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It is common for businesses to have long-term relationships with particular individuals. Still, when someone new comes into the picture, a business may have questions about the level of authority that person has.  This issue can sometimes arise in the context of contracts between parties.  When can a business assume that the individual they are dealing with has the authority to sign a contract for another business? This question is at the heart of what is known in law as the “indoor management rule.”

Principles of Agency Law Play a Significant Role in the Enforceability of Corporate Contracts

Before digging too deep into this rule, a recap of some general principles of agency law is necessary.  A corporation is a distinct legal entity with its rights and liabilities but is not a natural person.  If a corporation enters into a contract, it must do so through one or more individuals acting on its behalf.  Where an individual is authorized to enter into such a contract, an agency relationship is said to exist between them such that the individual is the agent and the corporation is the principal.  The agent is considered in law to have the power to represent the principal and affect the principal’s legal rights and obligations by the making of the contract (see 1196303 Inc. v. Glen Grove Suites Inc.).

An Agent May Have Express or Implied Actual Authority to Bind a Corporation

Where the corporation and the individual entering into the contract on its behalf agree to the relationship, and the corporation gives the individual the authority to affect the corporation’s legal position (per Glen Grove Suites), the individual is said to have “actual authority.”  This authority can be expressed or implied.

A third party entering into a contract with a corporation may be aware that the individual signing on the corporation’s behalf has the authority to do so.  In that situation, there may not be any concerns about the contract being enforceable against the corporation.  However, what about the situation in which the third party has no such knowledge?  Is there a risk the contract will not bind the corporation?

An Agent May Also Have Apparent Authority to Bind a Corporation

The third-party may be able to claim the individual purporting to sign on behalf of a corporation has “apparent” or “ostensible” authority and that the corporation is legally bound as a result.  This type of relationship is created by a representation made by the principal to the third party that is both intended to be and is acted on by the third party (see Monachino v. Liberty Mutual Fire Insurance Company, citing U.K. case law).  If the representation is that “the agent has authority to enter on behalf of the principal into a contract of a kind within the scope of the ‘apparent’ authority,” then the principal will be “liable to perform any obligations imposed on him by such contract” (per Freeman & Lockyer v. Buckhurst Park Properties (Mangal) Ltd., cited in Monachino).

For example, let’s assume Joe works for Company A.  Company B hires Tina.  Joe may not know the extent of Tina’s authority. Still, suppose the president of Company B tells Joe that Tina is authorized to sign contracts on behalf of Company B. In that case, Company B may be legally bound by any such contracts signed between the companies by Joe and Tina.  This is because Tina has apparent authority to bind Company B, even if she lacks the authority.

The Principle of Constructive Notice Complicated the Notion of Apparent Authority

The concept of apparent authority protects innocent third parties who have no reason to question the authority of an individual to enter into a contract on behalf of a corporation.  However, this protection was potentially undermined by another common law rule which provided that third parties dealing with a corporation were deemed to be aware of restrictions on authority set out in any corporate documents that were publicly filed, a principle known as “constructive notice.”  For example, if a corporation’s publicly filed articles of incorporation specifically required a particular individual’s contracts to be signed, then the common law would deem a third party to be aware of this restriction.  This made it difficult for the third party to argue that the corporation was bound by a contract signed by a different individual since it made it difficult for the third party to establish that the different individual had apparent authority.

The “Indoor Management Rule” Reinforced the Third Party Protection Offered by the Concept of Apparent Authority

The common law attempted to resolve this inconsistency by introducing what is known as the “indoor management rule.”   In The Midas Investment Corporation v Bank of Montreal, the Ontario Superior Court of Justice provided a useful summary of the rule.  In short, it holds that “if a corporation holds someone out as a director, officer or agent to third parties, the corporation cannot deny that the person is duly appointed or that he or she has the authority customary or usual for such a director, officer or agent.”  So long as the third party dealing with the corporation does so in good faith, they will not be required “to conduct an inquiry” into the corporation’s compliance with its internal procedures unless the third party “has actual knowledge to the contrary” or “ought to know that effect.”

Third-Party Protections Found in the Common Law Are Now Statutory

Both the common law principle of constructive notice and the “indoor management rule” are addressed in sections 18 and 19 of the Business Corporations Act.  Specifically, section 18 provides that “no person is affected by or is deemed to have notice or knowledge of the contents of a document concerning a corporation by reason only that the document” has been filed under that statute or is available for inspection at the corporation’s office.  With some exceptions, section 19 precludes a corporation from “asserting against a person dealing with the corporation” that various internal documents have not been complied with or that a person “held out by the corporation as a director, officer or an agent of the corporation” does not have “authority to exercise the powers and perform the duties that are customary in the business of the corporation or usual for such director, officer or agent.”

It is important to note that there is a significant exception built into section 19 of the Business Corporations Act.  A third party cannot rely on that section where, by virtue of their position with or relationship to the corporation, they knew or ought to have known that the purported agent of the corporation did not have the authority to act on its behalf.

In light of the above, it is not always easy for a corporation to challenge the enforceability of contracts it enters into because an individual does not have the authority to sign on its behalf.  Indeed, this argument failed in the recent case of Valtrol v. 1373007 Ontario Ltd.

For Legal Advice Regarding Contract Disputes and Corporate Commerical Litigation Contact Milosevic & Associates

The litigation lawyers at Milosevic & Associates in Toronto are available to provide representation in complex corporate commercial litigation.  Our team provides practical and strategic advice to effectively and efficiently resolve business disputes.  Contact us online or by phone at (416) 916-1387 for a consultation.