Suppose a newly appointed CEO wishes to hire an
Administrative Assistant. If the CEO signs an employment contract with a
prospective assistant, purporting to act on behalf of the corporation, will
that contract be binding on the firm? The answer to that question depends on
whether the CEO has authority as that term of art is used in agency law.
Accordingly, we must (briefly) digress into agency law and the authority of
agents.
1. The agency relationship defined
The agency relationship, in its broadest sense, includes any
relationship in which one person (the agent) is authorized to act on behalf of
another person (the principal). More specifically, an agency relationship
arises when there is a manifestation of consent by the principal that the agent
act on the principal’s behalf and subject to the principal’s control, and the
agent consents to so act.[1]
The requisite manifestation of consent can be implied from the circumstances,
which makes it possible for the parties to have formed a legally effective
agency relationship without realizing they had done so. Corporate employees,
especially officers, are generally regarded as agents of the corporation.[2]
Curiously, neither an individual director nor
even the board as a whole are regarded as agents of the corporation.[3] In a sense, when the board acts collectively, it
functions as a principal in agency law terms. Unless shareholder approval is
required, after all, the act of the board is the act of the corporation. As to
the individual director, recall that he “has no power of his own to act on the
corporation’s behalf, but only as one of the body of directors acting as a
board.” [4]
2. Authority of agents
An
agent may have either actual, apparent, or inherent authority to enter into
contracts on behalf of the corporate principal. Likewise, in some settings, the
corporation may be estopped from denying the authority of its employees.
Determining whether an agent had the requisite authority in any given situation
can be challenging. The differences between the various categories of
authority are complex and subtle. In addition, many of the categories
overlap—it is not at all uncommon for more than one type of authority to be
present in a single transaction. Finally, the courts are not always precise
when using labels. For example, estoppel and inherent authority are often
called apparent authority. For our purposes, however, it is critical for you to
understand that the legal consequences of an agent’s actions do not depend on
the type of authority at hand. For purposes of determining whether or not the
corporate principal is bound by the contract vis-à-vis the third party to the
transaction, authority is authority and the different types of authority are
essentially irrelevant.
Why then does the law distinguish
between different categories of authority? A former student of your author
claimed that it was a deliberate attempt to confuse people, which called to
mind the old joke—”just because you’re paranoid doesn’t mean you aren’t being
followed.” As Justice Holmes once observed, albeit in a different context,
“common sense is opposed to the fundamental theory of agency.”[5]
It will be
helpful to focus for a moment on the two basic types of authority: “actual
authority” and “apparent authority.” Consider the following hypothetical: Pam
owns Whiteacre. Alan is her real estate broker and, indisputably, her agent.
Ted is an outsider who claims that Alan entered into a contract on Pam’s behalf
to sell Whiteacre. Suppose Ted seeks to prove the existence of authority by
evidence relating to communications between Pam and Alan, such as a letter from
Pam to Allen in which Pam directed Alan to sell Whiteacre. In this instance,
Ted is attempting to establish the existence of actual authority. In contrast,
suppose Ted seeks to establish authority by evidence relating to communications
from Pam to Ted. Suppose Pam sent Ted a letter in which she said that she had
ordered Alan to sell Whiteacre. In this case, Ted is trying to establish
apparent authority. Importantly, the contract will be no less binding if Ted
proves apparent authority rather than actual. The difference between actual and
apparent authority thus arises out of the way in which Ted seeks to prove that
Alan was authorized to enter into the contract. In other words, the different
categories of authority really are ways of classifying the proof the plaintiff
must offer to bind the principal to the contract.
Actual authority exists when the agent reasonably
believes the principal has consented to a particular course of conduct.[6] Actual authority can be express, as where the
principal instructs the agent to “sell Whiteacre on my behalf.” In the
corporate context, express actual authority is usually vested in officers by a
resolution of the board and/or a description of the officer’s duties set forth
in the bylaws.[7] Actual authority can also be implied, however,
if the principal’s acts or conduct are such the agent can reasonably infer the
requisite consent. An agent has incidental actual authority, for
example, to use all means reasonably necessary to carry out a particular result
expressly mandated by the principal. A pattern of acquiescence by the board in
a course of conduct may also give rise to implied actual authority to enter
into similar contracts in the future.[8]
A contract entered into by an agent, purportedly
on the principal’s behalf, can be binding even if the agent lacks actual
authority. Apparent authority exists where words or conduct of the principal
lead the third party to reasonably believe that the agent has authority to make
the contract.[9] Of particular importance with respect to the
authority of corporate officers is the concept of apparent authority implied by
custom. Suppose the board of directors instructed the CEO not to hire an
assistant. The CEO thus lacked actual authority. The CEO nonetheless signs a
prospective assistant to an employment contract that purports to be binding on
the corporation. Is it binding? If the assistant (the third party) knew
that that the corporation had placed the CEO in that position and its was
customary for CEOs to have authority to hire assistants, the CEO will have
apparent authority by virtue of that custom and the contract will be binding.[10]
The economic rationale for this rule should be self-evident—it is the basic
concept of the cheaper cost avoider. Sound social policy dictates that the loss
be put on the party who could have most cheaply avoided it. Here the
corporation’s position, by definition, is idiosyncratic. Most firms let their
CEOs hire assistants. Its cheaper for the few idiosyncratic principals to take
precautions than for all job applicants to be obliged to take precautions.
3. Authority of corporate officers
Most of the case
law on the apparent authority of corporate officers relates to the powers of
presidents. Corporate presidents are regarded as general agents of the
corporation vested with considerable managerial powers. Accordingly, contracts
that are executed by the president on the corporation’s behalf and arise out of
the ordinary course of business matters are binding on the corporation.[11]
Cases dealing
with the authority of subordinate officers are much rarer. As to vice
presidents, a number of (mostly older) cases hold they have little or no
implied or apparent authority to bind the corporation. Accordingly, they have
only such authority as is expressly conferred on them in the bylaws or by board
resolution.[12]
The corporate secretary is assumed to be the custodian of the corporation’s
books and records. Accordingly, the secretary has actual authority to certify
those records. Otherwise, however, the secretary has no authority other than
that conferred on him by the bylaws or board resolutions.[13]
An important line of cases limits the implied and
apparent authority of corporate officers to matters arising in the ordinary
course of business. In the leading decision of Lee v. Jenkins Bros., the Second Circuit held:
The rule most widely cited is that
the president only has authority to bind his company by acts arising in the
usual and regular course of business but not for contracts of an
“extraordinary” nature. . . .
Apparent
authority is essentially a question of fact. It depends not only on the nature
of the contract involved, but the officer negotiating it, the corporation’s
usual manner of conducting business, the size of the corporation and the number
of its stockholders, the circumstances that give rise to the contract, the
reasonableness of the contract, the amounts involved, and who the contracting
third party is, to list a few but not all of the relevant factors. In certain
instances a given contract may be so important to the welfare of the
corporation that outsiders would naturally suppose that only the board of
directors (or even the shareholders) could properly handle it. It is in this
light that the “ordinary course of business” rule should be given its content.[14]
As Lee suggests,
there is no bright line between ordinary and extraordinary acts. It seems
reasonable to assume, however, that acts consigned by statute to the board of
directors will be deemed extraordinary.[15] Consequently, for example, the eight acts
specified in MBCA § 8.25(e) that a board of directors may not delegate to a
committee doubtless are extraordinary in nature. (Of course, once the board has
made its decision with respect to an extraordinary matter, implementation of
that decision can be delegated to officers.)
In
general, when one must decide a particular action is ordinary or extraordinary,
the following factors seem especially pertinent:[16] How much of the firm’s assets or earnings are
involved? Suppose a corporation running a video tape rental store has
$10,000 in cash available. A decision to spend $50 to buy a new tape would be
ordinary, a decision to spend $5,000 to establish a line of compact discs for
rent probably would be regarded as extraordinary. How much risk is involved? A decision to buy one tape is not
very risky and would be an ordinary action, while a decision to open a new
store might be very risky and therefore extraordinary. A decision to buy tapes
on installment where the purchase price is paid off in three months probably
would be seen as ordinary. A decision to take out a thirty year loan probably
would be seen as extraordinary. How long
will the action have an effect on the corporation? How much would it cost to
reverse the decision? A decision to open a new store might be very expensive to
reverse, as the corporation might not be able to get out of the lease if things
went bad. Such a decision thus would be extraordinary.
As to most matters falling in the
gray area between ordinary and extraordinary, a small host of decisions could
be cited on either side.[17]
There is relatively little consistency of outcome in this area. Courts are
divided, for example, as to whether such basic matters as filing a lawsuit[18]
or executing a guarantee of another corporation’s debts are ordinary or
extraordinary.[19]
One is tempted to remind them that Emerson’s famous dictum against a fetish for
consistency holds only that a “foolish consistency is the hobgoblin of little
minds.”
How should cases falling between the extremes be resolved?
Put bluntly, the authority of corporate officers should be regarded as
virtually plenary. Only matters expressly reserved to the board by statute, the
articles of incorporation, or the bylaws should be deemed “extraordinary” and,
consequently, beyond the scope of senior officers’ authority.
One rationale for this position is suggested by simple
statutory interpretation. recall that both the MBCA and Delaware law provide
that the business of the corporation “shall be managed by or under the
direction of a board of directors.”[20]
The use of the disjunctive prior to the phrase “under the direction of”
suggests that the statute’s drafters anticipated that the corporation would be
managed by its officers with the board mainly exercising oversight authority.
Unless a decision is expressly reserved to the board, the statutory language
thus contemplates that a corporation may act through its officers subject to
review by the board.
This reading of the statute comports with modern board
practice. The de facto role of the board in most large public corporations
consists of providing informal advice to senior management (especially the CEO)
and episodic oversight. An extensive definition of extraordinary acts thus
seems a needless formality.
An alternative justification for the proposed rule rests on
the costs the existing rule imposes on third parties. Persons who do business
with a corporation do so at some peril of discovering that their transaction
will be deemed to implicate an extraordinary act and, accordingly, required
express board action. An expansive definition of extraordinary matters
increases this risk. Transaction costs thus increase in several respects. An
expansive variant of the rule creates uncertainty, obliging third parties to
take costly precautions. They may insist, for example, on seeing an express
authorization from the board. Uncertainty about the outer perimeters of the
rule also encourages opportunism by the corporation. If contracts dealing with
extraordinary matters are voidable, the corporation effectively has a put with
respect to the transaction. Uncertainty as to the enforceability of a contract
gives the board leverage to extract a favorable settlement of the third party’s
claims.
Social Media