China: Minimizing the Risks that Legal Representatives Face

Last Updated: 4 February 2012
Article by Liu Xiang and Xia Dongxia

Under PRC laws, the legal representative of a company is the person who acts in the name of the company and represents the company in the exercise of its rights and obligations. The legal representative is a fundamental part of a company's corporate governance structure. To an extent, the person who is appointed to the position of the legal representative is authorized to conduct many of the company's affairs. However, the legal representative must fulfill certain duties while exercising his/her rights. This article will briefly introduce the potential legal risks that a legal representative may face under civil, criminal and administrative laws and how such risks are often prevented or minimized based on China's legal practices.

  1. The legal representative of a company should also be its board chairman or its general manager

Article 13 of the PRC Company Law (2005 revision) stipulates that,

"the legal representative of a company appointed under its articles of association shall be its chairman of the board of directors, its acting director or its manager and shall be registered as such in accordance with the law. Where the legal representative of the company is changed, the company shall comply with the formalities for amending its registration."

According to this provision, a company's legal representative must meet two conditions: she/he must: (a) be the core management personnel of the company, i.e. the chairman of the board, the general manager or executive director of the company; and (b) complete the formalities for application or amendment of business registration.

  1. Potential legal risks for a legal representative

Generally speaking, when a legal representative acts in accordance with the laws, administrative regulations and articles of association of a company, such acts shall be deemed acts of the company and the liability arising out of such activities are assumed by the company. In other words, a legal representative is not responsible for the actions he or she performs on behalf of the company.

However, under certain circumstances, especially when a legal representative is in breach of laws, administrative regulations or the articles of association of the company, the legal representative may have to bear civil, administrative and/or criminal liabilities for activities of the company due to the special capacity and duties of a legal representative.

  1. Potential civil liabilities of a legal representative
  1. A company shall assume civil liability for the business activities of its legal representative

    Article 43 of the PRC General Principles of Civil Law stipulates that,

    "a company shall assume civil liability for the business activities of its legal representatives and other employees."

    Generally, the operational activities of a legal representative in the name of a company fall within the scope of "business activities". Civil liabilities arising out of such activities will be assumed by the company. Hence, a legal representative will not personally bear civil liability in this context.

    Furthermore, if a legal representative acts ultra vires and causes the other party to the transaction to reasonably believe that he or she was acting on behalf of the company, such activities will constitute agency by estoppel and the company will assume the civil liabilities arising out of that transaction.

  2. A legal representative may be liable to compensate for losses suffered by the company when such losses arise either intentionally or due to gross negligence of the representative.

    Article 150 of the PRC Company Law stipulates that,

    "where any director, supervisor or senior manager violates any law, administrative regulation or the articles of association in the course of performing his duties, he shall be liable to compensate the company for any losses thereby caused to the company."

    Therefore, even where the losses of a company were caused by the activities of a legal representative who violates a law, administrative regulation or the articles of association of the company in fulfilling his or her duty, the legal representative will still be liable to compensate for the said losses upon the request of the company.

  3. A legal representative may be liable to compensate for losses caused by the directors, supervisors and/or senior mangers who harm the interests of the company
  4. Article 150 of the PRC Company Law stipulates that,

    "the directors, supervisors and senior managers of a company shall comply with laws, administrative regulations, and the articles of association and shall owe fiduciary duties and a duty of care to the company. No director, supervisor or senior manager may obtain bribes or any other illegal gains by taking advantage of his or her position or misappropriating company assets for personal use."

    According to Article 211 and 1492 of the PRC Company Law, if the de facto controller, directors, supervisors or senior managers of a company breach their fiduciary duties and duty of care to the company and harm the interests of the company, they shall be liable to compensate the company for any losses caused thereby.

    If a legal representative performed the said activities himself, he or she certainly will be liable for losses thereby caused to the company.

    In addition, where other directors, supervisors or senior managers conducted these activities and harmed the interests of the company, they shall be liable for losses suffered by the company. If the legal representative participated in the decision-making process or executed the relevant documents with respect to the related transactions, he is highly likely to be held jointly liable for the company's loss, unless he explicitly voted otherwise at the board meeting which was stated in the meeting minutes, or he was not aware of and was not at fault for such activities.

  1. Potential administrative liability of a legal representative

Article 49 of the PRC General Principles of Civil Law stipulates that,

"under any of the following circumstances, an enterprise as a legal person shall bear liability, its legal representative may additionally be subject to administrative sanctions, fines and if the offence constitutes a crime, criminal responsibility shall be investigated in accordance with the law:

  1. conducting illegal operations beyond the range approved and registered by the registration authority;
  2. concealing facts from the registration and tax authorities and practicing fraud;
  3. secretly withdrawing funds or hiding property to evade repayment of debts;
  4. disposing of assets without authorization after the enterprise is dissolved;
  5. failing to apply for registration and make a public announcement promptly when the enterprise undergoes a change or termination, thus causing interested persons to suffer significant losses;
  6. engaging in other activities prohibited by law, damaging the interests of the state or the public interest."

In accordance with the above provisions and other relevant laws and regulations, under certain circumstances, a legal representative may bear administrative liability for the acts of the company that are in violation of such laws or regulations unless the legal representative can prove that he or she was not aware of such acts and was not, subjectively, at fault or delinquent in fulfilling his or her duties.

  1. Potential criminal liability of a legal representative

Generally speaking, a legal representative will not be held criminally liable for criminal acts committed by the company while the company shall bear criminal liability for its own criminal acts. However, certain crimes stipulated under the PRC Criminal Law penalizes not only the entity but also "the persons who are directly in charge and the other persons who are directly responsible for the crime". Such persons shall be found liable and be subject to criminal punishment. Such crimes include, for example, production and sale of fake or substandard goods, tax evasion, copyright infringement and illegal business operations.

Although the laws do not provide the scope of the term "persons who are directly in charge", in legal practice, a legal representative is commonly deemed to be within such scope and will be found liable for the criminal acts committed by the company.

  1. Compulsory measures that may apply to a legal representative

Under certain circumstances, when a company has entered into bankruptcy proceedings, or a person or entity has applied to the court to impose compulsory enforcement measures upon the company, or the company has defaulted on tax payments, the judicial and administrative authorities shall have the authority to impose compulsory measures on the legal representative of the company.

  1. If a company has unsettled civil cases or fails to perform its duties imposed by legal documentation, judicial authorities may impose compulsory measures on its legal representative, including restrictions on him or her leaving the country

    Article 231 of the PRC Civil Procedure Law provides that,

    "where any person fails to perform the duties required of him/her as set out in the legal documentation, the People's Court may take steps towards or seek the assistance of his/her employer in the imposition of restrictions on him/her leaving the country, record or publicize the fact that he or she has failed to perform his or her duties through the public credit system, or adopt other measures provided by the law."

    Article 37 of the Interpretation of the Supreme People's Court on Issues regarding the Application of the Enforcement Procedure in the Civil Procedure Law of the People's Republic of China stipulates that,

    "where an enforcee is an entity, its legal representative, main personnel in charge or personnel directly responsible for influencing the performance of its obligations may be restricted from leaving the country."

    In accordance with the above provisions, when a person or entity has applied to impose compulsory enforcement measures upon a company due to its failure to perform its duties under legal documentation, the court may impose compulsory measures upon its legal representative including restrictions on him or her leaving the country.

    In addition, pursuant to Article 8 of the Law of the People's Republic of China on the Control of the Exit and Entry of Citizens, "exit approval from the country shall not be granted to persons belonging to any of the following categories: (ii) persons involved in unresolved civil cases as notified by a People's Court;" In practice, if a company has unsettled civil litigation, the court can restrict the company's legal representative from leaving the country.

  2. If a company has entered bankruptcy proceedings, its legal representative shall not leave his/her place of domicile without permission

    When a company has entered into bankruptcy proceedings, its legal representative shall not leave his/her place of domicile without permission of the court.

    In addition, during bankruptcy proceedings, a company's legal representative is required to undertake responsibilities including the safekeeping of all assets, property, seal, accounting books, documents, and other items that are occupied, used and managed by the legal representative; fulfilling his/her duties as required by the court and the administrator and answering their inquiries truthfully; attending creditors' meeting as a nonvoting delegate and answering creditors' inquiries truthfully; and not accepting a position as a director, supervisor or senior officer of another company.

  3. If a company defaults on its tax payment, the tax authorities may restrict its legal representative from leaving the country

    Article 44 of the Law of the People's Republic of China on the Administration of Tax Levying stipulates that,

    "should a taxpayer or its legal representative who owes tax payable need to leave China, the taxpayer shall settle the amount of tax payable, late payment interest or provide a guaranty to the tax authorities before leaving the country. If the taxpayer neither settles the amount of tax payable and the late payment interest nor provides a guaranty, the tax authorities may notify the emigration authorities to prevent the taxpayer from leaving the country."

    Therefore, if a company fails to settle the amount of tax payable and late payment interest or fails to provide a guarantee to the tax authorities, its legal representative may be restricted from leaving the country.

  1. III. How to minimize legal risks of a legal representative
  1. Incorporating exemption clauses into the shareholders' agreement, joint venture contract and articles of association

Under traditional corporate legal theory, there exists a "business judgment rule" which states that as long as directors and senior managers, in making business decisions or judgments, have acted in good faith and on a reasonably informed basis and fulfilled their duty of care, they may be exempted from liability even if the decision or judgment proves erroneous.

However, the "business judgment rule" is not expressly provided for under Chinese corporate law and whether such a rule should apply in legal practice remains in debate. Chinese companies may consider incorporating a provision similar to the following one into their articles of association so as to minimize the legal risks for their legal representatives:

"The company's directors, chairman of the board and its legal representative shall not be liable for any act, where such act is provided under the company's articles of association or stipulated by the board of directors, conducted in their respective capacity unless such act constitutes malpractice, gross negligence, wanton misconduct, or intentional damage to the company's interests."

Pursuant to the above provision, in the case of a claim for compensation against the director, chairman or legal representative arising out of their management of the company, the company will be liable for compensation if the claim succeeds, as long as the disputed act of the director, chairman or legal representative does not constitute malpractice, gross negligence, wanton misconduct or intentional damage to the company's interests. If the director, chairman or legal representative suffers damages as a result of such litigation, the company shall compensate the director, chairman or legal representative for such losses, including reasonable attorney fees and other expenses and costs.

  1. Minimizing legal risks through collective decision procedures and raising objections to acts violating the laws, regulations, articles of association and recording such objections into meeting minutes

In accordance with Chinese corporate legal theories, any major business decision should be made at a shareholders' meeting or a board meeting. In addition, any decision made by the board of directors, unless in violation of any law, regulation or the company's articles of association, will be deemed as a decision of the company and the legal representative shall not be liable for such a decision.

Therefore, when the chairman, executive director or manager acts as the legal representative of the company, in order to minimize their legal risks, they should leave complicated business decisions to shareholders' meetings or board meetings as provided for by the company's articles of association. He or she should raise objections in such meetings to any matter that violates the law, regulation, or the articles of association and record such objections in the meeting minutes.

  1. Companies should establish a risk/liability insurance scheme

Article 39 of the Code of Corporate Governance for Listed Companies issued by the China Securities Regulatory Commission on 7 January 2002 stipulates that,

"after approval in a shareholders' meeting, a listed company may purchase liability insurance for directors. Such insurance shall not cover the liabilities arising in connection with directors' violation of laws, regulations or the company's articles of association."

China's major insurance companies have introduced and now provide liability insurance for directors and senior mangers. In the event that a director or a senior manager suffers damages as a result of a lawsuit for alleged wrongful conduct while acting in their respective capacity for their company, the insurance can cover such losses. Companies can consider purchasing such insurance for their legal representatives and directors, so as to minimize their legal risks.

The above is a brief discussion of the potential legal risks that a legal representative faces and several basic measures to minimize such risks. In legal practice, attorneys should take into consideration the specific facts of a particular case and design the measures accordingly. Furthermore, it should be noted that none of the measures can excuse a legal representative who intentionally violates the law and harms the company's interests. The key to minimizing a legal representative's legal liabilities is to make sure one must comply with the laws and the company's articles of association and act to protect the company's interests in a diligent and loyal manner.

Footnotes

1 Article 21 of the PRC Company Law stipulates that "neither the controlling shareholder, the de facto controller, nor any of the directors, supervisors or senior management of a company may harm the interests of the company by taking advantage of any insider connection. Any person who causes any loss to the company by violating the preceding paragraph shall be liable to pay compensation."

2 Article 149 of the PRC Company Law stipulates that "No director or senior manager may: (1) Misappropriate company funds; (2) Divert company funds into an account held in his own name or in the name of any other individual; (3) Loan company funds or provide any guaranty to any other person by using company property in violation of the articles of association without first obtaining the consent in a shareholders' meeting or board meeting; (4) Become a party to any contract or business dealings with the company in violation of the articles of association without first obtaining consent in a shareholders' meeting; (5) Seek business opportunities for himself or for any other person by taking advantage of his position or operate on his own behalf or on behalf of any other person any business similar in nature to that of the company without first obtaining consent in a shareholders' meeting; (6) Personally accept any commission on any transaction to which the company is a party; (7) Unlawfully disclose confidential company information; or (8) Act in any way that is inconsistent with his duty of fidelity to the company. Any income received by any director or senior manager in violation of this Article shall be treated as the property of the company's."

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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