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Beware of Dealing With Individual Directors

The common law position that authority to bind a company must be conferred by a company’s articles of association, is altered by the Companies Act 2006 (CA 2006). Section 40 CA 2006 provides that where a person deals with a company in good faith the power of the directors to bind the company is deemed free of any limitation in the company’s constitution.

Section 40 CA 2006 came into force on 1 October 2009 and replaced similar provisions of the Companies Act 1985 (CA 1985). One key difference between the provisions of CA 1985 and CA 2006 is that section 40(1) of the 2006 Act refers specifically to directors rather than the board. Accordingly it seems that a company can be bound to any transaction by a single director who is acting with either:

  1. Actual authority given by the board; or
  2. The implied authority of the company;

This will be so, even where the act is contrary to the company’s articles of association. Section 43(1) (b) of the CA 2006 goes further in relation to contracts by providing that a contract may be made on behalf of a company by any person acting with the company’s express or implied authority.

In order for third parties to rely on section 40 it is essential that they have dealt with the company in good faith, though good faith is presumed unless proven otherwise. The nature of the transaction or its circumstances may put the person dealing with the director on enquiry that the act is outside of the director’s authority. It has been held by the Court of Appeal that the predecessor to section 40 CA 2006 (section 35A CA 1985) does not remove the duty to enquire as to the director’s authority once put on enquiry. The recent case of Magical Marking Ltd & Anor v Holly & Ors 2008 discussed below demonstrates this point.

The general principles of agency law govern what amounts to ‘implied authority’. Where a reasonable person would understand that an agent has the authority to act, the principal will be bound by the agent’s acts even if the agent in fact had no actual authority. Where a principal makes a representation (whether by words or conduct) that an agent has authority to act on his behalf, the principal will also be bound. This latter form of implied authority is also known as ‘ostensible authority’.

These issues were recently considered in the case of Magical Marking Ltd & Anor v Holly & Ors 2008. Mr Holly, a director of Magical Marking Ltd (the Company), had a disagreement with the other director of the Company, Mrs Phillis, which resulted in Mr Holly announcing that he did not wish to continue as an operational director. Subsequently Mr Holly engaged the services of an IT consultant named Mr Caravan and instructed him to copy all of the Company’s electronic records. During this process the Company’s computer systems were also disabled.

Firstly, the Court held that Mr Holly did not have ostensible authority to bind the Company. It was found that no unequivocal representations were made to Mr Caravan by the Company that Mr Holly had authority to instruct him. The Company had never held out Mr Holly as having authority to bind the Company to any contract.

Perhaps more interestingly were the comments which were made by the Court in relation to whether Mr Caravan had been put on enquiry to the fact that Mr Holly lacked authority to instruct him. Mr Justice Norris held that Mr Caravan had indeed been put on enquiry by the circumstances. Mr Caravan was aware that there was a dispute at the Company which involved Mr Holly. On the day that Mr Caravan went to the Company’s premises to copy the electronic records he and Mr Holly were accompanied by two men described in the proceedings as ‘thugs’. Whilst at the premises the staff were told that they could not use their telephones or touch their computers. Eventually the police were called. The Court also held that in any event Mr Caravan would not have been entitled to rely on any representations which he claimed had been made to him, as the abnormal circumstances should have put him on enquiry that Mr Holly may not have authority to instruct him.

Ostensible authority may also arise where a person holds a position within a company whereby it is expected that such a person would have authority to act on behalf of the company. This is pertinent to the implied authority of executive directors. For example when a director is appointed to a particular office within a company, such as Financial Director or Sales Director, it is arguable that by virtue of their appointment to that office they have implied authority to do everything necessary to perform their role.

In the case of Smith v Butler & Anor the Court considered the implied authority of a Managing Director. Judgement was delivered in September 2011. The Court was asked to determine whether it was within the implied authority of the Managing Director to suspend the Chairman who was also the majority shareholder. The Court held in favour of the Chairman and held that the Managing Director did not have implied authority for such an act. The Court reasoned that the decision to suspend the Chairman was not related to the day to day running of the Company and was not a commercial decision. The Court also held that the Managing Director could not use his position to grant himself powers properly exercisable by the board.

Interestingly leave has been granted for appeal. The Court of Appeal is due to hear the case at the beginning of 2012. Commentators have welcomed a ruling from the Court of Appeal noting that the extent of the implied authority of a Managing Director is unclear.

The implied or ostensible authority of individual directors to bind a company is a complex area of law. The relationship between section 40 CA 2006 and the agency law concepts is yet to be fully considered by the Courts. Until it is third parties should exercise caution when dealing with individual directors and where possible request proof of their authority to act on behalf of the company in the form of a board resolution.

December 2011

Girlings Corporate and Commercial Team

© Girlings Solicitors 2011 save as acknowledged.

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Before relying on this commentary please read the Reliance on information posted section in our Terms of Website Use in our Legal section. Please note that specialist advice should be taken in relation to any specific queries and the information above is provided for general information purposes only.

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