By Nicholas Hughes
Aug. 11 – Every business established in China, whether domestic or foreign, is required to have a legal representative. He/she is the main principal of the company and is the employee with the legal power to represent – and enter into binding obligations on behalf of – the company in accordance with the law or articles of association of the company. Essentially, the legal representative is someone who is appointed to act on the company’s behalf and Article 38 of the General Principles of Civil Law of the People’s Republic of China defines the role as the “responsible person who performs the duties and powers on behalf of a legal person in accordance with the law or the constituent documents of the legal person.”
However, foreign investors often have only a limited understanding of the legal representative’s role and are startled when they learn of their power and how difficult it is to replace an un-cooperative one. Legal representatives possess broad powers and potentially unlimited liability. When concluding a contract a legal representative’s acts are binding on the company even if he/she is acting beyond their authorized scope. Failure to properly understand the powers and responsibilities of a legal representative can therefore lead to a situation where foreign investors are held to ransom. In appointing a legal representative, it is vital to bear in mind that the legal representative will essentially have the full keys to the company, cash, and capital.
Amendments to the PRC Company Law require a new company established on or after January 1, 2006 to appoint a supervisor, or board of supervisors depending on the size of the company, whose role is to monitor the activities of the legal representative. Shareholders and employee representatives of a company can act as supervisors. However, members of the company’s board of directors or senior management may not simultaneously serve as supervisors. If a company has a board of supervisors, it must have a proportion of employee representatives which accounts for at least one-third of supervisory membership. The supervisor, like the company’s directors, is not required to reside in or visit China.
The main role of the supervisor is to safeguard and supervise the operation of a company and exercise supervision over the work of directors and senior management. The Company Law gives supervisors an array of powers, such as inspecting the company’s finances, supervising the company directors and senior managers, recommending dismissal of directors or senior managers who violate laws or damage the company’s interests, proposing shareholder meetings, and any other powers specified in the company’s articles of association.
The role of supervisor is very relevant to the potential liabilities of the legal representative as they are permitted to supervise and constrain the legal representative in order to reduce the potential risks of a rogue legal representative acting on behalf of the company.
Basic requirements and selecting a legal representative
The PRC Company Law does not impose any restrictions on the nationality of the legal representative and the selected individual could effectively be the resident of any country; he/she is also not required to reside in China. Under the Company Law, the legal representative may be the chairman of the board of directors, executive director (if there is no board of directors), or the general manager. However, the selection of legal representative varies depending on the structure of the company.
For a Sino-foreign equity joint venture, a board of directors should be established and its chairman will be the legal representative, which means the general manager cannot act in the same role. This also applies to a Sino-foreign cooperative or contractual joint venture in which either a board of directors or a joint management board may be established. For a wholly foreign-owned enterprise (WFOE), the chairman, executive director or general manager can act as its legal representative. The appointment of a legal representative, whether to a JV or WFOE, is required to be registered with the company registry authority and the legal representative’s name will also be on the company’s business license.
When choosing a legal representative for the first time, foreign investors typically choose either an existing employee (often lacking in China experience) or a new Chinese recruit (often lacking familiarity with the investor’s culture, policies, decision-making procedures and home-country compliance regulations). Foreign investors should select their legal representative carefully, and the legal representative should be made aware of the responsibilities and liabilities that come with the position.
Selecting an existing employee is often the favored route as the individual is familiar with the company’s culture and can be trusted and relied upon. Frequently, the preferred choice for legal representative is a director of the parent company since they also hold separate duties to the parent company under the laws of its place of establishment. The investor may then select a different person with greater local market experience as general manager.
Legal representative’s powers and responsibilities
The PRC Company Law does not clearly define the powers of a legal representative. However, it is clear that a legal representative is authorized to perform all acts regarding the general administration of a company according to the company’s aims and objectives. This may include:
- Acting (legally) to conserve the company’s assets;
- Executing powers of attorney on the company’s behalf;
- Authorizing legal representation of and litigation by the company;
- And executing any legal transactions that are within the nature and scope of that company’s business.
In China, every company is required to have a “chop” which will be in the custody of the legal representative. Control of the chop is important in order to minimize risks. The legal representative’s chop is required on numerous company documents and is regarded as a signature. In this sense, the legal representative plays a very important role in the company’s daily operations. Consequently, any person in possession of the legal representative’s chop may exercise their power to bind the company. In order to prevent unauthorized use, companies should restrict access to the legal representative’s chop by keeping records of who used the chop, at what time, and for what purpose.
Legal representatives are held by Chinese law to a higher standard of care and competence than other personnel, and they can face civil, administrative and even criminal liability for wrongful acts – both the company’s and their own. Accordingly, the legal representative may be subject to fines and penalties accrued by the company and, importantly, the liabilities of a legal representative extend to bankruptcy.
It is also critical to be aware that a company will generally be held liable for the unauthorized actions of a rogue legal representative. The Contract Law of the People’s Republic of China specifically provides that “[i]f the legal representative … of a [company] creates a contract in excess of authority limits, such representative action is valid except where the counterparty knows or should know that it exceeded authority limits.”
In order to persuade a court or arbitration tribunal to release a company from liability for an unauthorized contract or other action by its legal representative, the company will general need to demonstrate that it has made reasonable efforts to define, implement, record, and give notice of its legal representative’s authority limits.
Generally speaking, a company’s articles of association and related corporate documents, filed with the local Administration of Industry and Commerce, set the limits of the authority of its legal representative. However, in practice, counterparties may often argue that they are unable to view these documents to determine the legal representative’s authority. In order to avoid any difficulties it is important for companies to specifically limit a legal representative’s authority in the articles of association in order to minimize the risk the legal rep may expose the company to.
The liabilities of a legal representative can be divided into civil, administrative and criminal liabilities, each of which carries out different legal consequences.
The legal representative’s activities are deemed as activities of the company, which means that any civil liabilities arising from the legal representative’s actions are borne by the company. However, the company may claim damages from the legal representative for any losses caused by him/her.
A legal representative could be subject to fines and punishment if their company violates any PRC laws, in addition to any punishments meted out to the company. If the situation is serious, the legal representative may be subject to criminal liability.
The PRC criminal law imposes criminal liability on both the individual and the company who are in charge of, or responsible for, a company which commits a crime. As the main principal of the company, the legal representative will not be pursued with any criminal liability unless he/she participates in the crime and is directly in charge of or responsible for the crime of the company.
- Careful consideration should be given to the selection of a legal representative.
- The articles of association should sufficiently limit the legal representative’s powers.
- The legal representative should be required to sign and chop an undated termination-related documents before being appointed – termination of an uncooperative legal representative can be blocked if the outgoing legal representative does not sign the required documents as they need to approve their own termination documents.
- Companies should control the legal representative’s chop and establish procedure whereby chop use is closely monitored.
Dezan Shira & Associates is a boutique professional services firm providing foreign direct investment business advisory, tax, accounting, payroll and due diligence services for multinational clients in China, Hong Kong, Vietnam and India. For more information and advice regarding setting up and operating in any of these markets, please email firstname.lastname@example.org, visit www.dezshira.com, or download the firm’s brochure here.
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