The Risks Posed to Partnerships by Prioritising Companies in Agency Law
Josh Wilkins examines the progression of agency law in relation to companies and highlights the risks that recent legal developments pose to the desirability of using partnerships as a business model.
Introduction
This article aims to defend the increasing scope of apparent authority within the realm of agency law. It will discuss the ruling in First Energy v Hungarian International Bank,[1] whereby the court recognised apparent authority by virtue of the usual authority of an agent’s office, despite the contracting third party’s knowledge of a lack of authority to contract. It will then demonstrate that this ruling is a natural legal development, given that the evolution of commercial law prioritises the functionality of companies over other corporate structures. Despite this welcome development which may enhance the functionality of companies, this article will also discuss the undesirable side-effects this decision has had on the law of partnerships. It will be argued that partnerships have been made almost obsolete as a result of commercial law’s heavy focus on how the law impacts companies specifically, rather than recognising its uniform application to all corporate structures.
Apparent authority
We will start by explaining the concept of apparent authority. At the heart of apparent authority lies an agency relationship. An agency relationship is comprised of a principal and an agent. The principal may authorise an agent to act on their behalf and contract with a third party. Diplock LJ sets this out clearly in Freeman and Lockyer v Buckhurst Park Properties.[2] Diplock LJ said that apparent authority materialises where “a representation [is] made by the principal”, or an authorised agent, to a third party that the agent has the authority to enter into contracts on behalf of the principal, within the scope of their ‘apparent’ authority”.[3] This may act as a “form of estoppel”,[4] where the principal is estopped from denying that the agent is authorised to act on their behalf, despite the lack of actual authority, following the third party’s reliance on this representation. As a result, an innocent third party may enforce the contract that they negotiated with the agent, protecting their reasonable expectation that the agent was authorised to contract.
With regard to this idea of reasonable expectations, the law clearly offers strong protection to third parties, whose reliance may come at the cost of very little detriment, (or even none at all),[5] unlike with most forms of estoppel. Goode, a leading commercial lawyer, advocates for this lower threshold of detriment for innocent third-party protection.[6] However, in every commercial transaction, principals also require some degree of protection from their agents. Traditionally, such rights are defended by the cases of Freeman and Lockyer and Armagas v Mundogas which ensure that agents must have actual authorisation to represent that they have the authority to enter into contracts on behalf of the principal.[7] Furthermore, this representation of authority must be relied upon[8] and this reliance cannot be “dishonest or irrational”.[9] Such an instance occurred in Overbrook Estates v Glencombe Properties, where the third party was prevented from relying on the agent’s representation of authority because they knew of the agent’s lack of actual authority to make such a representation.[10] Thus, there is an attempt to balance safeguarding the interests of both the third party and the principal, which is factually contingent.
However, it is argued that this balancing of commercial interests has been excessively tipped in favour of third parties by Lord Steyn in the case of First Energy v Hungarian International Bank. In that case, the third party knew that a bank manager did not have the authority to contract. Yet, the court held that the agent had apparent authority by virtue of the usual authority of his office to represent that he had been authorised to enter into the relevant transaction with the third party. Notable commentators, such as Watts, have argued that this case may cause a “radical makeover of agency law if widely broadcasted”,[11] given that it departs from the Freeman and Armagas prohibition on self-authorising agents. Furthermore, this undermines the principal, as agents may contractually bind principals, regardless of the lack of authority to do so, weakening the principal’s right to confer (or not confer) authority upon an agent. Nevertheless, this approach was endorsed in the case of Kelly v Fraser,[12] whereby a third party was allowed to rely on the agent’s position of authority within a pension fund as a representation of authority to communicate the transfer of pension funds. Again, this result disregarded the lack of actual authority and the fact that this transfer was never approved.
These cases have been further criticised by Chan Sek Keong in the case of Skandinaviska Enskilda Banken v Asia-Pacific Breweries.[13] In this case, Chan states that an agent’s representation of their principal’s approval of a transaction is not like other representations that the agent may be authorised to make. Instead, it goes “to the heart of the agency relationship”,[14] given that it contractually binds the principal, despite the agent only having the authority to make general representations about a transaction, instead of the “specific representation that the principal has approved a transaction”.[15] Ergo, the undesired results of not distinguishing between authority to make general representations and authority to make specific representations include the principal being contractually bound, regardless of their wishes, and an erosion of the Freeman principle. Consequently, this is an important distinction in authorities to make. Nonetheless, the discussed distinction fails to account for commercial law’s purpose, which this piece argues is a justification of recognising general apparent authority in the discussed circumstances. As a result, we now turn to discuss this purpose in order to rebut the necessity of making this distinction of authorities in agency law.
First Energy and the natural progression of case law
In the case of Kum v Wah Tat Bank, Lord Devlin states that commercial law’s function is to allow “commercial men to do business in the way they want to do it”.[16] This is a clear call for commercial law to recognise and respect organisational structures that are currently prevalent. In line with this, Munday, another academic, has acknowledged the growing “impersonal nature of modern commercial dealings which are increasingly complex”.[17] This requires the law to allow commercial arrangements and powers to be distributed as business people require in an evolving context. In our context of apparent authority, this allows quicker and more efficient transactions that are not constantly held up by agents requesting specific principal authority in everything that they do. Lord Sumption further highlighted this issue in Kelly v Fraser where he said that “in a bureaucratically complex organisation”, the distribution of the communicative power in First Energy was a matter for that organisation.[18] Consequently, this distinction of authority is not an obscure creation, rather it is the courts’ prerogative to adhere to the function of commercial law by respecting new business structures. Instead of a radical departure from the orthodox Freeman position, the law is respecting the contracting parties’ reasonable expectations that the law will respect their commercial arrangements. Furthermore, this adheres to Goode’s final commercial maxim, “flexibility”. The law is allowing commercial practices to develop and is “responsive to the needs of the business community and reluctant to deny recognition to the legal efficacy of commercial […] practices in widespread use”.[19] As a result, the outcome of First Energy may be seen as commercial law naturally progressing alongside contemporary business practices.
The impact on partnerships
Although partnerships are a common business model in the UK, the discussed case law presents a number of challenges to their continued use and survival. Forming a partnership has various benefits. Firstly, it is cheap and easy, given that all they require is two or more legal persons (which could include entities such as companies) to strive to make a profit together.[20] Furthermore, they do not require any formalities or an intention to create a partnership. Consequently, were two companies to strive towards a common goal together, they would form a partnership, despite a lack of express desire or intention to do so. The grave consequence of such an occurrence is that the entirety of one of the partner’s assets may be at stake, given the joint and unlimited nature of liability of partners within a partnership.[21] This is because the partnership itself has no separate legal personality.[22] This is especially troubling, regarding the common law rules on agency, as an employee of either partner company (a non-partner, which disapplies section 5 of the Partnership Act 1890) could bind the partnership to an unknown and undesirable contract on the basis of the discussed apparent authority, a breach of which may result in the bankruptcy of either partner. Such consequences occurred in the Malaysian case of Sithambaram Chetty v Hop Hing,[23] whereby an agent of a partnership borrowed money from a third party without actual authority. Following breaches of the agreements, the original partners were held to be liable as a result of failing to highlight the manager’s lack of authority to conduct business, despite the fact that there was no public knowledge of the partner’s involvement in the partnership. This bizarrely results in partners having to either surrender vital benefits of partnerships (non-existent disclosure requirements and low administrative costs) in order to avoid liability or simply to accept the risk of future liability. Such a result has rendered partnerships almost completely undesirable as a business model.
It is noted that partnership deeds may be entered into in order to avoid these consequences by explicitly restricting the authorised actions in order to safeguard the interests of the partnership. However, this solution does not account for partnerships that may accidentally be entered into, the possibility of which has been highlighted. Nor does it restrict the acts of employees of either partner from entering the partnership into a contract. As a result, this potential safeguard may have been nullified due to the latest developments on the law of apparent authority.
This is a clear example of the law prioritising its relationship with companies, without due regard for the contours of the entire commercial environment. This is further evidenced by the regulation of companies under the Companies Act 2006,[24] one of the longest and most effective pieces of legislation in existence. In contrast, partnerships are governed by the 130-year-old Partnership Act 1890 and the common law, the undesirable results of which are clear. Returning to Lord Sumption’s comments in Kelly v Fraser, regarding the ability of businesses to organise their own affairs, we can see a clear example of the courts attempting to accommodate the interests of complex organisations at the expense of the simplest ones; partnerships. Furthermore, this is contrary to commercial law’s stated purpose as it overly restricts the viability of forming partnerships, given their potentially grave consequences, and increases the need for vigilance in ensuring that companies do not form partnerships. Such a result may require companies to explicitly sign deeds stating that partnerships are not entered into with all persons that they interact with in the pursuit of profit. This is a substantial and excessive administrative burden for organisations to take on as a result of commercial developments that prioritise the functionality of companies.
Written by Josh Wilkins.
[1] First Energy (UK) v Hungarian International Bank Ltd [1993] B.C.C. 533.
[2] Freeman and Lockyer v Buckhurst Park Properties (Mangal) Ltd [1964] 2 QB 480.
[3] ibid.
[4] Rama Corporation Ltd v Proved Tin and General Investments Ltd [1952] 2 QB 147.
[5] ibid.
[6] Roy Goode, ‘The Codification of Commercial Law’ (1988) 14 Mon LR 135.
[7] Armagas Ltd v Mundogas SA (The Ocean Frost) [1986] A.C. 717.
[8] Bedford Insurance v Instituto de Resseguros do Brazil [1985] 1 QB 966.
[9] Thanakharn Kasikorn Thai Chamkat v Akai Investments [2010] HKCFAR 479.
[10] Overbrooke Estates Ltd v Glencombe Properties Ltd [1974] 3 All ER 511.
[11] Peter G Watts, ‘Some Wear and Tear on Armagas v. Mundogas — The Tension between Having and Wanting in the Law of Agency’ (2015) Lloyd's Maritime and Commercial Law Quarterly 36.
[12] Kelly v Fraser [2012] UKPC 25.
[13] Skandinaviska Enskilda Banken AB (Publ), Singapore Branch v Asia Pacific Breweries (Singapore) Pte Ltd [2011] SGCA 22.
[14] ibid.
[15] ibid.
[16] Kum and Another v Wah Tat Bank Ltd [1971] AC 439.
[17] R.J.C. Munday, ‘Apparent Authority’, (2016) Oxford University Press 69.
[18] Kelly (n 12).
[19] Goode (n 6).
[20] Partnership Act 1890, section 1(1).
[21] Partnership Act 1980, section 9.
[22] ibid.
[23] Sithambaram Chetty & Others v Hop Hing & Others [1928] SSLR 53.
[24] Companies Act 2006.