THE IMPORTANCE OF YOUR LEGAL REPRESENTATIVE IN CHINA
By Adv. Michelle Tzhori, Partner and Head of China Practice
You are a foreign company that wishes to penetrate the Chinese market. You have already made all proper preparation for this big step: you have conducted a market research about the industry, learned about all relevant investment vehicles, created the right connections, relations and channels and found suitable managerial candidates to help you run your Chinese business; it is time to hit the road.
Among the first (out of endless) decisions a foreign investor is required to make after she has decided to penetrate China and register a Chinese foreign invested enterprise (FIE), is ‘who will be my Legal Representative in China’. Does it look simple? Yes, but it is not! If you have decided to incorporate in China and were requested to provide a name of a Legal Representative, please do not rush to give the name of your attorney that helps you register your investment in China. While your attorney will definitely support you along the long registration way, she will not serve as your legal representative in China.
The name of this important position may mislead the reader to believe that this role is a narrow legal role borne by a legal advisor, however, in practice, the Legal Representative role is a managerial position that grants the representative tight control over the Chinese FIE.
What is a Legal Representative and who can hold this position?
According to the PRC Company law, the Legal Representative of a company is a natural person who represents the company in the exercise of its rights and obligations. The legal Representative must hold the position of the Chairman of the Board, the Executive Director or the General Manager of the FIE. That is, the Legal Representative is a core management personnel of the FIE and is involved in the management and operation of the company on a regular basis.
The Scope of the Position
The Legal Representative has a broad power to act on behalf of the company and bind the company in any matter within the Business Scope of the company. According to the PRC Company Law, the actions of the Legal Representative may bind the company even if the representative acted beyond her authorities, unless the counterparty knew or should have known that the Legal Representative has exceeded her authorities’ limits.
How to Protect The Company Against a Hostile Legal Rep?
‘What might go wrong?’ you ask yourself while providing the name of your closest business friend in China to fill in the position of your Legal Rep. Well, many things can go wrong. In China, the Legal Rep is all-mighty. While holding the company’s chops and formation certificates, the representative can dictate the day-to-day operation, as well as the future, of the company. By failing to support the company – either by making unauthorized decisions, or by refusing to use the chops and certificates and refusing to apply the authorized signature on documents – the Legal Rep can actually paralyze the daily operation of the company.
There are various ways to protect the company against a hostile Legal Rep, including 1) beforehand – to constrain the powers of the Legal Representative through the Articles of Association of the company. This document is filed at the local Administration of Industry and Commerce and is accessible to business partners of the company, who can learn of the spectrum of authorities of the person they are contracting with. 2) Post factum – to apply to court in order to release the company from an unauthorized act of the Legal Representative or in order to gain control over the company and dismiss the Legal Rep.
The risks involved in bearing this position?
When a Legal Representative acts in compliance with the law and the internal rules of the company, it is usually the company that bears the legal consequences of the actions of its representative. In such case, the Legal Rep will not be personally liable for actions taken in the capacity of a Legal Representative. However, when a Legal Rep acts in violations of the rules and regulations, she may be subject to civil, administrative or criminal liability and penalties. Many individuals are therefore reluctant to accept this position.
Civil Liabilities Arising from Failing to Perform Fiduciary Duties
Articles 147 – 149 of the PRC Company Law define the fiduciary duties of directors and officers of a Chinese company, which include the duty of loyalty and the duty of care. These articles require the Legal Representative to act in good faith in order to promote and safeguard the company’s interests. If the representative acts in violation of laws – whether the state’s laws, the company’s AoA or internal laws – and causes damages or losses to the company, the Legal Rep might be required to compensate the company.
It must be emphasized that the duty to act according to law cannot be waived even if the Legal Representative was instructed by the Board to act in a certain way. The Legal Rep must use discretion and reject an authority granted to her by the board – if she finds such authority to be in violation of law.
Administrative and Criminal Penalties
The Chinese Civil Law stipulates that under certain circumstances, when an enterprise is found liable for improper or illegal activities, its Legal Representative may be subject to administrative sanctions and fines. If the offence constitutes a crime – e.g. illegal operations; concealment of facts from the registration and tax authorities; secretly withdrawal of funds or concealment of property in order to evade repayment of debts; disposal of assets without authorization after the enterprise is dissolved and other serious misconduct of an enterprise – criminal responsibility shall be investigated and the representative may be subject to criminal liability.
Do’s and Don’ts
Careful Selection of a Legal Representative: It must be emphasized that the Legal Representative is a trust-position and as such, must be well tailored in the Article of Association. If the owner of the parent company is the one holding this position, there are no special precaution measures to be taken. The farther the chosen person is from the investor’s corporate Headquarter and management, the broader and deeper the measures that must be taken beforehand should be.
Most investors prefer to choose a representative that is highly familiar with the parent company’s corporate culture and who holds a lead role in the Headquarter, therefore bears additional duties of loyalty and care towards the parent company. As such, the Legal Rep is obligated to not only promote the interests of the FIE but also safeguard the best interest of the shareholders – the investor – which sometimes is in conflict with the narrow interest of the FIE.
Limitation of power in the articles of association: The company’s articles of association, filed with the local Administration of Industry and Commerce, defines the authorities of the FIE’s officers and it is the best tool to limit such authorities.
Don’t put all your eggs in one basket: In order to bind the company, the Company Chop is applied on legal documents. In addition, sometimes it is required to present or submit various certificates of the company in order to bind the company in administrative bureaus. As such, it is recommended to ask another officer or trust person of the FIE, to hold in trust the company chop and registration certificates, and not to allow the Legal Representative to have possession over these tools. The use of the chop and the certificates by the Legal Representative will be allowed only to the extent the action is in line with the best interest of the company. In addition, Investors may want to closely monitor the use of the company chop (e.g. through a log book that records the use of the chop on legal documents).
Resignation documents signed in advanced: Some companies ask the Legal Representative to sign and chop an undated termination documents prior to the commencement of service, in order to be able to overcome the consequences of an uncooperative or malicious Legal Representative. This common practice must be reviewed in advance by a PRC attorney that specializes in the local labor laws, to ensure full compliance with the PRC labor laws.
*** Thanks to Jing Wang for assisting in the preparation of the article ***
Art. 43,the PRC General Principles of Civil Law
An enterprise as legal person shall bear civil liability for the operational activities of its legal representatives and other personnel.
Article 49 of the PRC General Principles of Civil Law