Companies in China are legally required to designate a Legal Representative together with a Director, Supervisor, and Finance Responsible Person. The Legal Representative is the primary signatory of the company and has the power and authority to enter into binding agreements on behalf of the company in accordance with the law and the company’s articles of association. This person, essentially, has broad control over the company and its business activities, bank accounts, and assets.
Due to the broad powers provided to the Legal Representative in China, foreign investors must carefully consider their candidates for this position. They do not want to find themselves in a situation where an uncooperative Legal Representative could be holding the company hostage or acting outside the best interest of the company and its shareholders.
As a result, foreign investors should understand the roles and responsibilities of a Legal Representative together with the potential risks and liabilities this person poses. It’s also important to create a segregation of duty and limit the powers of the Legal Representative as necessary to mitigate potential risks as much as possible.
The role of the Legal Representative in China
As defined by Article 13 of Company Law of the PRC (Revised 2018) a Legal Representative is a legal concept that refers to 1) a person appointed to 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 financial assets.
The designated Legal Representative is provided his/her own Chop. This chop acts as their signature and is required to be affixed on documents that require the Legal Representative’s authorization and/or signature – such as contracts and official documents for banking and government affairs.
Control of this chop is particularly important as anyone who physically possesses this chop can exercise the powers of the Legal Representative.
Liability of the Legal Representative
As the principal of a company, the Legal Representative faces civil, administrative, and criminal liability for their wrongful actions on part of the company. They may be held liable for fines and penalties accrued by the company for any wrongful behavior.
However, in practice, the company may be liable for actions of the Legal Representative including unauthorized behavior and actions which exceed his or her authority. Anyone who suffered losses due to their may hold the company liable as well.
The company, on the other hand, may claim compensation for fines, penalties, and other civil liabilities incurred resulting from the wrongful behavior of the Legal Representative. The company must demonstrate that it made a reasonable effort to define, document, and notify the individual of his/her responsibilities and authority.
The General Principles of the Civil Law of the PRC stipulate that if the Legal Representative or other staff engage in business activities in the name of the company causing economic losses to others, the company shall bear civil liability. This means that civil liability arising from the actions of the Legal Representative and other staff will be borne by the company. However, the company can claim compensation for economic losses caused by the Legal Representative and other staff for their inappropriate actions.
Article 49 of the General Principles of the Civil Law of the PRC states that the company as well as the Legal Representative shall bear administrative liability and may be subject to sanctions and fines for their wrongful behavior.
The following circumstances may give rise to administrative liability:
- Engaging in illegal business beyond the approved business scope;
- Concealing the true information from the registration authority or the tax authority, or resorting to fraud;
- Fleeing funds, concealing property, and evading debts;
- Disposal of property without authorization after being dissolved, revoked, or declared bankrupt;
- Failure to apply for registration and announcement in time for modification or termination of the Legal Representative, causing the interested parties to suffer heavy losses;
- Engaging in other activities prohibited by law that harm national interests or social public interests.
If the actions are severe, the Legal Representative may be investigated for criminal liability.
Both previously mentioned liabilities can be elevated to criminal liability based on their severity. According to the Criminal Law of the PRC, the criminal liability of the Legal Representative is contingent on his/her “direct involvement” in and being the “direct responsible persons in charge” of the crime committed by the company.
Unlike the previous two liabilities whose punishment is limited to economic penalty, criminal liability allows for imprisonment and other forms of punishment provided under the Criminal Law of the PRC.
Limiting the power of the Legal Representative
The broad powers granted to a Legal Representative can present great risks to companies if they are exercised in the wrong ways. A misbehaved legal representative can create significant challenges for a company to carry out its daily activities and investors may be surprised at the difficulty of removing such a Legal Representative in China.
Properly managing these risks becomes critical to enabling a Legal Representative to perform their role and ensure the long-term growth and stability of companies in China. Foreign investors can choose to limit their powers through the Article of Association, controlling the Legal Representative’s chop, and creating contingencies for removing a non-performing Legal Representative.
Articles of Association
The Articles of Association can define the role, responsibilities, and authority of the Legal Representative in addition to prevailing laws and regulations. This provides recourse by the company for unlawful actions by the Legal Representative if it is determined the company has made reasonable efforts to define the limits of the Legal Representatives’ authority.
The shareholders, in accordance with the Article of Association, may replace the Legal Representative if he or she is deemed to be unfit to carry out their duties. However, it should be noted, a legal representative cannot resign from the position without a duly appointed replacement.
Additionally, investors should also be aware the Articles of Association, and any changes thereto must be submitted and accepted by the Administration for Industry and Commerce to be valid.
Controlling the Legal Representative Chop
It is recommended that the Legal Representative’s chop is closely controlled including, by whom, when, and where the chop is used. The company may also designate a third-party “chop custodian”, bound by contract, to only permit the use of the chop according to internal control procedures and company policy.
Segregation of Duties
It is important that too much authority is not centralized in one individual. It is not uncommon for newly established companies to designate one person as the General Manager, Executive Director, and Legal Representative. In such cases, it may be extremely difficult to remove this individual without their cooperation. As a general rule, investors should appoint an Executive Director or Board of Directors independent from the Legal Representative and grant them the power to replace the Legal Representative should the need arise.