Business license and official seal are critical to a company and its shareholders, and are oftentimes at the center of contention in shareholder disputes. Regrettably, they are often neglected in risk control, possibly because shareholders believe it is a legal issue and should be the responsibility of lawyers, and the lawyers on the other hand believe it is a commercial issue and should be taken care of by the shareholders themselves. I recently came across such an incident, and felt it necessary to bring this to the attention of future shareholders.

A recent incident

A U.S. based company and a Chinese company set up a Sino-foreign joint venture company (“JV Co.”) in Beijing to engage in culture and creative business. The de-facto controlling persons on both sides are old business friends dating back many years, and appear to have deep mutual trust. The U.S. company has a 51% and the Chinese company 49% equity interest in the JV Co.. The Board of Directors, which is the governing body of the JV Co., is comprised of four directors, giving the parties equal representation. The de-facto American controlling person is one of the directors, and also serves as chairman of the board, and legal representative of the JV Co.. The de-facto Chinese controlling person is also a director, and he serves as the general manager of the JV Co.. As provided in the Articles of Association of the JV Co., major matters of the JV Co. are subject to unanimous approval of the full board, and other matters are subject to approval by a two third majority. In the initial stage following establishment of the JV Co., the de-facto American controlling person was busy with his own business in the U.S., and could not come to China to perform the duties demanded of a legal representative. As a result, the business license, the official seal and the financial seal of the JV Co. fell into the hands of the de-facto Chinese controlling person (i.e. the general manager).  The de-facto American controlling person (i.e. the legal representative) had made a personal chop and handed it over to the de-facto Chinese controlling person (i.e. the general manager) to facilitate his performance of the job.

Problems surfaced shortly after.

The JV Co. developed a culture and creative industry park, and intended to sell the residential units to companies or artists who move their business operations into the park.  The de-facto Chinese controlling person (i.e. the general manager) had in his control the business license, the official seal and the financial seal of the JV Co., as well as the personal seal of the legal representative, and without consent of the de-facto American controlling person (i.e. the legal representative), he directly signed sales and purchase contracts with the artists. As the accountant of the JV Co. is the daughter of the de-facto Chinese controlling person (i.e. the general manager), and all the sales proceeds are therefore entirely controlled by the de-facto Chinese controlling person (i.e. the general manager). When the de-facto American controlling person (i.e. the legal representative) came to perform duties as the legal representative of the JV Co., and asked for the return of the business license, the official seal and the financial seal of the JV Co., and his own personal chop, his request was met with deaf ears, and he was left powerless, and the JV Co. run out of control completely.

Such incidents are so commonplace! Could it be redressed? Some could, but some may prove very difficult.

Report it Missing

If either the business license or the official seal (not both) is in the hands of the de-facto Chinese controlling person (i.e. the general manager), the de-facto American controlling person (i.e. the legal representative) may apply to the competent administration for industry and commerce to report the missing of the corporate business license or official seal, and apply for a new business license or a new official seal, and the de-facto American controlling person (i.e. the legal representative) will then control the new business license and official seal. However, in our case, both the business license and the official seal are in the hands of the de-facto Chinese controlling person (i.e. the general manager), and it is difficult to regain both by reporting them missing. Generally speaking[1], to report a missing official seal and apply for a new official seal, it requires the signature of the legal representative and presentation of the business license, and to report a missing business license and apply for a new license, it requires affixation of the official seal[2], and presentation of a resolution issued by the governing body designated in the Articles of Association of the company. As stated above, the parties have equal representation on the board of the JV Co., and under the Articles of Association of the JV Co., major matters are subject to unanimous approval of the full board, and other matters are subject to approval by a two third majority. In our case, the two directors representing the Chinese shareholder would not have agreed to the JV Co. reporting loss of the business license and apply for a new business license, and thus the JV Co. could not report the loss nor apply for a new official seal and a new business license.

The JV Co. sues the de-facto Chinese controlling person (i.e. the general manager)

The de-facto American controlling person (i.e. the legal representative) may attempt to have the JV Co. sue[3] the de-facto Chinese controlling person (i.e. the general manager), demanding him to return the business license and official seal etc. to the JV Co., and the de-facto American controlling person (i.e. the legal representative) will then regain control of the business license and official seal. However, whether this request would be granted, or even whether admitted into docket by the court, is at the discretion of the judges, as there is no clear rules in the laws and regulations regarding who should hold the business license and the official seal. Some judges, minority in number, hold that “as the legal representative represents the company, the business license and official seal of the company should be held by the legal representative for and on behalf of the company”, while the majority view this as an internal management matter to be determined in accordance with the articles of association or other internal corporate regulations, or in the absence of such internal regulations, determined by a resolution of the governing body of the company, as there is no clear language in the PRC Company Law regarding who should hold the business license and official seal for the company.

Criminal Sanctions

It is an extreme measure. If the de-facto American controlling person (i.e. the legal representative) has evidence proving that the de-facto Chinese controlling person (i.e. the general manager) embezzled the properties of the JV Co. by virtue of his actual control over the JV Co., he may consider report the case to public security bureau and hold the de-facto Chinese controlling person criminally liable. If the de-facto American controlling person succeeds, he could completely eliminate the de-facto Chinese controlling person’s (i.e. the general manager’s) control over the JV Co., and recover the business license and the official seal etc..

Lessons learned

It seems that shareholders should prepare for the rainy days, and make plans regarding the business license and official seal from the outset on a case by case basis.

First of all, the shareholder which currently holds the corporate business license and official seal of a joint venture company (the “Holding Shareholder”) must not let the other shareholders have their hands on the joint venture’s business license and official seal, in particular if there is no express provision in the joint venture’s articles of association or internal regulations designating the Holding Shareholder to hold the joint venture’s business license and official seal. To be on the safe side, the Holding Shareholder had better introduce a clear provision in the joint venture’s articles of association or internal regulations that designate the Holding Shareholder to hold the joint venture’s business license and official seal, as in the ordinary course, other shareholders (the “Non-Holding Shareholders”) also have access to the business license or the official seal, and may likely use such access to take them away. In the absence of clear rules in the joint venture’s articles of association or internal regulations, it would be difficult for the Holding Shareholder to ever regain the business license and official seal.

Second, the Non-Holding Shareholder needs to make sure that the internal regulations of the joint venture expressly provide[4] for the authority, process and matters for use of business license and official seal, to prevent abuse by the Holding Shareholder, and also to determine liability[5] in case of such abuse. In addition, the Non-Holding Shareholder also needs to establish in the articles of association of the joint venture a mechanism where any single shareholder can make a decision to have the joint venture sue another shareholder to prevent the Holding Shareholder taking the joint venture prisoner and rendering it unable to sue the Holding Shareholder.

Third, if the powers of the shareholders are more or less balanced, the business license and official seal of the joint venture company may be separately kept by each shareholder or each coalition of shareholders. The business license should be held by the weaker shareholder, while the official seal by the stronger shareholder. When it is necessary to use the business license, the weaker shareholder will provide the business license or a copy thereof[6]. Thus, the weaker shareholder could constrain the stronger shareholder in certain cases, even taking the initiative in some instances, or have a certain deterrent effect on the stronger shareholder.

Finally, it should be noted that such internal regulations of the joint venture must be circulated within the joint venture company and signed off by the relevant persons, otherwise, it might not be admitted as evidence in a specific case.