Risks and Liabilities for Legal Representatives in China

By Lukas Steinberg & Maarten Roos

Posted: 6th April 2012 10:08

The legal representative is the person with the broadest individual authority in a company in China.  Unlike in other countries, PRC law requires that only one person – either the chairman of the board of directors, the executive director or the general manager – is appointed by the investor(s) to represent the company on its 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 authorise legal representation of the company.  The legal representative’s authorities are only limited by law and – internally – corporate governance rules such as the Articles of Association (AoA).  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: Exceeding Duties and Posing Harm to the Company’s Interests

In general, actions of the legal representative that fall in his professional assignment are considered actions of the company herself, and therefore the company will be held responsible.  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.  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.

However, civil liabilities to the company may arise when the legal representative clearly violates the laws or AoA, 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, she 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 authorised 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 parts to 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 that the company finds 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: Senior Management Misconduct and Criminal Practice

A potential risk for the legal representative is posed by activities of other executive directors or senior managers that harm the interest 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 at the 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 lease to risks of criminal liability for the legal representative include, most notoriously, tax evasion, customs duties evasion, bribery, environmental crimes and manufacturing of counterfeit or substandard quality goods.  As the legal representative is in charge for 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 the 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.

Bankruptcy Proceedings: Travel Restrictions for Legal Representatives

In case the company files for bankruptcy, the legal representative will have to take on a heavy burden that even influences his private life.  To make sure that the bankruptcy procedure runs smoothly, PRC law determines that the legal representative is responsible for preserving the company’s assets, stamps, accounting books and any documents under his control, and he is obligated to co-operate with 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 permission of the court, and may not take up senior posts 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 process.

Some companies consider illegally withdrawing 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 even lead to criminal charges.

Conclusion

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 AoA and other internal rules, as well as stipulations on stamp use, and termination strategies.

Minimising personal risk is much more difficult, 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, be able to show that he has done all he could to prevent unlawful practices, and If the threat of (criminal) liability does present itself, respond quickly to minimise further risks to his person.

 

Lukas Steinberg was educated at University of Cologne, Germany and Shanghai University of Finance and Economics in German and Chinese Law Studies, Lukas has a good understanding of the various legal and cultural challenges that foreign entrepreneurs have to approach in China. Lukas speaks English, German and Mandarin Chinese, and due to his training in two legal environments he serves as an important intermediary between Western clients and R&P China Lawyers’ Chinese legal specialists. Lukas can be reached by email at steinberg@rplawyers.com.

Maarten Roos is the managing director of R&P China Lawyers, a Chinese law firm that provides practical legal solutions to foreign businesses in China (www.rplawyers.com). Maarten advises and represents European and US companies on investment projects and corporate restructuring, commercial transactions, IP protection and dispute resolution in China. Maarten is the author of Chinese Commercial Law: A Practical Guide (Kluwer Law, 2010), a popular guide on the legal and practical aspects to doing business in China, is fluent in Chinese, and has been on the list of Asialaw’s Leading Lawyers since 2008. He can be reached at +86 2161 738 270 or by email at roos@rplawyers.com

 

 


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