Corporate Governance: Understanding the Four Legal Roles in China
The four legal roles in China are ultimately responsible for the operations and governance.

by | Jul 26, 2022 | Legal

When establishing a company in China, shareholders are required to appoint individuals to fulfill certain roles as required by Company Law in China. These roles carry implications for both the individuals and the company as they collectively serve as the decision maker of the company and are ultimately responsible for the operations and governance of the company. Thus, it is important to carefully select individuals to serve in these positions from a legal as well as a practical perspective.

Normally, there are certain key positions to be appointed within a Chinese company; namely, a legal representative, executive director or board of directors, supervisor or board of supervisors, and general manager. The basis for the legal roles in China is found in the Company Law of China which outlines the duties and responsibilities of these positions and establishes the fundamentals for corporate governance in China.

The Company Law of China further grants companies to specify the duties and responsibilities of each legal role in the Articles of Association. These provisions should only supplement the duties and responsibilities of the legal roles but shall not replace the provisions of Company Law of China unless clearly stated.

 

 

Duties and Responsibility of Shareholders in China

 

The shareholder of a company in China can be either an individual or an enterprise. Shareholders have the highest level of authority and can decide the key positions in the company. It is important to note that none of the individuals serving any of the legal roles can be removed without an immediate replacement.

 

The duties and responsibilities of shareholders are as follows:

  • Decide on the business direction and investment plan of the company;
  • Elect or replace directors and supervisors who are not representatives of the employees and decide on the remuneration of the directors and supervisors;
  • Review and approve reports of the board of directors, reports of the board of supervisors or the supervisors, as well as the annual financial budget plan and financial accounts plan of the company;
  • Examine and approve the company’s plans for profit distribution and loss recovery plan;
  • Adopt resolutions on the increase or reduction of the registered capital of the company, the issue of corporate bonds, and the merger, division, dissolution, liquidation, or change of company structure;
  • Amend the articles of association of the company; and
  • Other functions and responsibilities provided in the company’s articles of association.

 

Convening a shareholders meeting

Shareholder meetings fall into two categories, general meetings convened according to a fixed schedule stipulated in the Articles of Association of the company and interim meetings. Shareholders who hold more than one-tenth of the voting rights, or one-third of the board of directors or board of supervisors may convene an interim shareholder meeting by providing at least 15 days prior written notice to shareholders.

 

Liability of shareholders in China

Shareholders are liable for the debt of the company up to the portion of the registered capital not yet paid into the company. In other words, shareholders can be personally liable for the difference in the registered capital and the paid-in capital. Shareholders can also be held personally liable for intentional fraud designed to divert funds and put creditors in an unfavorable position.

 

 

Legal Representative

 

The legal representative carries an important role and is responsible for performing duties on behalf of the company. The legal representative is the primary signatory of the company and has the power and authority to enter the Company into binding agreements with other parties.

The role of the legal representative is to 1) exercise the rights in accordance with the law and the will of the enterprise; 2) be responsible for organizing and leading production and business activities within the enterprise; 3) represent the enterprise externally, with full authority to handle all civil activities.

 

In practice, he/she generally performs the following duties:

  • Entering the Company into contractually binding agreements;
  • Executing power of attorney for banking, administrative, and government affairs;
  • Authorizing legal representation for litigation by the Company;
  • Safeguarding the company’s assets.

 

The legal representative can simultaneously serve as the executive director (or chairman of the board) or the general manager of the company.

 

Liability of the legal representative in China

The legal representative is not liable for the debt of the company. However, as the principal of the company, he/she can be held liable for civil and administrative penalties for wrongdoings on behalf of the company. The legal representative is held to a higher standard than the other legal roles due to his/her broad responsibilities. Their personal liability can include wrongdoings in which they are directly involved or for matters they should have been aware of and failed to prevent even when the legal representative was not directly involved.

Thus, the legal representative faces significant liabilities if they are not careful and should be cautious in organizing and leading the business activities to ensure compliance with the law.

 

Read more on The Role of the Legal Representative in China.

 

 

Executive Director and Board of Directors

 

For large-sized companies in China, a board of directors with between 3 and 13 members is required to be appointed by the shareholders of the company. A board of directors must include a chairman of the board and may include a vice-chairman of the board. Small and Medium Enterprises (SMEs) can choose to appoint a single executive director in place of a board of directors.

The executive director shall be accountable to the shareholders and execute their duties and responsibilities in accordance with the law and the will of the shareholders.

 

The duties and responsibilities of the executive director include:

  • Convening shareholder meetings and reporting to the shareholders;
  • Executing the resolutions of the shareholders;
  • Deciding on the operational plans and investment plans of the Company;
  • Formulating plans on the following:
  • the annual financial budget plans and final accounts of the Company,
  • profit distribution plans and loss recovery plans of the Company,
  • increase or reduction of the registered capital of the Company and on the issuance of corporate bonds, and
  • merger, division, dissolution, or changes to the company structure;
  • Making decisions on the setup of the internal management of the Company;
  • Deciding on the appointment or dismissal of the deputy manager and the person in charge of finance and their remuneration according to the nomination of the manager;
  • Formulating the fundamental management system of the Company; and,
  • Other duties as stipulated by the Articles of Association of the Company.

 

Liability of the executive director and board of directors in China

The executive director or board of directors is not liable for the debts of the company. Shareholders can hold directors liable for civil penalties against the company resulting from their direct involvement in wrongdoings which resulted in economic losses to the company.

 

 

Supervisor and Board of Supervisors

 

The supervisor or board of supervisors acts as a check and balance on the executive director or board of directors and other senior management. They are accountable directly to the board of shareholders and are responsible for supervising the performance and implementation of the duties of the executive director or board of directors, legal representative, and other senior management.

 

The duties and responsibilities of the supervisor or board of supervisors are as follows:

  • Conducting inspections of financial issues of the Company;
  • Supervising the performance of duties by the executive director and senior management personnel and submitting a proposal on the removal of the executive director or any senior management person who violates laws or administrative regulations, the Company’s Articles of Association, or shareholder’s resolution;
  • Requiring the executive director or senior management personnel to correct their conduct that prejudice the interests of the Company;
  • Putting forward proposals to shareholders;
  • Filing actions against the executive director or senior management personnel in accordance with the law; and
  • Exercising other functions and responsibilities stipulated in the articles of association.

 

The supervisor may conduct an investigation if they discover any abnormality in the company’s operation and where necessary, may engage an audit firm and other outside parties to aid their investigation, with relevant expense borne by the Company.

The supervisor is also next in line to convene and chair a shareholder meeting if the executive director is unable or fails to convene a shareholder meeting.

For most SMEs, the supervisor is an inactive role in the company. However, they are important in the case of an uncooperative legal representative and/or director as they can step in and help pass a shareholder resolution to remove the individual.

 

Liability of supervisors or board of supervisors in China

As the role of the supervisor is to observe and report, the supervisor or board of supervisors is not liable for the debt of the company nor civil liability arising from the actions of the company. However, supervisors can be liable for aiding in the concealment of information with the intention of defrauding the company or creditors.

 

 

General Manager

 

The Company Law of China provides companies the ability to designate senior management roles in the company through the Articles of Association. A general manager is the only required role, however, additional roles can be created and appointed by the executive director based on the requirements of the company – such as a deputy general manager, CEO, CFO, and other senior management positions needed to carry out day-to-day activities.

 

The general manager shall be accountable to the executive director and exercise the following duties and responsibilities according to Company Law of China:

  • Managing the production and business operations of the company and organize and implement resolutions passed by the board of directors;
  • Organizing and implementing the annual business plan and investment schemes of the Company;
  • Drafting the plans for setting up the internal management organization of the Company;
  • Drafting the basic management systems of the Company;
  • Formulating company rules and policies;
  • Recommending appointment or dismissal of deputy manager(s) or financial controller of the Company;
  • Decide on the appointment or dismissal of management staff other than those positions which are to be decided by the board of directors or executive director; and
  • Exercising other responsibilities conferred by the executive director.

 

The Company Law of China provides the director with the ability to define the duties of a general manager in the Articles of Association which shall take precedence over the provisions above.

 

Liability of the general manager in China

The general manager and other senior management are considered regular employees under the company and cannot be held liable for the debt or civil liability of the company absent their direct involvement in the wrongdoings giving rise to the civil penalty against the company.

 

 

Finance Responsible Person

 

Companies in China are required to designate a finance responsible person. The duties and responsibilities of the finance responsible person are not clearly defined in Company Law of China or the Articles of Association. However, this person serves as the first point of contact for liaising with the tax authorities and is a required signatory for the company’s internal accounting documents for statutory audits and tax reports.

 

The duties of the finance responsible person can be summarized as follows:

  • Participating in the company’s major business and operation decisions
  • Planning the company’s financial strategy
  • Establishing a budget inspection and control system
  • Allocating the company operating funds and cost controls
  • Reviewing and approving company financial report

 

Typically, this role is assigned to a local accountant or an accounting firm to carry out this function on behalf of the company.

 

Liability of the finance responsible person in China

The finance responsible person is not liable for the debt of the company nor civil liability arising from the actions of the company. However, the finance responsible person can be liable for misleading or concealing information with the intention of defrauding the company, tax authorities, or creditors.

The finance responsible person can also be personally blacklisted in China’s social credit system for financial fraud committed by the company. This can impact other companies where the person serves as the finance responsible person due to their association with the blacklisted individual.

 

 

Guidance for Appointing Key Roles

 

Choosing the legal representative

With the broad responsibilities awarded to the legal representative, their influence over the daily operations can create potential risks for shareholders. The company can consider entrusting a third-party service provider, such as a lawyer or an accountant, to safe keep company chops. Chops will only be used and applied with the permission of designated persons agreed with the service provider beforehand to ensure no misuse of chops.

 

Segregation of duties

Assigning a single person to multiple roles such as executive director, legal representative, and general manager or a combination thereof consolidates many responsibilities onto one individual. It can often be difficult and time-consuming to remove this person if this person cannot live up to the shareholder’s expectations and may be detrimental to the company.

 

Corporate governance

Shareholders, directors, and the legal representative all have an important role in the governance of the company. It is important to understand clearly the duties and responsibilities of these roles to ensure the normal operations of the company and full compliance with PRC laws and regulations.

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