profile, scope of activity, competitiveness, viability, capital intensity, market conditions, role played in the region are extremely varying.

Joint feature of their sales method:

• simple privatisation method
• quick cash revenue
• quick change of the owner and so:
• (expected) efficiency improvement.

The decision covered 114 companies, out of which:

• for 88: the ownership percentage of PSHC is between 0.01%-25%, the value of the subscribed capital for sale is HUF 5,76 billion (24 M EURO),
• for 26: the ownership percentage of PSHC is between 25.01% and 50%, the value of the subscribed capital for sale is HUF 4,53 billion (18,9 M EURO).

The simplified privatisation was announced in three paces, in 1995, 1996 and 1997. There are different opinions on the efficiency of the method, however it is a fact, that 131 companies were bought at an average price of 50%-51% if rated to the subscribed capital.

In addition to the simplified privatisation, there were cases when minority holdings were placed in a privatisation portfolio package and offered for a change of shares.

PSHC established more companies for gathering and more efficient management of the minority holdings. PSHC has minority holdings even currently, however the decomposition rate of the state assets does not make necessary the realisation their quicker privatisation.

4. Conclusions, considerations

It is worth to supervise the practice in respect of minority holdings after finishing the privatisation in great rate and it is advisable to summarise the experiences in order develop a more efficient policy of „portfolio-handling". The legal possibilities would give the opportunity to increase the economic „weight" of the minority holdings in certain cases in favour of a more efficient operation or higher benefit. The minority holding is not appropriate for direction of companies, but it may be set as an economic strategy what we wish to achieve on a longer or shorter term. The PSHC - as minority shareholder - should and may apply different strategies under different circumstances.

It is worthy to consideration of follow, instead of passive behaviour, a more active, a more critical and from case to case a more aggressive behaviour for the companies, where though PSHC is in minority in mathematical terms, however it is the largest shareholder if considering its business position. Nevertheless we have to see also that the possibility of the state as minority holder is rather restricted because of the more difficult decision making mechanism and the vulnerability of the "expectations" from the state.

The expectations of the minority holder of companies listed on the stock exchange may be different. For successful companies operating with efficiency on a long term basis, the dividend revenue may be a goal, but in the current position of the Hungarian economy, "coupon cutting" as a source of revenue remains in the eclipsed of the price revenue attributable to movement of the share premium.

In a company that is loss maker, the state-owned minority holding requires really only further state supports, which might be an indirect goal of the majority owners as well. If we wish to further operate and/or monitor the minority holdings as organised in a portfolio package, the main purpose is increase of the assets. This may be achieved through the dominant role played in the executive boards. Also this requires a change of the views, as the legal ruling of the Company Act gives possibility for option this, but we did not use it appropriately up to this date.

If the purpose is to sell the minority holding, then the selection of the optimal price and date is important. We may determine our owner’s behaviour on this bases, which - in order to achieve the purpose - may be even „unpleasant" for the majority owner. According to the experiences gained to date we met such methods of the majority holders, that were addressed to depreciate and clear out of the company because of transitional or short term interests. In these cases, unfair business purposes are not rare, and the minority holder should consider its legal possibilities in order to minimise loss.

As minority holder, the purpose may be to gather information to both the private and state owners. This practice is followed particularly by concurrent companies, not with small result. For a state owned company this may not be a long-term target, however we might not fully set it aside.

4.4 Enforcement of the rights attached to the gold share

We may achieve certain strategic goals and/or participation in the decision processes through the so-called gold share (described in the point 2.1), nevertheless we consider its role to be reduced more and more, as it is very difficult - according to experiences - to validate the rights granted by law.

In summary

The state as an owner has to review, from time to time, its role as an owner, revise its economic policy and, within that its property policy according to the requirements of the given economic environment.

It is relatively easy to calculate where and under which conditions a larger privatisation revenue can be achieved, nevertheless the strategy followed by the state for its minority holding is strictly attached to this. The current flexibility conditions of PSHC does not make possible e.g. to carry out operations at the stock exchange, that is to increase the state revenue either by price revenue or at dividend side through circulating the shares of the companies belonging to it at the stock exchange.

In my view, the state has to play a responsible role in handling its minority portfolio through its bodies founded for the management and utilisation of its property with considering continuously the interest of minority holders in parallel to its own interest. These aspects have to be considered when amending the actual law of privatisation.

Prepared by Dr Árpád Kovács and Emil Kemény, Hungarian State Audit Office (using the Study of PSHC), Budapest, 31 May 1999