Corporate Contracting and the Risk of Self-Authorised Agents

Kahill Sarronwala takes a look at the nuanced rules of agency law and focuses on the commercial risks posed to companies as a result of self-authorised agents.

This piece will firstly seek to outline the fundamental rules of corporate contracting, which are largely derived from agency law. It will then go on to discuss the risks associated with unauthorised agents and their ability to bind companies to contracts through self-authorisation. We will then explore the potential costs which businesses may be exposed to as a result of this. Lastly, this piece will seek to prescribe, very generally, how companies might reduce this risk.

Actual authority

Companies can enter into contracts by virtue of their separate legal personality.[1] This essentially means that the law treats companies as legal persons. However, in some respects, a company is a legal fiction. It does not possess a voice to negotiate with, nor a hand to shake on a deal with. Therefore, a firm needs to contract through agents. Agents are individuals within a company who are authorised to act on its behalf.

The most basic forms of authority within agency law are actual express and actual implied authority. An individual's actual express authority is derived from the company's constitution, including its articles of association, which expressly grant individuals the authority to contract on behalf of the company.[2]

With regards to actual implied authority, an agent is deemed to have the actual authority to contract. This is implied by virtue of the agent's position within the company. For example, a senior loan officer in a bank will likely have the implied authority to approve small loans, as that is the 'usual' authority that accompanies that job title.[3] An individual may also have actual implied authority by virtue of a prior course of dealings. For example, in the seminal case of Hely-Hutchinson v Brayhead Ltd,[4] although the defendant did not have actual express authority to contract, he was involved in a course of dealings. Lord Denning MR held that the actual authority could be implied because the board of directors had consistently allowed the defendant to contract this way in the past.[5] These two forms of authority are relatively straightforward and do not often cause much confusion in practice.

Ostensible authority and self-authorised agents

The situation becomes more nebulous when it concerns ostensible authority. Ostensible authority is relevant where an agent does not have actual implied or actual express authority. The rules for ostensible authority were espoused by Diplock LJ in the case of Freeman Lockyer v Buckhurst Properties.[6] Firstly, the company or the agent makes a representation to a third-party that an agent has the requisite authority to contract on behalf of the company. Secondly, the third-party enters into the contract in reliance on that representation. Diplock LJ astutely clarified that in order for an agent to represent that they have the authority to contract on behalf of a company, they must actually be authorised to make that representation.[7] The authority to make a representation should be carefully distinguished from the authority to enter into a contract. This operated to create a clear legal rule. This rule prevented self-authorisation because agents could not make arbitrary representations in order to confer authority on themselves. An agent would have needed to have actually been authorised to make that representation. As rationalised in Armagas v Mundogas,[8] this rule attempted to strike a balance between protecting companies from unscrupulous agents and protecting third-parties, who enter into contracts in reliance on a representation.

English agency law has since been plunged into a state of some uncertainty. For example, in the case of First Energy v National Hungarian Bank,[9] it was held that a branch manager did not have the actual authority to enter into the relevant transaction, nor had he been authorised to represent that he could do so. Nevertheless, the court found that the manager did have the actual authority to represent that the head-office had conferred authority upon him.[10] As the head office had not conferred this authority on him, this exemplified a situation of self-authorisation. To further complicate matters, this was not an isolated judgement. Self-authorisation reared its head again in the cases of British Bank of the Middle East v Sunlife Assurance,[11] Kelly v Fraser,[12] and ING Re v R & V.[13]

This state of affairs is undesirable for two reasons. Firstly, this creates the risk that companies could end up being bound by contracts which were entered into without proper authority. This could result in an undesirable cost being imposed on conducting business. Secondly, this generates uncertainty in the law, which is yet another cost on business. The concept of costs refers to the financial costs of having to breach or complete contracts that were entered into without authority. Moreover, there are costs involved in taking steps to mitigate the risk of self-authorised contracting. Additionally, there are reputational costs; as third-parties will look unfavourably on companies who appear unreliable and disorganised.

Notable academics, such as Gower, have pointed out that self-authorised contracting is geared towards protecting third-parties, who may not have a reliable method of finding out whether an agent is in fact authorised to contract.[14] While this is a sound rationale, the possibility of self-authorisation can impose a disproportionate cost on conducting business for the reasons mentioned above. This line of argument is further augmented when we consider the myriad of methods available to a third-party to discover whether a transaction or contract has been duly authorised.

What does this mean for corporate contracting in practice?

Self-authorised contracting is a relevant issue for companies to keep in mind when structuring their hierarchies and constitutions in order to minimise risk. One of the most interesting facets of this issue is the stance that this risk of self-authorisation is a product of good law. Economic commentators, such as Kraakman, have argued that the possibility of self-authorised contracting is useful in protecting third-parties who have relied on a representation and entered into a contract with a self-authorised agent.[15] This is an attempt by the law to shift the burden of controlling agents to the entity which is best placed to do so. In this context, this would be the company that the agent is purporting to act on behalf of. This is also quite pragmatic given how fast-paced and dynamic the contemporary business world is.

Since it is the contracting company, and not the third-party, who is in the optimum position to control its agents, there are steps companies can take in order to minimise their risk. For a start, companies can clearly outline who has the authority to engage in certain dealings within the articles of association, board minutes, and resolutions. Due to the fact that much of a company's constitution is made public on mediums such as Companies House, third-parties are often aware (or put on notice) of when an agent is authorised to contract. Therefore, third-parties may not irrationally rely on a representation when the company's constitution expressly provides that no authority exists. Companies may endow themselves with a further safeguard by structuring their hierarchies and policies in such a manner that agents without authority are not given the opportunity to engage in self-authorised contracting.

Written by Kahill Sarronwala.

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[1] Salomon v A Salomon & Co Ltd [1896] UKHL 1, [1897] AC 22

[2] Meridian Global Funds Management Asia Ltd v Securities Commission [1995] UKPC 5

[3] Hely-Hutchinson v Brayhead Ltd [1968] 1 QB 549

[4] Ibid

[4] Ibid

[6] Freeman and Lockyer v Buckhurst Park Properties (Mangal) Ltd [1964] 2 QB 480

[7] Ibid

[8] Armagas Ltd v Mundogas SA (The Ocean Frost) [1986] A.C. 717

[9] First Energy (UK) v Hungarian International Bank Ltd [1993] B.C.C. 533

[10] Ibid

[11] British Bank of the Middle East v Sun Life Assurance of Canada (UK) Ltd [1983] BCLC 78

[12] Kelly v Fraser [2012] UKPC 25

[13] ING Re (UK) Ltd v R&V Versicherung AG [2006] EWHC 1544 (Comm)

[14] Davies, P., Gower, L., Worthington, S. and Micheler, E. (n.d.). Gower's principles of modern company law

[15] The Anatomy of Corporate Law: A Comparative and Functional Approach, Book by Gerard Hertig, Henry Hansmann, Klaus J. Hopt, Paul Davies, and Reinier H. Kraakman