Understanding the Concept of a Legal Representative 

By: Daisy Xu, Attorney, Beijing Office & Matthew McKee, Foreign Legal Counsel, Beijing Office  

Introduction

At Lehman, Lee and Xu we are constantly advising foreign clients on all aspects of their foreign direct investment in China. One of the issues that we constantly come across is that of the concept of the legal representative. Many of our clients initially have little understanding of this position as there is no equivalent in common law countries. Our clients are continually surprised when we explain the extent of the power of the legal representative and how difficult it is to have them replaced should they be uncooperative. Failure to understand the powers and responsibilities of a legal representative can lead to the situation where a foreign investor is held to ransom. Unfortunately, such a situation, from our experience, is not uncommon. 

What is a legal representative?

A “legal representative” is a compulsory position required under the Company Law of the People’s Republic of China (the “Company Law”). A legal representative is defined in Article 38 of the PRC General Principles of Civil Law as the “responsible person who performs the duties and powers on behalf of a legal person in accordance with the law or the constituent documents of the legal person”. The legal representative of a company may be represented by the chairman, executive director or manager of a company in compliance with its articles of association and registered in accordance with the law. With the promulgation of PRC’s new Bankruptcy Law, a legal representative working in foreign invested enterprises (“FIEs”) will face more risks from 1 June 2007. Accordingly, companies will need to take more care in selecting a legal representative and legal representatives should be made aware of the responsibilities that come with the position. Furthermore, a recent amendment to the Company Law now requires all companies to appoint a supervisor whose role is to monitor legal representative’s behaviour and power..    

Representative's Powers & Company Liability

The Company Law does not articulate the extent of a legal representative’s power. However, it is clear that the legal Representative is authorized to execute all the company general administration acts, according to the corporate purpose. In that sense, he or she is able to undertake any necessary acts for the conservation or exploitation of a company's assets, authorise legal representation of the company and execute any legal transactions included in the nature of the business of the company.   

It is important to be aware that the company is liable for the unauthorized actions of a rogue legal representative. As classified by the PRC’s Contract Law, "If the Legal Representative … of a [company] creates a contract in excess of authority limits, such representative action is valid except where the counterparty knows or should know that it exceeded authority limits." Generally speaking, the limits of the legal representative’s authority are specified in a company’s articles of association and business licence which are kept by the local Administration of Industry and Commerce. In practice, counterparties may justifiably argue that they have no capacity to view these documents to determine the authority of the legal representative. Notwithstanding, it is important from a legal perspective to specifically limit a legal representative’s authority in the articles of association. A further protection would be to publicise the limits on the company’s official website - this would likely to be an effective approach providing sufficient public disclosure of the power of the legal representative. 

How to Select a Legal Representative?

Different foreign investors have different preferences for this legal representative. Some investors prefer to choose an existing employee even though they may lack management experience in the Chinese market. Other investors will select a new PRC recruit to be the legal representative. We generally advise our client against choosing the latter. We prefer they choose someone with experience in the company’s culture and whom they trust completely. A director of the parent company would represent a prudent choice as they would hold duties to the parent company under the laws of that country. The investor can then choose a different person to be general manager who has greater experience with the local market. The Company Law provides that a company’s Chairman, executive director or general manager can be the legal representative. 

Liability of legal representative

To be a legal representative does not only mean power, but the person will also undertake substantial personal risk.  The legal representative is potentially liable and subject to fines and penalties for the full range of company activities. Legislators require more care and competence from the legal representative than other personnel. Legal representative, as a senior officer of the company, will probably undertake civil, administrative and even criminal liabilities for the full range of company activities.  

Choosing a supervisor

What is the “supervisors” role? The Company Law has specified the company supervisor’s role as follows:

1. to inspect the company’s financial situation;
2. to exercise supervision over the acts of the directors and manager carried out while performing their corporate functions which violate laws, regulations or the company’s articles of association;
3. to demand remedies from a director or manager when the acts of such director or manager are harmful to the company’s interests;
4. to propose the convening of an interim shareholders’ meeting; and
5. other powers specified in the company’s articles of association. 

Furthermore, the supervisors may attend board meetings, present inquiries or proposal with regards to the issues to be determined by the board of directors. It is obviously that the supervisor is entitled to effectively supervise and constrain the legal representative. It is arguable that because of the existence of a supervisor, the legal representative may bear less risk for their individual actions on behalf of the company.  

Tips to avoid legal representative abuse

Our corporate governance tips to clients in relation to legal representative are as follows:

1. Take extreme care in selecting the person who will be your legal representative. It may be better to select a person not based in China.
2. Ensure that the powers of the legal representative are sufficiently limited in the articles of association;
3. Prepare resignation documents for the legal representative to sign upon appointment;
4. Establish a transparent procedure for the use of the company seals so that all transactions are recorded. We regularly advise clients to store their company seals with our office to avoid misuse. Many clients find the security of such an approach to outweigh any related inconvenience.
5. Take every effort to understand your China business rather than simply relying upon your senior people based in China

The above illustrations should not only raise investor’s attention to the importance of choosing a loyal and competent legal representative, but also assist in developing the appropriate mechanisms to reduce risk.

For more information about the firm, please visit our website at www.lehmanlaw.com.