What is Contract Authority
Contract authority is a legal concept that governs the extent to which a person can bind another person, typically an organization or business, into legal obligations. Contract authority has its roots in the agency relationship. An agent is a general term for a person who is authorized to act on behalf of another person, known as the principal. The scope of authority that the agent has is determined by its contract with the principal , or by operation of law. The principal is bound to contracts entered into by its agent within the authority granted.
The principle in contract authority is simple. In order to create contractual obligations with a third party an individual must have either actual authority or apparent authority to do so. Actual authority may be express or implied. Express authority is where the principal expressly grants authority to the agent through communications to the agent. Implied authority arises where the agent’s authority is reasonably inferred based on the position the agent holds. Apparent authority refers to a situation where the principal creates the impression that an agent holding a position has authority to act on behalf of the principal even where the principal does not intend to confer such authority.
Types of Contract Authority
The five different types of authority are actual authority, ostensible authority, inferred authority, apparent authority, and ratified authority.
Actual authority
Actual authority is both express and implied. Express authority can be written or oral authority given by the principal to the agent to do a specific act, such as signing a contract in the name of a corporation. Implied authority allows the agent to complete acts needed in order to carry out the principal’s express authority. An example of express authority to sign a contract would be an article in the by-laws for a corporation which requires that all contracts be signed by the president of the corporation. When an agent has expressed authority to perform a particular act, he or she is also deemed to have implied authority to perform acts which are necessary to carry out that specific act.
Ostensible or apparent authority
Apparent authority exists when a principal represents to third parties that someone is his agent when in actuality the individual is not a true agent. Apparent authority simply means that the other party, through the words or conduct of the agent, came to reasonably believe that the agent had authority from the principal. It is considered reasonable for the other party in the circumstances to have believed that the agent had the authority of an agent.
Implied authority
Implied authority may be either where actual authority is implied by contract or relationship of the parties. Implied authority may arise in agency relationships which are considered quasi- or de-facto agency relationships.
Ratified Authority
Ratified authority is authority which both the principal and agent have agreed to, after the agent has already acted. For example, a letter of intent proposes the terms of a transaction and is signed "Kenneth Lawyer, by his attorney, John Lawyer." The principal is not bound by the terms of the deal, unless Mr. Lawyer expressly or implicitly ratifies the terms of the letter of intent.
How Contract Authority is Created
Contract authority can be provided through a number of methods, all of which will serve to grant contract authority; however, the nomenclature used to describe the authority could be different depending upon the method of conveyance. Contract authority may be granted in writing, verbally, or implied by acquiescence through a course of conduct. Generally speaking, any formal, on-the-record actions or resolutions granting authority will be classified as formal and will vary depending upon the entity involved, whether it is a corporation, government agency, non-profit corporation, etc. The Article 9-104 list of entities refers to "the governing body[of a legal entity]" in the second sentence of subsection (f). That is, not only must the governing body grant authority, but such authority should be granted on the books and records of the entity. This ought to be done by a majority of the governing body in a bonded transaction involving commercial paper or an amount in excess of $1,000,000, with reduced levels of authority for commensurate smaller amounts.
Many business people do not expect or want their parties to the transaction to give formal authority that has been voted upon and something similar. Contract authority can also be given verbally and this appears to be the principal means for administrators of private schools and for government employees to generally get the various tasks done. However, this may be out of the norm for business transactions. After all, a common disagreement between buyers and sellers focuses upon the party’s need to make sure that the authority given is actually with the buyer. In many instances, the buyer could not care less where the money comes from, as long as he knows that the money will be there. Unfortunately, if there is not written evidence of the authority, the seller would have no recourse against the buyer if the money he used to fund the deal did not actually belong to him.
Another possibility is that someone may acquire actual authority due to a course of conduct where the party receiving the authority does not speak out to correct a misunderstanding that he holds regarding his authority. The mistaken belief held generally by the party who holds the mistaken belief is enough to create actual authority in many instances, even though the person refusing to correct the mistaken belief has no intention to confer authority. That is, passive inaction may be enough to confer authority. Contract authority may be acquired in many ways, but any attempt to limit the scope of authority must be clear; otherwise, a third party may conclude that the agent has broader authority than actually intended.
Limitations and Risks Associated with Contract Authority
One of the core elements of business risk management is a company’s contract authority or who has the power to commit the company to a legal obligation such as a lease or the purchase of goods and services. Thus, it is not uncommon for the company’s by-laws to define officers and directors and their roles in the management of the company. Similarly, the company’s organizational chart may define the lines of authority for certain employees, the budget each has to manage, and the company’s policies and procedures will set forth the limitations on that authority, if any.
The power of contract authority is even recognized under Washington law: RCW 23B.08.320 provides that "[a] corporation’s board of directors may, by resolution, establish salary and other compensation for all corporate officers, none of whom need be a director." However, this does not mean that parties contracting with a corporation need be concerned only with identifying the agreeing corporation.
The authority granted within an agreement can be explicitly defined within that agreement, but it can also be implicitly authorized or be granted by the corporation’s by-laws, policies, and procedures. Thus, it cannot be assumed that employees have the authority necessary to bind the corporation until that authority has been confirmed. Such limitations can be identified by asking if the signer is an officer of the company and checking online for notices filed with the Secretary of State, or, when appropriate, having the signer provide an officer’s certificate or resolution confirming the signature.
The authority may be exceeded when the signer fails to follow the company’s approval process. This can happen, for example, when a signer commits an employer to a contract, but does not have the budgetary authority or access to company funds to pay for the goods or services provided under that contract. This can also happen in the context of a formal lease agreement where a tenant agrees to lease space at a specified rate but the rate is outside the company’s prescribed guidelines for the treatment of lease expense.
When such authority is exceeded, most companies have an approval or waiver process where higher level approval by a qualified officer is obtained, or the applicable provisions of an agreement are obtained. This allows a company to ensure that agreements formally executed on its behalf do not exceed the bounds of its express or implied contract authority. Notably , if the authority is exceeded and approval is not obtained, the contract may technically not be authorized and therefore not binding on the company. In some instances, the company could be liable to the third party for breach of any obligation to approve the agreement.
This obligation by a company to obtain approval can save it from the risks associated with the expenditures of funds or access to sensitive proprietary information. However, what happens when a company has signed an agreement but neither it nor the signer has obtained the requisite approval from the company to incur the costs described in that agreement? Assuming that the third party acted in good faith in entering the agreement, does the company have the flexibility to negotiate renegotiation or exit of the agreement? The answer to this question can depend on the circumstances and whether the company had the power to approve the unauthorized contract in the first instance. For example, in comparatively small transaction where the company did not seek to rescind the agreement, the company may be required to pay according to the terms of the agreement. But when a company enters into a significant agreement, especially likely if the agreement is also not to the benefit of the company, a company may be able to avoid the agreement in some instances. In these circumstances, the right of rescission may be based on the extent to which the third party failed to verify the authority of the signer. In virtually any transaction, even one where the agreement is unauthorized or exceeds the signer’s authority, the company may still be required to hand over any consideration it has received. If it fails to do so, the legal doctrine of "equitable estoppel" may prevent it from subsequently challenging the validity of the agreement.
Thus, although all corporations may well have the general capacity to enter into contracts, that does not mean that any given agreement is binding on the company. Likewise, even if it is binding, there is no guarantee that the company can be held to its terms. When the company itself (or its agent) acts without authority and is challenged, that company must be careful to understand the nature and extent of its contracting authority so that it can better manage the risks and benefits of contract authority.
Verifying Proper Contract Authority
Secretary: "I don’t think I have the requisite authority."
Attorney: "Why not? Don’t you have the contract in front of you? Didn’t you sign it?"
A common misconception is that requiring a signature constitutes authority and executing (or signing) a contract ensures validity. Not so fast. Authority is a legal concept that is established through the combination of a principal, an agent, the scope of authority and actions taken within that scope. And when it comes to determining authority, an audit trail serves as the preferred proof.
An agent is an individual or entity that has been empowered to act on behalf of a principal. When an agent exceeds the authority given, the contract can be deemed unenforceable. The amount of authority an agent receives from a principal is dependent on statute, circumstance, express authority and implied authority. Since authority is typically established in one of these ways, understanding the parameters is key to verifying and validating authority.
The best way to address contract authority is to identify and track the chain of communications and document each step along the way. Here are some best practices to consider:
For businesses:
For legal professionals:
Keeping a clear record of communications helps eliminate future questions, and can serve as a useful reference point.
Contract Authority Case Studies
Consider the case of Corporate Buyer Inc., a company interested in acquiring Competitor Corporation. After some negotiation, the two companies reach an agreement on the terms for the sale of Competitor to Corporate Buyer. However, the legal department at Corporate Buyer wishes to review the details and prices to ensure Corporate Buyer is getting the best deal possible before closing. Corporate Buyer adds the language "Subject to contract" to the MSA. Competitor subsequently takes the position that agreements have been reached and corporate buyer is bound to proceed to contract and complete the deal. Who is right?
Or take for example Builder Corp, a construction company. Builder Corp. accepts a tender from City Developer Inc. to build a community centre for $50,000. Builder Corp. signs the contract and has no further signatures required according to the agreement. Builder Corp then discovers that it miscalculated the price of the tender, which it meant to be $75,000. Does Builder Corp. have the ability to change the price for the tender, or is it stuck with its mistake? Does City Developer have the ability to then walk away from the community centre? What if City Developer does not walk away, and Builder Corp . begins to perform the work at the reduced price? City Developer then refuses to pay Builder Corp. for the work performed, and contends the work is defective. Builder Corp. insists the work is fine, and wants payment under the contract. The matter ends up in the Court of Appeal.
In HPA Ltd. v. Lightning Fast Courier Service Ltd., 2003 ABCA 251 (CanLII) a review of the facts reveals that company "A" (Lightning Fast Courier) sold its courier business to company "B" (HPA Ltd.) for $325,000. It was to provide "carpets to cover the floor of the courier operation space", as well as a "brass plaque to the front door" There was no mention however of how the carpets were to be fastened to the floor. Neither was there any detail on the type of plaque to be placed on the front door. Lightning Fast says they have fastened the carpets with nails, but that isn’t what HPA says it meant to purchase. City Developer and Builder Corp. both have considerable attorneys fees, and find no solution at all to the problems between the parties. These issues are all properly addressed in an written agreement, and if there is any issue on these details, they are properly addressed through clear definitions of performance in a Contract which represents the intentions of the parties.