Articles of Association – 3 biggest mistakes to look out for

By Richard Hoffmann, ECOVIS Beijing

Foreign investors tend to view the Articles of Associations as just a formality. They constitute a long term commitment and it is critical to establish them in a way that suits your needs best.

Making mistakes in this document can bear consequences, ranging from financial losses to losing control of their enterprise.

Mistake 1: Losing control of management

One of the biggest issues shareholders face while, or usually after, signing their AoA’s is based on the internal structure of the company.

Example: Fred’s Asiashop GmbH opens a WFOE in Beijing. The shareholder stays in Germany and appoints himself executive director. A new general manager, Person A, will be on-site and is hired externally for this task. The appointed supervisor of the director, Person B, one of his German employees, stays in Germany.

A standard AoA contract is written without special provisions for this case. The GM is not limited in any way and engages in fraud, gets kickbacks and takes money directly from the firm for personal purposes. Summed up, in addition to running the company badly, there are also very direct financial and legal implications.

This could have been prevented by adding limitations to his rights as GM in the AoA’s. The amount of money he can deal with could have been capped there; also a provision could have been added on his ability to make deals on his own.

In addition to limiting the GM’s rights using the AoA’s, there are many practical ways for a company to stay in control. A trustworthy third party can be hired to take care of the company stamps – also, external entities can be utilized to perform reliable and independent checks on the Chinese subsidiary. These checks also insure smooth procedures with the tax audit by the authorities.

By law, the shareholder must decide on:

– The Director:
Here one faces two options. One hires one director, the executive director, or a board of directors. The board must have at least 3 directors; also the number of directors must be an odd number. One of these directors must be the chairman.

– Supervisor of director:
The supervisor is legally necessary for all companies to safeguard the interest of the company and to supervise management. Therefore, the supervisor cannot simultaneously hold the position of the director or GM.

– GM for daily operations:
The general manager takes care of daily operations. He is also directly employed by the director – in many cases the GM is also the director

– Legal Representative:
The legal representative is the most important figure of the company. He represents the company at all times and must be the chairman, executive director or the general manager of the company

Mistake 2: Setting the groundwork for bureaucratic mess and registration amendments

One is fairly free to write about one’s company in the AoA’s but a very big mistake shareholders make here is forgetting that they might want to change something later. The amendment of registrations creates a massive bureaucratic mess for the company and should be avoided. Therefore, we suggest you to:

• Not include technical topics and stay as basic as you can
• Not include detailed plans or estimates
• Not write down the actual names of people in the company (as in directors, GM), as these can quickly change

If you are the only shareholder, it is safe to say you want the AoA’s as brief as possible.
If there are more than two shareholders though, more comprehensive AoA’s are suggested in case any disputes between shareholders arise, especially in terms of the internal management system, vote rights, profit distribution.

Mistake 3: Losing control of other shareholders

When you are not the only shareholder, you need to watch out that you don’t lose control of your company.

The first step here is of course to cautiously choose your business partner. After having taken care of the due diligence check, one needs to set up certain security mechanisms in the WFOE or JV contract and AoA’s.

If one holds a minority stake in the company and therefore controls only a minority of the directors, one doesn’t necessarily have to give up all of the power. The AoA’s can be customized so as to include special provisions on this.

For example, if you have a company with three directors, but 2 are controlled by your JV partner, what can you do to protect your interests? Normally, 2/3 or a simple majority vote can be enough to reach a decision – that means you can be excluded from these. The following chart shows an example of how to customize these points so as to include such provisions.

Naturally, it is advisable to get a thorough review by your lawyer or a trustworthy law firm to make sure that you are maximizing your security and are staying legally compliant with the contracts.

Conclusion

The AoA’s are not a one size fits all deal. Most articles are very flexible. Utilize them to minimize a big variety of risks that could endanger your business and instead focus on making your company safe. Focus on what you as a shareholder need in these articles to stay secure, reduce excessive points to stay out of the grasp of bureaucracy.

Get more tips on your company set up – call our office now at +86 10 6561 6609 – 824.

with contribution of William Herpichböhm (ECOVIS Beijing)

	Richard Hoffmann is a Partner at ECOVIS Beijing China. Richard obtained an honor’s degree in law and worked in Germany, America and China for various prestigious law firms prior to joining ECOVIS. He has published more than fifty articles in international magazines, frequently speaks at high profile events in China and abroad and is often invited as a legal expert by international TV. Contact: richard.hoffmann@ecovis.com
Ecovis Beijing is the trusted tax and legal advisor of several embassies and official institutions in China. It specializes in mid-sized international companies and focused on tax & legal advisory, accounting and auditing. If you’re interested in finding out more about tax and legal, don’t hesitate to sign up to our Newsletter or give us a call +86 10-65616609 (ext 811/806) or contact us directly via Beijing@ecovis.com