Guarding Your Business: Understanding the Impact of Actual and Apparent Authority on Your Contracts

Whether it's hiring a new employee, ordering supplies, or securing a lease, contracts are the lifeblood of commerce. All businesses, from sole proprietorships to large corporations, rely on various individuals - be they employees, managers, or other representatives - to enter into these agreements on their behalf. We do not always have time to verify whether these individuals are actually authorized by the person or entity that they purport to represent to enter into this transaction.  How do we know that the representative on the line is authorized to issue a refund or that the salesperson is authorized to sell at the negotiated price?  This is where a fundamental aspect of agency law critically determines the enforceability of these contracts: apparent and actual authority.

What is Actual Authority?

Actual authority is the real power that a business (the principal) gives to its agent (like an employee or a representative) to act on its behalf. This can be explicitly stated in a contract or implied from the conduct of the business. For example, a manager hired to negotiate contracts for a company has actual authority to do so. If this manager signs a contract within the scope of their authority, the business is bound to it, and both parties must adhere to its terms.

What is Apparent Authority?

Apparent authority, on the other hand, is a bit like an optical illusion in the legal world. It's not about what the agent is actually authorized to do; it's about what a reasonable third party would believe the agent is authorized to do based on the business's conduct. If a business acts in such a way that a reasonable person would believe an employee has the authority to act, then that employee has apparent authority. For instance, if a staff member is consistently seen negotiating deals and the company knows about this and doesn't object, outsiders might reasonably assume the employee is authorized to make such deals.

Real-World Implications

In everyday transactions, these distinctions can have significant implications.  Businesses should ensure that the levels of authority are clearly defined and communicated within the organization. Only individuals with actual authority should be entering into contracts.

That said, be mindful of how your business's conduct might be interpreted by outsiders. Regularly review and manage the representations your business makes about who has the authority to do what.

Apparent authority protects the third party dealing with the employee, representative or agent of the company that strikes the deal.  So, who is protecting the company?

The company should be protecting itself.  After all, it is in a much better position to know who in its organization is authorized to act on its behalf. 

The remedy for the person or entity that relied on the apparent authority (assuming that it can be proven) is that the contract will be enforced.  The company whose agent exceeded the authority would have to seek relief against that agent.    

Limitation of Apparent Authority

            The concept of apparent authority does not allow persons dealing with your business to completely take advantage of an employee that exceeds the actual authority given.  If the person has reason to suspect that the employee does not have actual authority, he or she cannot later claim that the employee had apparent authority.  For example, if the person through its dealings with your company knows that only a manager can authorize a refund or that in the past any discounts above a certain threshold had to be authorized by the owner, that person cannot then avail itself of the defense of apparent authority when seeking to enforce the contract.     

What if an Outsider Uses my Company’s Name to Defraud Others?

When a non-agent of the company falsely represents that he or she is an agent of the company in order to commit fraud, there is no contract – no matter how real the authority appeared to a reasonable third party.  There is no actual authority since the fraudster is not an actual agent of the company, he or she would have no actual authority. This is straightforward — the company did not authorize them to act in any capacity.

For apparent authority to exist, the principal (the business in this case) must represent to the third party that the agent has authority. This representation is usually based on the principal's statements or conduct. However, if a third party fraudulently claims to be an agent without the company's knowledge, the company has not made any such representations. Therefore, there's generally no apparent authority either.

Legal Position of the Defrauded Party

The victim of the fraud (the person who entered into the contract thinking the fraudster was a legitimate agent) generally cannot enforce the contract against the company on the grounds of apparent authority, as the company did not make any representations about the fraudster being an agent. However, this doesn't mean the victim is left without any recourse:

• Against the Fraudster: The victim can usually take legal action against the fraudster for damages arising from the fraud. This might include suing for the return of any money paid to the fraudster or compensation for losses incurred due to the fraudulent contract.

• Possible Reliance on Company's Negligence: In rare cases, if the company's negligence contributed to the believable impersonation of an agent (for example, if they failed to secure their credentials or identity badges properly), the victim might argue that the company should bear some responsibility. This would be heavily dependent on the specifics of the case and typically requires a higher burden of proof.

Bona Fide Purchaser for Value

The concept of a bona fide purchaser for value is somewhat related and comes into play more in the context of property transactions. This legal principle protects those who purchase property in good faith and without knowledge of any other claims or defects in the title. Essentially, if you purchase something without knowing or having reason to believe that the person selling it to you doesn't really have the right to do so, the law might still protect your purchase assuming you paid market value or something close to it.  Remember, that the person attempting to enforce a contract based on the concept of apparent authority canny have reason to believe the agent does not have authority to enter into that particular transaction.  If you pay much less than the market value for a property – well, that should indicate that something may be wrong and you should conduct further inquiries (burying your head in the sand will not protect you). 

For Individuals Dealing with Businesses:

Always verify the authority of the person you're dealing with. If there's any doubt, ask for written confirmation or check directly with the principal.  Understand that if you enter into a contract with someone who only has apparent authority, and the principal disputes the contract, you might have to prove that your belief in the agent's authority was reasonable.

When Doubt Arises

What happens when someone suspects that an agent does not have actual authority? This is where due diligence comes in. Suppose you're entering into a contract and something seems off, maybe the so-called agent is hesitant, or the terms seem unusual. In that case, it's your responsibility to dig deeper. Failing to do so might lead you to lose the protections normally offered to those who deal with agents having apparent authority.

Friendly Advice

For those not well-versed in legal jargon, here are some practical tips:

Always Check: When in doubt about an agent's authority, ask for proof or confirmation.

Observe Consistency: If an individual's role in the company suddenly changes or expands in unexpected ways, it's worth a second look.

Get it in Writing: Ensure that agreements, especially those involving significant commitments, are documented.

Know the Signs: Be wary of rushed, secretive, or unusually high-pressure situations. These can be red flags that something isn't right.

By understanding and paying attention to the concepts of actual and apparent authority, both businesses and individuals can navigate contracts more safely and effectively, minimizing risks and ensuring that agreements are honored and enforceable. Whether you're a seasoned business owner or someone engaging in a contract for the first time, a little knowledge and a lot of vigilance can go a long way.  Our experts can help clarify any contract issues your business may be experiencing and inform you of your rights and responsibilities.  To schedule a free consultation with VAdam Law, visit our online scheduling portal or call 24 hours a day at (954) 451-0792.