June 21, 2011
by Robert Worthington
PURCHASINGB2B MAGAZINE: JUNE 2011
In a previous article, I addressed principals outsourcing their procurement functions to independent contractors. We suggested if outsourcing is done with careful planning and with an understanding of agency law it can be an excellent corporate strategy. To help readers understand how agency law can impact a principal’s relationship with outsiders, we cover here the topic of agents and agents’ authority.
In procurement—indeed in all forms of business—most of an organization’s work is done by authorized representatives (i.e. agents) of an organization. The organization (i.e., the principal) expressly authorizes each agent to act on the principal’s behalf, for example, to make contracts with outside third parties. This express authority given to an agent is usually limited, for example, by type of contract, contract dollar value or another restriction to protect the principal from becoming liable for things they did not authorize their agent to do.
In many organizations, creating these internal limits on authority is as far as principals go, wrongly believing they’re protected from liability. Unfortunately, such principals can be creating problems for themselves.
In law, the onus is on a principal to place limits on their agents and then to publicize these limits to the outside world. By doing so, the principal will not be legally bound if their agent does something in excess of their known express authority.
If, as is unfortunately all too common, a principal doesn’t make known to third parties an agent’s authority is limited, third parties are entitled to assume an agent’s authority is what is usual or what appears to be that agent’s authority.
However, merely publicizing an agent’s authority limits is only part of the solution. A principal must also avoid the appearance of authority (or what is known in law as “apparent authority” or “apparent agency”).
Apparent agency is designed to protect an innocent third party, not the agent, or, in practice, the principal. How it works is as follows. The principal, by word or deed, leads a third party to believe an agent is authorized to do something, even though in fact that agent is not. The third party, relying upon this appearance of authority, does something they would not otherwise do (i.e., negotiate a contract with the apparently authorized agent). To protect the third party who was misled by the appearance of authority, the law won’t allow the principal to deny the resulting contract.
In such a situation, a principal who has created an appearance of authority must face the consequences of that misrepresentation with respect to the transaction with the third party. Between the principal and the agent however, as they both knew that the agent was not authorized, depending upon the facts, the principal may sue the agent. Practically, however, few principals sue agents for recovery of such losses (many simply fire them).
For a third party to claim an agent had apparent authority and that therefore the principal is bound, the third party must point to some statement or representation from the principal that led them to believe the agent had authority. The misrepresentation may be verbal, written or implied but it must emanate from the principal. Statements from the agent as to the extent of their authority do not amount to apparent agency.
A third party, when making a claim based on apparent agency, must also prove they were reasonably relying on the appearances of authority. If a third party was being unreasonable in relying on appearances or if they should have been suspicious, the law holds that the third party has a legal duty to check with the principal and can’t claim apparent authority.
For principals, apparent authority of an agent is troublesome, since it’s based on appearances, not realities. Wise principals will take steps to protect against apparent authority by, for example, having double signature requirements on cheques, head office approval requirements stated on contract documents, published levels of staff authority available to contractors and vendors via the web and so on, to demonstrate what authority their agents have.
Apparent authority claims can’t be made if no agency exists. A person must already be an agent before an apparent authority claim can be made. Thus, principals can’t be made to abide by what a non-agent did.
For agents, the concept of apparent agency is scary business. It allows an agent to create personal liability and gives them no protection for their own actions. Agents are in positions of utmost good faith and trust and if an agent exceeds their express authority but the transaction falls within their apparent authority, the agent can potentially be held personally liable to the principal. If a principal is forced into a contract they didn’t authorize, they can sue the agent. The outcome will depend on whether the agent proves the principal was more at fault than the agent (agent not liable), or that the agent was the real cause of the problem (agent liable).
When examining an agent’s authority and its potential to create liability for a principal, all principals must take care. As with many things in law, appearances count. b2b
For more information on Robert Worthington’s products and services, visit his website at www.purchasinglaw.com.