Handling disputes over corporate representation

To everyone’s surprise, the seemingly insignificant particle bei in the Chinese language, which traditionally indicates the passive, has suddenly gained a new meaning – “false”, “unauthorized” or “ultra vires”. In the area of corporate governance, as a company is merely a legal fiction and requires natural persons as its representatives to implement any actions, its true intentions may be slanted and even completely distorted by inappropriate behaviour on the part of its representatives. Taking shareholder disputes in foreign-invested enterprises as an example, this article analyses the reasons for the recent controversy over “representation” and “false (bei) representation”, and suggests some measures to help companies guard against the risks described above.

Authorized or false representative

Foreign investors in foreign investment enterprises (FIEs) often tend to focus their attention on the domestic company’s management and neglect the control exercised by foreign shareholders and their local authorized representatives. There are many reasons for this. Sometimes it occurs simply because of negligence; sometimes it is because the overseas company is itself a “shell” company. Also, in some countries the chairman of the board does not have the same substantive powers as in Chinese companies, and the position is thus not accorded enough attention.

In an arbitration case we have dealt with, the principal, as the major shareholder in both the domestic and foreign shareholder in an FIE, had the advantage in terms of shareholder’s rights and board seats. However, the other party used the seemingly insignificant position of an authorized representative of the foreign shareholders to launch a premeditated surprise attack, and overnight deprived the major shareholder of his right to manage the domestic company.

This case underlines the problems that exist when Chinese administrative organs responsible for examination and approval review decisions made by foreign shareholders regarding domestic companies, but only verify the signatures of the authorized representatives of the foreign shareholder without asking whether the decision truly represents the will of the foreign shareholders. With authority vested in him of “representing the foreign shareholders of the company”, the authorized representative has almost total control over the domestic company. He can go against the will of the overseas company, reappoint board members as he pleases, change the legal representatives and even amend the articles of the company. This leads to the strange situation where the foreign shareholder is misrepresented and the majority shareholders must bow to the will of minority shareholders.

Small seal, big trouble

Even in domestic companies where standards of corporate governance are higher, foreign investors often fall into a quagmire because they are not familiar with the realities of China. To foreign investors, corporate governance is a matter of the shareholders, the board of directors and the right to control the appointment of key positions. Often they are insufficiently vigilant about the management of the company seal.

There is a saying that the importance of precious things is realized only after they are lost. After foreign investors have lost control of the company seal, they often find to their surprise that this little seal can paralyze the operations of the whole company. Even if they resort to filing reports, initiating litigation and other means, the person holding the seal can openly approach the public security organs and courts to get the reports and litigation before them revoked. The above reflects the gap between Chinese corporate governance and normal international practice. Foreign investors should deepen their understanding of corporate governance in China to increase their ability to guard against such risks.

Once they have unfortunately been “(mis)represented”, foreign investors must decide how to deal with situation.

Foreign channels

When a party uses an authorized representative to behave inappropriately, priority should be given to seeking a solution overseas. This is a more realistic approach, firstly because when the authorized right of representation has fallen into the wrong hands, it is difficult to take effective action from inside China. Secondly, even if a temporary resolution to the problem is achieved domestically, so long as the other party still acts as representative, that party may launch another attack at any time.

However, there may also be obstacles to solving the problem outside China. For example, although many offshore investment jurisdictions offer tax advantages, their court system may be relatively slow. If the situation in China is urgent, a settlement overseas may not be reachable in time and the parties may have no choice but to take decisive measures in China.

Domestic measures

The shape of a solution in China will depend on the circumstances. If the other party uses a forged seal, forged signatures or other obviously defective methods in seeking approval, registration or filing, administrative review, administrative litigation and other means may be able to correct the matter directly. Otherwise the conventional means of litigation or arbitration may offer a remedy. However, in litigation or arbitration the other party is likely to cite the approval, registration or filing procedures for foreign-invested companies as a defence. That party may propose that the applicant or plaintiff should lodge their claim through administrative channels rather than resorting to arbitration or litigation. In practice, arbitrators and judges are often reluctant to change the decisions of the executive authorities directly. However, as the relevant law has expressly granted arbitrators and judges the right to change administrative acts through their arbitral decisions or judgments, the parties should do their utmost to explain matters, to dispel any concerns the arbitrator or judge may have.

The key issue

The issue of representation is the core and focus of corporate governance. It is the black hole that is the source of many types of dispute, but also the key to resolving disputes and conflicts. If foreign investors wish to protect all their legitimate rights and interests effectively, they must develop targeted arrangements and countermeasures to ensure that their investments in China achieve sustained, healthy growth.