Legal Compliance and Supervisor Control

Business in China is not a spectator sports and passive supervision from Corporate Headquarters does not work in China and, thus, every company is required to build active internal control measures, fraud prevention strategies and careful inspection to strengthen company overall performance and handle risk management diligently at the Chinese market.

Experience has shown three levels of legal compliance approach which are producing the best possible results in China and these are presented below.

1. Knowledgeable Corporate Governance and Legal Compliance Officer

Since 1.1.2008 a Corporate Supervisor is an obligatory legal requirement for every company established after that date, and when entering China, foreign investors are legally required to build internal Supervisor position at company Board of Director level. Remote control does not work in China and local on-site control mechanism is the best option as part of best practice Corporate Governance structure.

For corporate governance, Foreign Invested Companies shall form a Board of Directors of minimum 3 members, where, typically, the Chairman of the Board is acting as the Legal Representative of the Company. Chinese Company Law requires the Investor/s to nominate one or several Supervisors allowing the owners or shareholders to have better control supervision over China entity legal compliance, management and operation.

Such Legal Compliance Officers should not be company’s own employees or people in charge of controlling issues at the Headquarters level but shall be entrusted to third-party legal professionals knowledgeable at China business environment and control as well as located in China or Hong Kong.

Foreign investors are required to include Supervisor duties and rights at company’s Articles of Association. According to China Company Law such nomination shall be recorded in the China Company Registry and the Supervisor may have personal liability over company issues in case of cross-negligence.

2. Company Chops, Assignment and Custody Arrangements

In China, company seals and chops have special representation and decisionmaking power and each company must pay close attention to the safety and assignment of the custody of various company chops. Chops in China have required company details to legally authorize documents and, therefore, the person who holds the chops is de facto granted authority to act in the company’s name.

For everyday business, using of corporate seals and chops means legally signing contracts on behalf of

the company, authorizing payments at the bank or receiving deliveries or notifications. When assigning the chops employees without proper control authorization and supervisions, there is a risk that this individual ends up acting in his or her self-interest which can cause a considerable harm to the company.

Corporate Governance and control mechanism must ensure that corporate seals and chops are only used legitimately, kept in company safes and guardianship of different chops is divided between different level of management and persons. For custody of the most important Company Seals can be transferred also to third-party custodian safeguard such as the law offices or CPA companies located in China or Hong Kong.

Best practice corporate governance requires that all usage of the chops is properly recorded on company logbooks including date, person and reason of the usage.

3. Fraud Prevention, Pricing and Inventories

For foreign Invested companies conducting manufacturing, logistics and trading operation internal control, fraud prevention and inventory management are crucial.

In China, opportunities for fraud are present both at sales-side and sourcing level especially where there is room for negotiations with each client. Every company must establish an internal control system for tendering and sourcing with certain limits and ranges of flexibility requiring approval from senior managers.

For import & export, warehouse and inventory management, companies shall ensure the transparency and consistency between sales and purchasing figures, invoicing, inventory, imports & exports and shipping records. The duties relevant to all these activities are to be appropriately segregated and automated SAP system is required for accuracy of all transactions, documents and business dealings as well as minimize the risk of un-proper human interference such as claiming export rebates for un-exported items or using domestically in China inputs designated for export processing trade.

Finally, company finance staff and cashiers must use modern e-banking system to limit the risk related to financial management and responsibilities between executing payments and their approval are to be separated.

Corporate Legal Compliance Officer must inspect the control and monitoring system for all above company actions, and such internal control processes, their implementation and compliance with internal corporate policies shall be included in the Annual Supervisor Reports.

Today, the use of electronic signatures, corporate seals and chops are entering the China market making their tracking and tracing and proper usage easier.

In China, it is better to be safe than sorry in order to avoid possible unpleasant consequences later on even though proper Legal Compliance and Supervisor Control seems sometimes to be over protective.