Valentine’s Day is just around the corner, so this seems as good a time as any to discuss relationships. But I’m not talking about romantic relationships - although there may be a bit of that. I’m talking about business relationships - specifically the principal-agent relationship.
Agency & Actual Authority
Principle-agent relationships arise in a variety of business situations. A principal-agent relationship exists whenever a person (including a business) authorizes another to speak or act on their behalf. The person who does the authorizing is called a principal, and the person thereby authorized is called an agent.FN1 Through this authorization and the power it creates, an agent is capable of creating responsibilities and obligations for their principal.FN2
Agents – whether other owners, officers, representatives, or employees – allow businesses to get things done on a day-to-day basis. Businesses, therefore, give these agents some actual (explicit or implicit) authority to speak or act for the business itself.
Most business owners understand that agents, as a result of their actual authority, can bind the business and create obligations and liabilities. For example, a store manager can sign for a delivery of goods, a CFO can open an operating account with a bank, and a CEO can issue a statement on behalf of the company to the news media.FN3 Activities like these are not attributed to those persons individually, but to the business itself.
What is less commonly known is that an agent – or even former agent – of a business can bind that business when that person has only apparent authority to speak or act on behalf of that business.FN4 Apparent authority arises when a third party reasonably believes that someone is an agent of the business.FN5 In these situations, the law protects reasonable third parties and the business is bound as if the (purported) agent acted with the business’ actual authority.
To explain the idea behind apparent authority, consider the context of a committed, romantic relationship. Suppose you know two people in such a relationship and that one of them told you that the other would attend some party or event. Here, you’d likely normally expect that other partner would actually attend (absent reasonable excuse). And you’d expect this precisely because you were told by the one partner that the other would, in fact, attend.
Therein lies the danger for businesses and their owners: persons with apparent authority are not actually authorized to speak or act as they do, but they nevertheless create business obligations and liabilities...
It wouldn’t matter whether the partner was specifically authorized to bind the other in this way – which would be a very odd sort of authorization to have in such a relationship anyway. What matters is the reasonableness of your belief that they have the capacity to speak for the other in such a way. If your belief is reasonable under the circumstances, then the partner acted with (at least) apparent authority.
Moreover, it would not matter that this relationship had ended, so long as you should not have known that they were no longer together. If you were faultlessly unaware that the relationship had ended, then they would each still possess in your eyes the apparent authority they had while together.
That in a nutshell is the concept of apparent authority. As a result, apparent authority has much more to do with the reasonableness of third parties in their particular situations than it does with the actual authority or power of a particular person. And, therein lies the danger for businesses and their owners: persons with apparent authority are not actually authorized to speak or act as they do, but they nevertheless create business obligations and liabilities.
The Good News
The good news is that the law is clear that apparent authority arises only because of the actions, or inactions, of the principal.FN6 Agents and purported agents cannot create the circumstances that give rise to their apparent authority.FN7 However, sometimes this means that the principal must actively let third parties know that some person or people lack the authority to bind them or their business.
Depending on the business entity, notice requirements for third parties may vary. Filings with the Secretary of State by partnerships and corporations (e.g. bylaws) may provide notice to the public that only certain individuals, officers or other representatives are authorized to act in specific ways for that business.
For Colorado limited liability companies (LLCs), required information contained in the Articles of Organization provides notice to the public as to that information.FN8 This is particularly significant with respect to the option to organize the LLC as either member-managed or manager-managed. Depending on the choice made in the Articles, there will either be a reasonable expectation that any member is an agent of the business or that only persons designated as managers are.
As a result, well-drafted formation or other filed documents may provide appropriate notice to relevant third parties so as to avoid apparent authority problems. But sometimes a simple letter or email to those third parties may be the best course of action.
In either case, it is best to seek the assistance of qualified counsel. If you need legal assistance drafting or reviewing a business' formation or other organizing documents, please Reach out, Today!