huangknows

General BUsiness Law: Contract Liability and Agency Theory

In previous articles, we disucssed how corporations' actions are carried out by natural persons as directors and officers. This structure adds a layer of complexity to corporation transactions. Parties to a contract may dispute the validity of a contract when they disagree on whether the person who signed on behalf of the corporation had the authority to do so. In some scenarios, the signatory may be an outsider impersonating an officer of the corporation; in some other scenarios, the signatory may have actual authority but denies it for corporation gains; in some more complicated scenarios, the signatory may trick the counter party into believing that he has authority with misleading evidences when he in fact does not. Common law has developed a body of law named "agency theory" to address these issues. In addition, the Ontario Business Corporation Act (hereafter "OBCA") has incorporated its own statute addressing the problem. In this article, we will walk through some of the foundamental principles of agency authority.

In common law, the party that acts on behalf of another party is called the agent, and the party whom the agent acts for is addressed as the principal. If the agent has proper authority to act for the principal, then the agent's actions binds the principal, and vice versa. For example, Principal has explicitly permitted Agent to enter into contracts for Principal. When Agent enters into a contract on behalf of Principal, even if Principal is not present and does not sign the contract himself, Principal is bound by the contract, because he previously authorized Agent to act for him. Sometimes, such authority is not created by prior express consent, and there are three forms of agency authority recognized by common law: actual authority, apparent authority, and ratification. 

Actual authority refers to authority actually granted. That seems to be obvious, but actual authority also includes constructive authority not explicitly given. There are two types of actual authority, express and implied. When an authority is expressly given, such as through contract, it is called an express authority. When an authority is given through some other ways of communication, such as acquiescence, it is called an implied authority. Both types require the principal to manifest some sort of assent which leads the agent to reasonably believe that the agent is granted with authority to act on behalf of the principal. How the principal manifests his assent determines which category that the authority belongs to. There is no difference between express and implied authority regarding the existence and the scope of the authority. The court created the theory of implied actual authority to recognize that an agent can have authority even if the principal did not explicitly grant such authority, for the purpose of justice, otherwise principal and agent can cheat together easily in many scenarios. Not only must the principal manifest assent, but the agent's belief in agent having authority must be reasonable. There is no actual authority if the principal shakes his head and the agent thinks that the principal is saying yes.

While actual authority depends on the agent's reasonable belief in him having authority, apparent authority depends on the third party's reasonable beleif in the agent having authority. Apparent authority is established when a third party reasonably believes that an agent has authority due to some manifestation of the principal. The manifestation the third party perceives is usually indirect, taking forms such as the agent's position or the agent's title. For example, Agent is the inventory manager of Principal Company. Third Party enters into a contract with Principal Company through Agent. When Third Party sees Agent's title as the Principal Company's inventory manager, apparent authority is established. Agent's title is Principal Company's manifestation of assent for Agent to act on behalf of Principal Company. This rule protects third parties in scenarios where the agent appears to have authority, but lacks explicit and direct consent from the principal like the ones obtained required for actual authority. However, there is an exception to this rule - constructive notice. When an agent is an officer or director of a principal, but the agent's ability in binding the principal is limited through certain document that is publicly available, such as articles of incorporation, then third party is deemed to know it and thus is not protected by the apparent authority doctrine.

Both actual and apparent authority are granted before a liability is established, and there is one last source of authority and it is established afterward - ratification. This usually happens when a party attempts to enter into a transaction on another party's bebalf, but at the moment when the transaction is made, the acting party has no authority to bind the represented party. After the represented party learns of the transaction, the represented party decides to accept the terms of the transaction, and ratifies it. The represented party gives after-fact authority to the acting party to validate the prior transaction and becomes bound to the terms of the transaction. This is called ratification and the authority created is as legitmate as actual and apparent authority. 

The OBCA has adopted a similar rule. Section 19 of the OBCA, "Indoor Management Rule", states that a corporation may not use the following reasons as defenses to void its obligations: the article or other internal documents have not been complied with, the person named in most recent filings is not director of the corporation, person held out by a corporation as a director or officer is not duly appointed or does not have authority, a document issued by a director or officer with authority is not valid, etc.1 These rules serve similar purposes as common law agency theories do. They protect innocent third parties who enter into transactions with corporation personnels in good faith believing that these personnels have the authority to act on behalf of the corporation. Even if these personnels do not have the in fact authority, the third parties are protected because the appearance that these personnels do have authority. Section 19 also provides an exception that if the third party knows or has reason to know that the personnel indeed has no such authority, then the third party is not protected by the law. The exception is consistent with the purpose of the statute to protect good faith innocent third parties. If the third party knows or has reason to know that the transaction is flawed, but still decides to enter the transaction, then it is at least partially at fault so it is not the innocent good faith victim the law intends to protect.

These rules may seem complicated and intertwined. Aside from consulting a lawyer, there are certain things more fundamental for a party during the course of business, and these things are nonlegally basic - do not be lazy, be diligent, be wary, and use common sense.



1 R.S.O. 1990, c. B.16, s. 19