Abuse of the Seal in China

ChopThe use of seals, as a signatory instrument and a way of legally binding entities, is a deeply-rooted tradition in the Chinese business world. Like the emperors in ancient China who rendered their decisions with the imperial seal, business managers today recognise and authorise the contents of a document by affixing their company’s seal—colloquially known as a chop—or gongzhang (公章).

In the following article Emmanuel Meril and Raphael Chantelot of LPA (Lefèvre Pelletier & Associés) discuss some of the potential abuses that can occur when company chops fall into the wrong hands and provide some measures that can be taken to prevent these situations from arising.

For the day-to-day running of the company, in addition to the principal and official seal of the company, specific seals are used for various operations such as opening bank accounts, issuing invoices or paying taxes.

The importance of these seals is too often neglected by foreign managers who, from a cultural standpoint, are used to relying on the handwritten signature of an authorised company representative. Unfortunately, many of them are not even aware of the sometimes dramatic consequences for their subsidiary in China resulting from the loss or theft of seals, which can lead to loss of control of the subsidiary or the misappropriation of its assets.

It is thus vital to know how to use each seal properly and to identify and prevent the most common risks associated with the use of the company’s seals.

The use of seals

Under Chinese law, any entity that is legally registered in China must possess an official company seal and several additional seals with specific functions. These seals have to be made by a specialised company and registered with the local Public Security Bureau.

The company’s official seal may be used to sign all company documents except those pertaining to financial transactions.

Since the Contract Law of 1999, in order to be valid, a contractual document theoretically requires the handwritten signature of an authorised person or must bear the seal of the company. Thus, a document with no signature but which bears the official seal legally binds the company. It is thus advisable to implement extremely strict control of this seal because the holder of the seal essentially controls the company.

The financial seal (mandatory) is used for all financial transactions of the company, such as issuing cheques, and is generally kept by the finance director of the company.

The seal of the legal representative of the company (optional) contains his/her name or his/her handwritten signature. If the legal representative is not available or present in China it is possible to carry out financial transactions using this seal provided it was registered with the bank and accompanied by the financial seal.

Dramatic risks

There are frequent risks associated with the fraudulent use or theft of seals to which foreign companies in China may be exposed, such as the following:

  • In the event of a dispute with an employee, the employee may try to put pressure on the employer by stealing one or more seals. Thus, the company’s operations could be constantly interrupted if the seal is not returned quickly. He/she may then blackmail the employer and negotiate severance pay. In practice, such situations are generally resolved amicably.
  • The holder of official seal can bind the company in important transactions, even if they were not authorised by the legal representative or the shareholders. Thus, this person could sell company assets using the company’s seal. It is subsequently very difficult to cancel these sales because they are legally binding.
  • If all the seals and certificates are stolen or lost, the company can be completely paralysed (i.e. unable to pay wages, sign contracts, withdraw funds, etc). This may occur if the licences and seals are kept together in a place to which unauthorised persons have easy access.
  • The most common risk is that someone will use the seals and/or official documents to take control of the company unbeknownst to the actual managers (in particular, when the managers are outside China and if no regular checks are carried out on the company). If the perpetrator is the legal representative or chief executive officer of the company, it will be very difficult, or even impossible, for the shareholders to remove them and declare their removal to the authorities in the absence of the seals and corporate documents.

What to do?

If a seal is lost or stolen, an announcement must be published as quickly as possible in an official journal recognised by the local authorities. This public advertisement makes it possible to request the cancellation of the lost or stolen seal, to have it remade and to register the new seal with the Public Security Bureau. The company can then prove that any documents stamped subsequent to this new registration were stamped using a stolen seal and will thus be able to annul them.

The original business licence must be presented in order to officially register the new seal. If the licence has been stolen too, another declaration of theft and a request for a replacement will have to be made, which can take several weeks.

It is also possible to lodge a complaint with the police, producing proof that the theft actually occurred. However, the police intervene very rarely in commercial affairs, which poses something of a problem. In addition, filing a complaint generally requires the company seal.

Preventive measures

Since the consequences of the loss or theft of the seals can be extremely detrimental and difficult to correct, it is essential to put in place internal control systems and preventive measures, for example:

  • Expressly designate the persons responsible for each seal in the internal regulations of the company (e.g. the HR manager will keep the HR seal);
  • In large companies, avoid the situation where one person keeps the financial seal and the seal of the legal representative as that person would then control the bank account;
  • For smaller companies, the seals and licences should be kept in the safe of the chief executive officer or of the legal representative and all documents bearing the seal should be checked;
  • Keep and file a copy of all documents that bear the seal;
  • In the event of the risk of litigation with the holder of a seal, or if the latter leaves the company, it is vital to recover control of the seal;
  • Persons designated to keep the seals must be trustworthy, especially the person who holds the seal of the company.

LPA (Lefèvre Pelletier & Associés) is currently one of the top French law firms. It provides advisory and litigation assistance to clients in all areas of business law. LPA has expanded internationally with the opening of overseas offices in China, Europe and North Africa.

Emmanuel Meril is a partner of LPA in Shanghai. He has 21-year’s experience in foreign investment in China. Raphael Chantelot is a partner of LPA and head of the China Desk in Paris. He had been stationed in Shanghai for six years and has 15 year’s experience advising on cross-border M&A transactions.