The Problem with Apparent Authority

April 13, 2006

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The issue of authority under contract law is not always clean-cut. In most situations, express or implied authority is granted to an agent of the business. But sometimes apparent authority muddles the picture.

In most cases, apparent authority arises when there has been what is termed a "past course of dealing" with a creditor. In this situation, the agent, acting with actual authority, has on many prior occasions contracted with this particular creditor on behalf of the principal. In each of these cases, a bill was sent to the principal, and the bill was paid.

Subsequently, the employee's authority is revoked or curtailed. It is easy to see that, because of the past course of dealing, the creditor can reasonably believe that the agent is still authorized to represent the principal, if the creditor is not notified otherwise. Thus, if the agent subsequently forms a contract with the creditor, while representing that he is acting for the principal, the principal is liable on the contract because of apparent authority. In short, an employee may be fired, or a partner may withdraw from a business, and still bind the business to contracts.

Here, it is the limited liability company (LLC) or corporation that will be the principal held liable--provided, of course, that the owner has properly taken the precautions to separate the owner from the business's liabilities.

By eliminating apparent authority, the small business owner can protect his investment in the business. The key to this comes down to one word--notice. Specifically, if apparent authority is to be eliminated, notice that the agent no longer has authority to act for the principal must be provided to creditors.

There are two types of notice:

actual individual notice
constructive notice

The law requires that the principal provide actual individual notice to all creditors with whom the business and the agent have established a past course of dealing. It also requires that the principal prove the creditor actually received the notice.

A telephone call, for its immediacy, and a letter should satisfy this requirement. The business owner should always document the date and time of telephone calls, and the name of the individual who took the message. Where immediacy is not an important issue, the business owner may want to bypass the telephone call.

A copy of the letter should be retained. Moreover, if a serious question of possible wrongdoing by an agent exists or exposure to liability is particularly high for some other reason, a certified letter, return receipt requested, is recommended.

Of course, it is not possible to make a telephone call or send a letter to a creditor with whom the business has not yet established a relationship. Here, the law provides that constructive notice is sufficient. This type of notice is best represented by a newspaper advertisement, in a newspaper that circulates in all the areas the company has done business. Here, there is no requirement that the principal prove the notice was actually received.

Note that constructive notice is ineffective against creditors with whom the principal and agent have a past course of dealing (unless the principal is able to prove the creditor actually read the advertisement, which is usually impossible).

The best course is for the small business owner to use both actual individual notice to known creditors and constructive notice to cover all future potential creditors.

Warning

Agents can bind a principal to a contract based on express authority, implied authority or apparent authority.

Apparent authority can represent a significant source of liability for a business. 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.

This is likely to be a problem when an employee's authority is curtailed, an employee is fired, or a partner withdraws from a business. The business owner must terminate apparent authority by providing notice to creditors that the agent no longer has authority to act for the principal, in accordance with the rules discussed above.

When notifying creditors to terminate apparent authority by letter or newspaper advertisement, the small business owner must be careful to avoid saying anything regarding the agent that might be actionable as defamation. No explanation should normally be given. A simple report that John Jones no longer is an employee or agent (or partner) of the company is appropriate.