Authority Under Contract Law

April 13, 2006

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In order to limit liability for contracts and torts, a small business owner should have a basic understanding of contract law.

Ordinarily, an agent of the business must have actual authority to form a contract for a principal of the business. Usually, this will be express authority--permission from the principal given verbally or in writing. Obviously, written authority is preferable, as it is difficult to substantiate verbal authority. In a corporation, common sources of written express authority include bylaws and resolutions from directors' meetings. In a limited liability company (LLC), common sources include an operating agreement and resolutions from managers' meetings (or members' meetings, in a member-managed LLC).

Actual authority also may be implied. Specifically, someone who is implied to automatically have all the authority necessary to carry out the express authority. For example, if an agent representing a Connecticut company is expressly authorized to sign a contract in California, and he must travel there to accomplish this, he is also (most likely) impliedly authorized to contract for travel and lodging, as an agent of the company, because this is necessary if he is to accomplish his express authority and sign the contract in California.

Clearly, implied authority can present problems, because it is neither in writing nor verbal. It is simply understood. Remember, though, that implied authority stems from express authority. By specifically addressing express authority, problems with implied authority can be avoided.

The bigger problem for the small business owner is apparent authority. If apparent authority exists, an agent or employee can bind the business to a contract, even though the agent or employee has no actual authority to act for the business. Apparent authority can represent a significant source of liability for the business.

If it reasonably appears to a creditor that an agent has actual authority to represent a principal on a contract, then the principal is legally bound to the contract, based on the apparent authority theory, even though the agent had no actual authority at all to represent the principal.

This is frequently a problem when an employee is fired or the scope of his authority is curtailed, and creditors of the business are not properly notified of this fact. Clearly, this can especially be a problem when the agent had significant authority (e.g., an officer in a corporation, a manager in an LLC or an employee such as a purchasing agent).