Every company in China, whether local or foreign, is required to appoint a legal representative. Armed with extensive powers, the legal representative is a position that wields considerable authority within an organisation. You are, therefore, well-advised to exercise prudence and care when choosing a new legal representative. A note of caution should be added: choosing a rogue legal representative can land you in hot water, which may lead to reputational loss and being blacklisted.
As the cliche goes, “with great power comes great responsibility”. If there is one particular individual in the organisation that is most at risk of being potentially exposed to liability at every turn, that person will be the legal representative, who is held accountable for all actions of the company.
This article walks you through some important considerations, the procedure for changing your legal representative in China and a checklist of documents required.
What is a “legal representative” exactly?
While China’s Company Law stipulates that all legal entities designate a legal representative, the role’s functions are rather loosely and ambiguously defined. According to the General Principles of the Civil Law, a legal representative shall administer the company in accordance with the purpose and methodology for achieving its goals as set out in the articles of association.
Contrary to the technical-sounding title, the role of a legal representative would roughly equate to that of what we call a CEO in the West. Some of the wide-ranging functions that fall within the scope of the role include:
- Legally conserving the company’s assets;
- Executing the powers of attorney on the company’s behalf;
- Authorising litigation and legal representation thereof on the company’s behalf;
- Entering into negotiations and signing contracts in the company’s name without needing to produce evidence of corporate authority.
Who can be your new legal representative?
Article 13 of Company Law requires that the role of the legal representative be assumed by the chairman of the board of directors, executive director or general manager of the company. Prior to 1 January 2020, only the chairman of the board of directors was eligible to take up the role.
Despite the restrictions imposed on the selection of a suitable candidate, there are no residence or citizenship requirements so long as the legal representative is a natural person, i.e., not a corporate entity or other forms of legal persons.
Furthermore, the following types of individuals cannot be legal representatives:
- A person with no or limited civil capacity, e.g., a minor;
- A person who has been convicted and sentenced for corruption, bribery, misappropriation of property, embezzlement of property or disruption of economic order, and less than five years have elapsed since the payment of the fine or end of the prison term;
- A person who has acted as a director or general manager of another company that has filed for bankruptcy or been declared insolvent and is personally liable, and less than three years have elapsed since the end of proceedings;
- A person who has acted as a legal representative of another company whose business licence has been rescinded due to non-compliance with the law, and less than three years have elapsed since the revocation.
What are the potential liabilities to watch out for?
Risks for your company
As mentioned in the introduction, the selection of a suitable candidate for the position is of paramount importance. The legal representative is given statutory power to represent your company, which, in practical terms, means that their acts as well as omissions can bind your company in relation to third parties. In other words, the legal representative’s wrongful acts that do not comply with the law and the provisions as set out in the articles of association could be considered wrongful acts committed by your company — even though you may not have authorised such acts.
Subject to certain restrictions relating to the legal principle of apparent authority, any commercial contracts entered into by the legal representative purporting to act on behalf of your company, even unbeknownst to you, shall be deemed to have been entered into in the company’s name. As long as the other party reasonably believes that the legal representative is acting on behalf of your company, the contract shall be binding — despite the fact that he/she exceeds his/her scope of authority.
Risks for your legal representative
Since liability operates as a two-way street, the legal representative also risks being held liable for wrongful acts committed in the name of the company by directors and employees, leaving him or her exposed to administrative sanctions or fines. The decision to appoint an “absentee” legal representative, or indeed become one, should be carefully deliberated and approached with utmost caution. According to Article 49 of the General Principles of Civil Law, the legal representative may be held liable if the company:
- Conducts illegal business activities that are beyond the business scope approved by and registered with the relevant authorities;
- Engages in fraudulent activities;
- Conceals material facts from the relevant authorities;
- Withdraws funds or conceals assets to evade debt payments;
- Disposes of assets without authorisation after a company has been dissolved, declared bankrupt or closed;
- Fails to register or make public announcements regarding changes to the company in a timely fashion, which as a result has caused material loss to interested parties;
- Engages in other illegal activities that harm the interests of the state or the public.
It is important to note that a strict liability standard is imposed on legal representatives, which means that they need not have actual knowledge of, or be personally involved in, any of the offending activities above to be held liable. Generally speaking, however, legal representatives are not exposed to criminal liability in respect of criminal acts committed in the name of the company, unless they have directly participated in the crime.
In the case of grave losses or damage, there is a tendency to pin all the blame on the legal representative, despite the lack of clarity surrounding this legally. This tendency is particularly pronounced in respect of liability owed to third parties, such as to employees, consumers and the general public.
In the context of safety and employment during the COVID-19 pandemic, legal representatives are exposed to heightened risk in the event of the company’s mishandling of employer—employee relations.
How to mitigate risk when appointing a new legal representative
Make sure that your articles of association and internal set of rules are clearly defined
In short, it is vital to ensure that proper corporate governance is in place, i.e., a system of rules, practices and processes that dictates how a company is to be run. Lines of power and accountability should be clearly identified in the articles of association and elsewhere; who calls the shots and for what? You can require your legal representative to abide by an internal set of rules established from the outset, stipulating them to obtain authorisation from the board before taking certain actions. It should also delineate specifically which actions shall be deemed his/her own personal actions and not that of the company.
Draw up an indemnification agreement
To assuage the legal representative’s well-justified fear of being potentially exposed to unlimited liability, an indemnification agreement can be drawn up. It can be a standalone contract or part of the employment contract itself. Essentially, an indemnification agreement provides the legal representative with protection against certain claims and losses arising out of or relating to his personal acts or omissions in his/her role as a legal representative. Moreover, the types and amount of damages can be limited, which should be determined on a case-by-case basis. Nevertheless, it is difficult to minimise the personal risk involved. The risk of incurring personal liability should be accepted as part and parcel of the nature of the role.
Tips on practical issues when changing your legal representative
Promptly register your new legal representative
Pursuant to the law, a legal representative must be registered at all times. Hence, from a procedural point of view, rather than just de-registering the former legal representative, you must replace him/her with a new one instead. In addition, according to Article 40 of the Administrative Regulations on Company Registration, an application must be filed within 30 days from the date of the passing of the company’s resolution in respect of the decision to replace the legal representative.
Plan ahead to ensure a smooth transition
It is important to account for the transitional period, namely the period between the removal of the existing legal representative and the official appointment of the new one. You can ask the existing legal representative (who is still officially registered) to grant the new one or another individual a power of attorney until the necessary formalities have been completed.
Take precautionary measures against a bitter and uncooperative former legal representative
In the event of your former legal representative committing violations, resulting in his/her removal from office, it is important to safeguard against malicious behaviour on his/her part. Given the importance of company chops, it may be a good idea to confiscate them in advance, since things can turn sour very quickly. It is not rare for resentful and spiteful legal representatives to take the company chop “hostage” and demand a “ransom” for it. In some cases, further precautionary measures may need to be taken, such as changing the authorisation codes for online banking as well as notifying key customers and other stakeholders.
This article has been provided courtesy of CW CPA, one of our long term service delivery partners in Greater China.