The issue of governing law often arises in cross-border M&A deals or contractual relationships. At such times – either due to the UK domicile of a contracting party, or to the widespread use of the Anglo-Saxon templates – it is often the English law that is chosen. It may turn out to be important to understand the difference it can mean to the parties’ positions if instead of Hungarian law they were to opt for English law – for example, when drawing up the documents for a company acquisition.
The most important and most closely scrutinised aspect of all M&A transactions is the extent of liability undertaken by the seller for the past of the company. If we rely purely on the provisions of Hungarian law, the seller’s warranty liability will only extend to the shares of the company being free from encumbrances and claims, and not to the company's legal, financial or business status.
Contracts concluded under Hungarian law have, however, recently adopted the concept of “representations and warranties” from the English-speaking world, that is translated simply as ”szavatossági nyilatkozat” (warranty declaration). If any such “warranty declaration” of the seller later turns out to be untrue, the seller must indemnify the buyer for its losses incurred as a result of this, under the general rules of civil law.
It’s important to bear in mind that if the contract is subject to UK law, then a breach of the representations and warranties could incur slightly different sanctions to those described above. Any “misrepresentation” may result in other sanctions – for example, the right to rescission – over and above the indemnification claim. For example, if the seller warrants that the target company is not under liquidation, and it later turns out that this representation was untrue, then – if UK law is chosen – the buyer could actually rescind the contract if it proves that acquiring a company under liquidation is not in its interest.
Contracts following the English model often contain an “indemnity” clause, based on which the seller incurs a payment obligation towards the buyer upon the occurrence of some predefined event (for example, the enforcement of a claim against the target company).
In contracts governed by Hungarian law, this tends to be translated as “kártalanítási kötelezettség” (compensation obligation). Although there is not yet any Hungarian case-law in this regard, presumably the court would require proof that all the conditions for the indemnification or compensation are in place, in order for an indemnity clause to be enforced. This means that the buyer would have to prove, among other things, the extent of the losses suffered, and the existence of a causal relationship between the event and the losses.
Indemnity is judged differently, however, if the contractual provision is based on English law. This is because, in the UK legal system, the seller’s liability is triggered immediately in the case of a payment obligation based on indemnity, regardless of whether the buyer has incurred a loss. In other words, in the above example, if the liquidation was a consequence of a threatened tax audit or fine and the seller undertook indemnity for this, then the sum in question must be paid to the buyer without any need for it to prove that it has incurred losses as a result.
What’s in a name?
Contracts written on the basis of English law often use expressions with subtleties of meaning that have no particular relevance in Hungarian law, but which are nevertheless important in contracts concluded under English law. For example, in a contract under Hungarian law it matters little whether the parties refer to a commitment as an “undertaking” or a “covenant”. Under English law, however, an “undertaking” is a more serious commitment than a “covenant”, because the financial expenditure necessary for fulfilling an undertaking is not regarded as limited in English legal practice.
Similarly, in English legal practice it makes a difference whether someone agrees to make its “best effort” or its “best endeavours” to fulfil an obligation. While in contracts concluded under Hungarian law, both phrases would probably just mean that the contracting party agrees to “do all in his power” to achieve the specified objective, under English law “best efforts” require more effort than “best endeavours”; and, according to case law, the latter is also held up against a standard of reasonableness.
So which legal system is more favourable?
Like most questions asked of legal advisers, there is no simple answer to this one either. Naturally, the use of a foreign legal system will entail certain complications, a diminished sense of security and, due to the involvement of foreign legal advisers, additional costs. It is particularly ill-advised to stipulate a foreign governing law if the judicial body presiding over the case will be Hungarian: untold complications and additional costs could be incurred if a Hungarian court will later have to interpret English law.
On the other hand, if the parties use a contract based on the English model, there are several arguments in favour of stipulating English law. While the interpretation of certain expressions used in English legalese may be backed by hundreds of years of case law, it is often highly uncertain how a Hungarian court will interpret a commitment that has been borrowed from English law but is articulated under Hungarian law. And this could easily lead to unpleasant surprises for either of the parties to the contract.