A Man's Word is (Whose?) Bond
The Extent of Real and Apparent Authority
November 1, 2008
“A man’s word is his bond,” runs the old saying. Both men and women are responsible for their personal promises, but who has the ability to bind a corporation, partnership or LLC?
When ZDocs, a Utah copying and printing company, ordered a commercial copying machine a year ago, a branch manager for the company selling the machine confirmed in writing that the machine would be sold with certain warranties. When ZDocs complained that the machine’s performance didn’t match the warranties, the seller refused to honor ZDocs’ claim. It asserted that the branch manager had no authority to give those warranties. Such fights can go on and on; the companies are still disputing whether the branch manager had apparent authority to give the warranties.
On Good Authority
Corporations are governed by their directors and partners, and LLCs by their managers or members, as designated in LLC articles of organization.
Banks making substantial loans require resolutions from a company’s board of directors, manager/members or partners to be certain that authority has been appropriately given for the loan. The resolutions approve the loan and designate the person who can sign loan documents. As an extra precaution, banks may review copies of the documents creating the company, such as articles of incorporation and bylaws, for a corporation. They may even ask for a written opinion from attorneys representing the company that the person signing on behalf of the company actually has authority to do so. These actions are the gold standard for confirming that someone really is authorized to act on behalf of a company. When it is critical to know that a company’s action is valid, it pays to follow the banks.
What is “Real” Authority?
The documents creating companies often specify who must take certain actions. For instance, a corporation’s bylaws usually state that the directors have the ability to take all actions on behalf of the company, but that certain actions are delegated to the president, secretary and other officers as designated in the bylaws. This constitutes“real” authority. When the directors sign a resolution authorizing the president to sign a certain contract, that is also “real” authority.
The laws creating business entities also state rules about who can bind the company. Those rules are another source of “real” authority.
What is “Apparent” Authority?
Sometimes, a person does not have “real” authority to sign on behalf of a company, but the courts protect whoever relies on his signature anyway.
In the 1990s, a flurry of Utah lawsuits and bankruptcies involving a man named Dean Larsen illustrated the difference between real and apparent authority. Larsen used a company named Granada to serve as general partner in a number of companies whose investors knew little about the circumstances. In Luddington v. Bodenwest, Foothill Thrift, a creditor, foreclosed on property owned by Bodenwest, one of Larsen’s companies, on the basis of a promissory note and trust deed signed by its general partner, Granada. The investor/limited partners in Bodenwest claimed the note was invalid because they never authorized Granada to sign the note and Bodenwest never received the money. The court considered whether Granada had “apparent” authority to sign the note, even though the investor/limited partners never gave “real” authority.
The Utah Supreme Court said that apparent authority exists when 1) the principal (the investors) gives consent to the exercise of authority or “knowingly permits” the agent (Granada) to exercise the authority; 2) the third person (Foothill Thrift) knows of the facts and, acting in good faith, believes that the agent (Granada) possesses the authority; and 3) the third person (Foothill Thrift), relying on the appearance of authority, would be injured if the agent’s act (signing the note) did not bind the principal.
On the apparent agency issue, the court ruled against Foothill Thrift and in favor of the investors, because the loan proceeds were not used to further the business of Bodenwest, and it should have been obvious to Foothill Thrift that Bodenwest was not benefited by the loan.
Tips for Enforceable Contracts
When a contract is extremely important, ask for a corporate resolution authorizing the transaction and double-check cor-porate filings with the Department of Commerce (which can be done online at www.commerce.gov
) to make sure the company is in good standing and is the type of entity it says it is. Add language in your contracts that the person signing on behalf of the business entity represents that he/she has been authorized to do so. Make sure important contracts are signed by an officer of the company (which gives you a better shot at the apparent authority argument).
If you learn facts which raise questions about authorization, such as loan proceeds not going to the debtor or purchased goods being shipped somewhere other than to the person who bought them, ask for additional proof of authorization. And in important transactions, use a lawyer to help you identify and document authorization issues.
Gretta Spendlove is a shareholder with the law firm Durham Jones & Pinegar. She can be reached at email@example.com