By Lyzz Leise
Football season is back, and every team has a playbook that determines who is responsible for making the call. Businesses are not so different. While many people may play an important role in a company’s operations, not everyone necessarily has authority to act on the company’s behalf.
As part of this week’s Tuesday Tax Take, we are looking at a practical issue that comes up in businesses of all sizes: who actually has authority to sign a contract on behalf of the company?
Businesses enter into contracts every day. These may include customer agreements, vendor contracts, leases, loan documents, employment agreements, purchase orders, and service contracts. But before a contract can bind a company, an important question sometimes gets overlooked: Does the person signing actually have authority to bind the business? The answer is not always as simple as looking at the person’s job title.
Actual Authority
Just as players have defined roles on the field, individuals within a business may have different levels of authority. Actual authority exists when the business has authorized an individual to act on its behalf. Actual authority may be expressly granted. For example, a corporation’s board of directors may authorize its president to sign a particular purchase agreement. An LLC operating agreement may give the manager authority to enter into contracts on behalf of the company. Authority can also be broader. Depending on the company’s governing documents and internal structure, certain officers or managers may have authority to enter into contracts in the ordinary course of business without obtaining separate approval each time. The scope of that authority matters. An employee may be authorized to place routine supply orders but not to sign a five-year lease. A company president may have broad operational authority but still need approval from the board, shareholders, members, or other governing body for a significant transaction, such as the sale of substantially all of the company’s assets.
Apparent Authority
Problems can arise when someone appears to outsiders to have greater authority than the business intended to give them. Even without actual authority, a company may sometimes become bound by a person’s actions under the concept of apparent authority. Apparent authority generally arises when a company, through its words or conduct, causes a third party to reasonably believe that a person has authority to act on the company’s behalf. For example, suppose a company allows an employee to negotiate vendor contracts, communicate with vendors as the company’s representative, and sign similar agreements over a period of time. A vendor may reasonably believe that the employee has authority to enter into another agreement of the same type. That can create problems when the company believed the employee’s authority was more limited than it appeared from the outside. For this reason, businesses should think not only about the authority they formally grant, but also about how they present employees and representatives to customers, vendors, and other third parties.
Titles Do Not Always Tell the Whole Story
A title such as “President,” “Vice President,” “Manager,” or “Director” can suggest authority, but a title alone does not necessarily answer the question. Whether an individual has authority may depend on applicable law and several other factors, including:
the company’s articles, bylaws, operating agreement, or other governing documents;
resolutions adopted by the board, members, or managers;
the individual’s position and customary responsibilities;
prior dealings between the parties; and
the nature and size of the particular transaction.
The larger or more unusual the transaction, the more important it becomes to confirm authority. For example, a vendor may not question whether a store manager can order ordinary inventory. A bank financing a multimillion-dollar transaction, however, will typically want formal documentation showing that the transaction and the individuals signing the loan documents have been properly authorized.
Why Businesses Should Pay Attention
Authority issues can create risk on both sides of a transaction. For the company signing the contract, unclear authority can result in employees committing the business to terms management never intended to approve. For the other party, there is a different risk. If the signer lacked authority, the company may later argue that it is not bound by the agreement.
Businesses can reduce these risks by establishing clear internal signing policies. Those policies may identify which individuals can sign contracts, any dollar limits on their authority, and which transactions require approval from owners, managers, or the board. Companies should also make sure their governing documents accurately reflect how the business actually operates.
Confirming Authority in Significant Transactions
For larger transactions, the parties often take additional steps to confirm authority. Depending on the circumstances, this may include reviewing governing documents, obtaining board or member resolutions, requesting certificates from an officer or secretary, or reviewing incumbency certificates identifying the company’s current officers and authorized signers. These requirements may feel administrative, but they serve an important purpose. They help establish that the company properly approved the transaction and that the individuals signing the documents have authority to do so.
The Bottom Line
In football, not every player gets to call the play. The same is true in business. A signature on a contract does not exist in a vacuum, and the person signing must have authority to act for the business. For routine transactions, that authority may be relatively straightforward. For significant contracts, unusual transactions, or situations where authority is unclear, businesses should confirm who has the power to approve and sign the agreement before the contract is executed. Knowing who is authorized to make the call can help keep the business moving down the field and avoid costly disputes later.
This article is provided for general information purposes only and should not be construed as legal advice. Those requiring legal advice are encouraged to consult with their attorney.
