Apparent Authority: How to avoid it and what to do if it exists.

Apparent authority is the silent killer of hard fought and won contract rights. Every purchasing / contracting professional (and even a few lawyers) has his or her own "horror story" about regrettable commitments made by employees who have no actual authority to buy, sell or act on behalf of their organization. Such "contracts'' can be a real headache to the conscientious professional whose job it is to secure the best goods and services at the best price with the best commercial terms and conditions possible at the time. It also creates real potential liability for the organization as well as loss of leverage. The reason "contracts" or commitments made by those without actual authority can be a problem is the way the law looks at the issue of authority.

An employee, as an “agent”, is only allowed to act within the scope of authority as given by the “principal”, i.e., his or her employer. This authority can be either "actual" or "apparent". An employee or agent cannot, by his or her actions or statements create authority which the principal has not given. However, an employer can, by words or conduct, inadvertently "cloak" an employee with “apparent” authority which can have the same effect as giving an employee “actual” authority. Employers who know, or should realize, that an employee is acting without actual authority and do nothing about it are setting up apparent authority in that employee.

Actual authority consists of authority which is given in spoken or written form, i.e. "express", and includes any "implied" authority which would logically and reasonably be expected to accompany an employer's expressly stated authority. An organization’s by-laws or delegation of authority document are examples of express actual authority.

Apparent authority is also created by the principal ( i.e. your company or organization). However, unlike actual authority which is given to the agent ( i.e. the employee) by the principal, apparent authority is created by how the principal acts toward third parties who reasonably rely on the principal's behavior. That behavior can include failing to object to the unauthorized actions of an employee or by "dressing up'' the employee with all the trappings of authority so as to mislead an innocent third party who relies on the principal's behavior to his or her detriment. Essentially when an organization lets an employee act as if he or she has authority it creates the hobgoblin of apparent authority.

As a practical matter, there are limits to every agent's inferred authority. For example, the authority to manage does not generally include the authority to make unusual or extraordinary contracts. The test for apparent authority is whether a reasonable person of ordinary diligence would believe that the employee/agent had the authority to do what he or she did. However, as Leonardo da Vinci noted “Nothing strengthens authority so much as silence”. It is that “silence” by the employer the face of unauthorized conduct that empowers the employee.

How can we reduce the risk of unauthorized contracts or commitments? The best way to avoid confusion about authority is to clearly express both internally within the organization, as well as externally to vendors, who has authority and the limits of that authority. Note that terminating an agent's actual authority does not automatically terminate apparent authority until the third party with whom the agent has been dealing receives notice, either actual or constructive, that the agent's authority been terminated.

If vendors are on notice that only certain individuals in an organization can contractually bind the company, they cannot claim that they were misled. By the same token, employees acting outside the scope of their authority need to be counseled on the risk their behavior presents. These risks include undermining the competitive bidding process, loss or rights or remedies, and unintended / sub-par contacts or commitments.

Giving vendors such notice as to who has the actual authority cuts out unauthorized contracting by placing the risk of such adventures squarely on the vendor. This way the vendor has a vested interest in enforcing the company's policy on who can sign for or otherwise commit the company. The notice to vendors could be something like:

"Only certain designated Company employees consisting of Company Officers, Purchasing Agents, or others who are expressly authorized can contractually commit the Company up to the limits of their authority. Vendors should not assume that employees who are not officers or Purchasing Agents are authorized to sign agreements or make any contractual or other commitment on behalf of the Company."

Don’t fall into the trap or be a victim of apparent authority. Be on the look-out for apparent authority and take steps to reduce that risk. Make sure your employees: (1) understand the limits of their authority and act accordingly; and, (2) only rely on statements or representations made by those with actual authority. If you discover instances of apparent authority by an employee take action by correcting the employee’s behavior and informing the other party of the limits of his/her authority. And when negotiating with a counter-party make sure you know his or her actual authority. Of course prevention remains the best “ cure” for avoiding the apparent authority trap. It is all part of good contract management.

Paul Humbert has co-authored several books for Supply Chain, Procurement and Project Management professionals.  These include: Contract and Risk Management and Model Contract Terms . Both are  available through Amazon.com and are on the American Purchasing Society recommended reading list. These books highlight how to stay out of  contract traps...the "got yahs that get yah" commercially. Learn about the "inventory trap", the "but you said" trap and many others. Don't become a seminar story. Let's stamp out apparent authority and other  contract traps.