Legal Representatives, Company Supervisors and their Roles and Responsibilities in China
One of the more common vehicles for entry into Chinese market is for foreign investor to establish a wholly foreign-owned entity (“WFOE”).
While a WFOE is the subsidiary of the foreign parent, it is also a Chinese company and governed by the Chinese Company Law. The Chinese Company Law requires that the Chinese company shall have an appointed legal representative. The two most frequently asked questions in my practice over the past years are: 1) what is a legal representative; and 2) if I am the legal representative what exposure do I have for acts of the company. More recently with the revised Chinese Company Law, effective January 1, 2006, many companies are asking what is the requirement for a supervisor or supervisory board, what role does the supervisor play and how much power does the supervisor have. This article seeks to address these questions and assist foreign investors in understanding these aspects of the corporate law in China.
In the fast paced and modern surroundings of Shanghai, it is easy to forget how young the foreign investment laws are in China. Before China adopted its “reform and opening” policy, almost all the companies in China were owned and controlled by government. The government decided for a company as to what to produce, where to sell the products, how to allocate the profit, and even who to be appointed as management personnel. Under this circumstance, a company did not have its independent personality, and the concept of legal representative did not exist then.
Beginning in the 1980s, market economy has been gradually developed in China. Legislators started to realize the importance of recognizing the independent personality of a company, as a result company has more freedoms to decide its business operation activities. Thereafter, Chinese government did not interfere so much with the company’s business activities as before or represent the company any longer. Instead, Chinese company has independent legal personality and is represented by its own appointed representative whom we call legal representative.
The legal representative of a company is its main principal of the company who holds a special position therein and is the officer with the legal power to represent, and enter into binding obligations on behalf of, the entity s/he represents in accordance with the law or the articles of association of the company. A legal representative’s acts, when concluding a contract, are binding on the entity, even where made ultra vires (i.e. beyond the authorized scope), unless the counterpart knew, or should have known, that the legal representative was exceeding his or her powers when entering into the contract.
Under the PRC Company Law, the Chairman of the board of directors, executive director (in case where there is no board of directors) or manager of a company can be legal representative according to the previsions of its articles of association. However, the selection of legal representative varies within different types of foreign invested enterprises. For a Sino-foreign equity joint venture (“EJV”), a board of directors must be established and its Chairman shall the legal representative, which means manager can not act as the same role. Either a board of directors or a joint management board may be established within a Sino-foreign cooperative or contractual joint venture (“CJV”). Where a board of directors is established within CJV, then the Chairman shall be its legal representative. However, manager can act as the same role if the CJV sets up a joint management board. While for a WFOE, either the Chairman, executive director or manager can act as its legal representative. Importantly, the appointment and change of legal representative of a company, no matter of JV or WFOE, shall be registered with the company registry authority. Since the legal representative represents a company, his/her name will also be indicated on the company’s business license.
Responsibilities, Qualifications and Forbidden Activities of Legal Representative
In China, a company must have a “chop” which will be, normally, in the custody of the legal representative. Many important corporate documents and contracts will need the company to stick its chop and the legal representative to sigh thereon. Most financial instruments even need the legal representative to stick his/her personal chop and/or his/her signature. Further more, the legal representative needs signing many application documents to the company registry authority when the company goes through establishment or alteration registration formalities with the authority. In this sense, the sample of signature of the legal representative shall be submitted to the company registry authority for recordal. In this sense, the legal representative plays a very important role in company’s daily operation. S/he shall exercise rights and performs duties within the permission of laws and regulations as well as the articles of association of the company, represent the company to participate in all kinds of civil activities subject to supervision of the company and relevant authorities. As main principal, the legal representative will be responsible for the company’s registration, production and operation, alteration and liquidation, as well as executing various legal documents. For instance, the legal representative of a company which is in the process of bankruptcy and liquidation shall be responsible for keeping and delivering the book accounts, records, chops, etc., presenting at the creditor rights’ meeting and answering inquiries from the creditors. While, the legal representative of a company against which a judgment is being enforced in a legal proceeding must go to the court to answer inquiry upon court’s summon.
Since the legal representative is the main principal of a company and may exert a decisive influence on the company, to act as the legal representative, s/he shall not satisfy any of the following conditions and, in practice, the company registry authority will also review those conditions:
(1) without civil capacity or with only limited civil capacity;
(2) being pursued with criminal punishment or other criminal compulsory measures;
(3) being ordered for arrest by public security bureau;
(4) having been sentenced to any criminal punishment due to an offense of corruption, bribery, encroachment, misappropriation of property or disrupting the economic order of the socialist market and five years have not elapsed since the completion of the execution of the punishment;
(5) being a former director, factory director or manager of a company or enterprise which was bankrupt and liquidated, whereby s/he was personally liable for the bankruptcy thereof, and three years have not elapsed since the completion of the bankruptcy and liquidation of the company or enterprise;
(6) being the legal representative of a company or enterprise, but the business license thereof was revoked and this company or enterprise was ordered to close due to violation of the law, whereby s/he is personally liable for the revocation, and three years have not elapsed since the revocation of the business license thereof; or
(7) having a relatively large amount of debt which is due but uncleared.
Since the legal representative holds an important position in a company and plays an important role therein, s/he can make full use of her/his position to damage the interests of the company, therefore, the Company Law prohibits the legal representative from conducting certain behaviors, otherwise, the income arising therefrom shall be owned by the company. These forbidden activities include but not limit to the followings:
(1) misappropriating the company’s fund;
(2) depositing the company’s fund into an account in his/her own name or in any other individual’s name;
(3) loaning the company’s fund to others or providing any guaranty to any other persons by using the company’s property without consent of the shareholders’ meeting, or board of directors, and in violation of the articles of association of the company;
(4) signing a contract or dealing with the company by violating the articles of association of the company or without consent of the shareholders’ meeting;
(5) seeking for business opportunities for himself/herself or any other person by taking advantages of his/her powers, or operating for himself/herself or for any other person any similar business of the company s/he works for without consent of the shareholders’ meeting;
(6) taking commissions from the transactions between others and the company into his/her own pocket;
(7) illegally disclosing the company’s trade secrets; and
(8) other acts inconsistent with the obligation of fidelity to the company.
Potential Liabilities on Legal Representative
The legal representative of a company has the power to represent the company, and his/her act will bind the company. To prevent the legal representative from abusing his/her statutory power, under certain circumstances, the legal representative may assume liabilities imposed by laws.
The liabilities of a legal representative can be divided into civil, administrative and criminal liabilities, each of which carries out different legal consequences.
Since the legal representative represents the company in many material aspects, normally, his duty-related behaviors shall be deemed as the activities of the company. The respective civil liabilities arising therefrom shall be born by the company, while the legal representative is not directly liable to any third parties. For instance, if a legal representative acts beyond the authorization, and the third party has no knowledge of that, the company shall first be bound by the act of the legal representative, however, the company, after having undertaken liabilities to the third party, may claim damages from the legal representative for its losses caused by him/her. So, in this sense, civil liability for legal representative in this context means compensation. Also, if the legal representative violates his/her obligations on diligence, loyalty and confidentiality to the company and causing losses to the company, the company may also claim compensation from the legal representative. Where the legal representative colludes with a third party to damage the interests of the company, then s/he shall be jointly liable, together with the third party, to compensate the company. If a WFOE is established by foreign individual(s) who also act(s) as its legal representative, but the legal representative impairs the interests of any creditors of the WFOE by abusing the WFOE’s independent legal person status or the shareholder’s limited liabilities, s/he shall bear several and joint liabilities for the debts of the WFOE.
Under a certain specific circumstances, if a company violates laws and regulations, its legal representative may have to subject to fines and administrative punishment in accordance with the procedures of the relevant PRC government authorities, in addition to punishment against the company. If the situations are serious, the legal representative may even have to subject to criminal liability which will be further discussed below. The circumstances where a legal representative may have to subject to administrative liability include the following situations where the company
(1) conducts illegal operations beyond its business scope approved by and registered with the registry authority;
(2) conceals facts from the registry and tax authorities and practises fraud;
(3) secretly withdraws funds or hides property to evade repayment of debts;
(4) disposes of property without authorization after being dissolved or declared bankrupt;
(5) fails in applying for registration and making a public announcement promptly when it undergoes a change or terminates, thus causing interested persons to suffer heavy losses; or
(6) engages in other activities prohibited by law, damaging the interests of the State or the public interest.
Though the fine imposed thereon in the above circumstances is only up to RMB 2,000 which is relatively low , however, where a company undergoes liquidation and if it conceals any asset, makes any false record in its balance sheet or property checklist or fails to pay off its debts before distribution of its assets, and the legal representative is liable for such activities, and may subject to a fine between RMB 10,000 and RMB 100, 000.
The PRC Criminal Law imposes criminal liability on both an entity and the persons who are directly in charge of or responsible for the crime of the entity which commits crime. In this sense, the legal representative as the main principal of the entity will not be pursued with any criminal liability unless s/he participates in the crime and is directly in charge of or responsible for the crime of the entity. In other words, though an entity commits crimes, however, its legal representative does not directly participates or plays an important role in the crime of the entity, s/he will not be pursued with any criminal liability just because s/he acts as the legal representative of such entity which commits crime. However, if the legal representative of an entity commits any non-duty-related crimes, s/he will personally have to subject to criminal liability.
The PRC Criminal Law provides for around 80 types of crimes which an entity may commit. The criminal liability for legal representative of an entity, if s/he shall be responsible for the crime of the entity, includes fines, public surveillance, criminal detention, imprisonment and even life imprisonment or death, as the case may be.
Supervisor and His Roles, Qualifications and Liabilities
The PRC Company Law requires any new company established on or after January 1, 2006 to set up a supervisor or a board of supervisors depending on the size of the company. Shareholders and employee representatives of a company can act as its supervisors. However, members of the company’s board of directors or senior management may not concurrently serve as supervisor. In the event of a board of supervisors, it must have a proportion of employee representatives which shall account for at least one-third of supervisory membership.
The main role of supervisor is to safeguard and supervise the smooth and lawful operation of a company. For this purpose, the law has delegated supervisor a board rang of rights, such as inspecting the company’s finances, supervising the company directors and senior managers, recommending dismissal of directors or senior managers who violate laws, regulations, the company’s articles of association, or shareholders’ resolutions, demanding directors or senior managers to make corrections if their actions will cause damage to the company, proposing interim shareholders’ meetings, making proposals at the shareholders’ meeting, initiating legal action against directors and senior managers, attending and speaking at the meetings of the board of directors and initiating investigations if s/he finds “unusual” circumstances in the company’s operations. The expenses which are necessary for supervisor to perform his/her duties will be borne by the company. A supervisor bears the obligations of fidelity and diligence to the company and may not take any bribe or other illegal gains by taking the advantage of his/her powers, or encroach on the property of the company.
Since supervisor also plays an important role in safeguarding the smooth operation of a company, the law has also imposed the same qualification requirements of being a supervisor of a company as those on legal representative above discussed.
In terms of legal liability, a supervisor will possibly have to bear civil and criminal liability. The law does not provide for administrative liability for supervisor. Where a supervisor of a company violates any law, administrative regulation, or the articles of association of the company during the course of performing his/her duties and thus causing losses to the company, s/he will be liable for compensation to the company. So the civil liability for supervisor in this sense means compensation again. How much the supervisor shall compensate the company depends on the degree of defaults of the supervisor and the losses of the company suffering therefrom. Similarly, supervisor will not subject to any criminal liabilities unless s/he participates in and plays a major roles in the crime of the entity s/he serves and shall be directly in charge of or responsible for the entity’s crime.
Unlike in most western countries, while in China, the position for legal representative is mandatory. The legal representative of a company represents the company in all material aspects, such as entering into contracts and participating in various civil activities on behalf of the company which shall bear all consequences thereof. While supervisor mainly safeguards the lawful and smooth operation of a company. So the law, on the one hand, has empowered both legal representative and supervisor with various rights and privileges, but on the other hand, also set strict qualifications of being a legal representative and supervisor.
Both legal representative and supervisor bear obligations on diligence and loyalty to the company, otherwise, they will have to subject to certain civil, administrative and even criminal liabilities. The law does not provide for administrative liability for supervisor. The civil liability of legal representative and supervisor mainly means compensation to the company if their duty-related performance has caused losses to the company. The administrative liability of the legal representative includes fines and administrative punishment if the company s/he represents conducts certain activities in violation of laws and regulations. Normally, both the legal representative and supervisor will not bear any criminal liabilities unless they participate in and play an major role in the crime of the entity they serve and are determined to be in charge of or responsible for the crime of the entity. Notwithstanding these liabilities, the possibility of being pursued thereof because of acting as legal representative or supervisor of a company is low if they are diligent and loyal to the company and operate the company within the permission by the law.
ABOUT THE AUTHOR: Bill H. Zhang
Bill H. Zhang is the managing partner of China Sunbow & Associates with rich experience in cross-border transactions involving China, particularly on corporate and commercial matters, such as mergers and acquisitions, direct investment, corporate governance and compliance, restructuring and reorganization, labor and employment, and dispute resolutions, as well as on intellectual property transactions such as patent and trademark prosecution, enforcement, dispute resolution, infringement analysis, due diligence, license and transfer. He has advised many multi-national companies on merging and acquiring Chinese enterprises, making investment, resolving commercial disputes in China and represented them to register, prosecute and enforce various trademarks, patents and copyrights in China.
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Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer. For specific technical or legal advice on the information provided and related topics, please contact the author.