Unlike in other countries, the law in China requires that only one person – either the chairman of the board of directors, the executive director, or the general manager – be appointed by the investor to represent the company on his behalf.
In other words, this one person has access to and control over the company’s assets and capital, and in most cases the company’s stamps. For foreign companies, it is therefore important to understand not only the powers that are transferred to this one position but also the liabilities that come with it.
On the one hand, the legal representative executes great authority in the company’s daily operations, as he is considered to act on behalf of the company and has the right to make decisions regarding the company’s assets, to confirm transfers, and to authorize legal representation of the company. The legal representative’s authority is only limited by law and – internally – corporate governance rules such as the articles of association.
On the other hand, the legal representative faces certain responsibilities that may lead to personal risks for wrongdoings either by himself or by the company and its employees, subject to civil, administrative, or even criminal liability.
Risks for the Company
In general, the actions of the legal representative that fall in his professional assignment are also considered to be the actions of the company itself, and therefore the company will be held responsible if something goes wrong. Even in cases where the legal representative exceeds his authority while concluding contracts and his actions do not comply with the actual intent of the company, the contract will be binding and the company will be held liable if the business partner reasonably believes that the legal representative acted on the company’s behalf.
Therefore, a legal representative that has not been carefully chosen can seriously damage the business. So it is vital to take precautionary steps. If the company can prove to the court that it has clearly defined and recorded the limits of the legal representative’s authority, it may ask a court to release it from the liability for the action.
Civil liabilities to the company may arise when the legal representative clearly violates the law or articles of association, or if his actions constitute malpractice, gross negligence, or intentional harm to the company’s interests. If the company suffers any losses from the legal representative’s actions, it can claim compensation.
Access to Company Chops and Termination of Employment
In China, business contracts are usually “signed” with the company stamp that is registered with the Public Security Bureau. In practice, the company stamp is much more powerful than a written signature. In fact, contracts are legally binding even without the signature of the company’s authorized representative, as long as they are properly stamped.
This can be convenient, as the person in charge does not have to be physically present to conclude a binding contract. Moreover, rules on stamp-use and procedures to restrict access and monitor use – with or without the assistance of a law firm – are key elements in managing and supervising the activities of senior managers.
Firing an uncooperative legal representative can be painful if the proper precautionary measures have not been taken in advance. For a valid termination of employment, the legal representative must sign and approve his own termination documents, and a person who is confronted with accusations of exceeding his competences and harming the business may have anything in mind but co-operating with the employer who tries to get rid of him.
It is not uncommon for a company to find itself in the unfavorable situation where a legal representative keeps the company stamps “hostage” and demands a financial settlement. A good strategy to facilitate termination is to ask the person to be appointed as legal representative to sign and stamp an undated termination agreement.
Risks for the Legal Representative
A potential risk for the legal representative is posed by the activities of other executive directors or senior managers that harm the interests of the company. Since the legal representative’s actions are considered as those of the company, he can only avoid joint liability for the misconduct of others if he can show credibly that he was not aware of the harmful acts, did not participate in them, or explicitly disagreed with them at board meetings.
Criminal activities of the company generally result in liability of the company itself. However, if the legal entity is charged with a crime, the persons directly in charge or the persons responsible for the crime may also bear criminal liability.
Illegal business operations that could lead to risks of criminal liability for the legal representative include tax evasion, customs duties evasion, bribery, environmental crimes, and manufacturing of counterfeit or substandard quality goods. As the legal representative is in charge of the company’s business activities, the illegal activities may be considered within the scope of his duties and therefore he could be held directly responsible.
When China’s infamous melamine milk scandal was exposed in 2008, the legal representatives of various dairy companies were held responsible for manufacturing and selling substandard goods and had to face criminal prosecution.
If the company files for bankruptcy, the legal representative will have to take on a heavy burden that can even influence his private life. To make sure that the bankruptcy procedure runs smoothly, Chinese law determines that the legal representative is responsible for preserving the company’s assets, stamps, accounting books, and any documents under his control and that he is obligated to co-operate with the courts and the bankruptcy administrator.
Unless a replacement is found to take over the responsibility for unpaid taxes and liabilities, the legal representative may be prevented from leaving his domicile without the permission of the court, and may not take up a senior post in another company. While the appointed legal representative is not required to reside in China, for those who are located in China this may result in a lengthy restriction on exiting the country.
A way to mitigate this restriction is to seek permission of the courts to appoint an agent (usually a law firm) to represent the (foreign) legal representative in the bankruptcy process.
Some companies consider to illegally withdraw their investments from China, even though this means that it will be extremely difficult to conclude any future business in the country. In this scenario, the legal representative may be jointly held responsible for failure to complete liquidation procedures, which can lead to criminal charges.
Limits and Rules
The legal representative occupies a powerful and important position in the company. Due to the broad scope of authority and access to the company’s most valuable properties, it is important to carefully choose the right person for the position and, even more, to make use of best practices to prevent abuse of power. This includes clear limitations of the legal representative’s powers in the articles of association and other internal rules, as well as stipulations on stamp use, and termination strategies.
Minimising personal risk is much more difficult as liability insurance is generally available only for directors of listed companies, and in any case, does not protect against criminal liability. Best practice is for the legal representative to know what is going on so that he is able to show that he did all he could to prevent unlawful practices, and – if the threat of (criminal) liability does present itself – to respond quickly to minimize further personal risks.