Authority of Agents and Principals (Actual, Apparent, Ratification)

7.2 Authority of Agents and Principals (Actual, Apparent, Ratification)

In any business environment, the actions of agents on behalf of principals can generate binding commitments, obligations, and legal consequences. Understanding how authority is created and recognized is essential for accountants, auditors, and business professionals—particularly those preparing for the CPA Exam’s Business Law content within the Regulation (REG) section. This chapter covers three primary types of authority: actual authority (express and implied), apparent authority, and authority by ratification.

Whether you represent clients, serve as an internal advisor in a company, or aspire to become a CPA, grasping these concepts is crucial to properly advising on contracts, liability disputes, and third-party claim cases.

Importance of Agency Authority

The nature of the agency relationship carries significant legal consequences for both the principal and the agent. Principals rely on agents to conduct transactions on their behalf, enter into contracts, and sometimes even make decisions that can bind the principals financially and legally. The key question in each instance is whether the agent acted within his or her authority—be it actual, apparent, or ratified.

From an exam perspective, authority issues often revolve around:

1. Determining whether an agent had legitimate power to act.
2. Evaluating if the principal bears responsibility for unauthorized acts.
3. Understanding the role of third parties who may rely on the appearance of authority.

Keep in mind that agency law is shaped by common law principles and statutory guidelines, such as those found in the Restatement (Third) of Agency. These standards help define the rights and obligations of all parties involved, providing structured tests for establishing or denying liability.

Defining an Agency Relationship

An agency relationship typically arises when a principal grants an agent the power to act on behalf of the principal. This relationship can be created by:

• A formal written agreement (power of attorney).
• An informal agreement or conduct demonstrating mutual consent.
• Subsequent ratification of the agent’s initially unauthorized act.

In general, the principal is held liable for acts committed by the agent within the scope of the agent’s authority. By contrast, if the agent acts outside the scope of authority, the principal may disclaim liability—unless other doctrines, like apparent authority or ratification, apply.

Forms of Authority

Actual Authority

Actual authority arises when the principal directly grants the agent the power to act. This falls under two further categories:

1. Express Authority: Authority explicitly granted through oral or written communication.
2. Implied Authority: All powers deemed necessary or incidental to fulfill the expressly granted authority.

Apparent Authority

Apparent authority emerges when a third party reasonably believes, based on a principal’s statements or conduct, that the agent has authority to act—even if such authority has not been expressly or implicitly granted.

Ratification

Ratification occurs when a principal, upon learning about an agent’s unauthorized act, decides to affirm or accept the benefits of that act. This retroactive acceptance effectively places the agent’s act within the principal’s scope of authority, making the principal liable.

Actual Authority: Express and Implied

Express Authority

Express authority is the clearest form of authority—often in the form of a direct written or oral instruction. For example, a CEO might tell an employee, “Negotiate and sign the lease for our new warehouse.” The employee’s power is explicit in carrying out that directive. In the CPA context, express authority might manifest in powers of attorney, engagement letters, or direct instructions from a client to a CPA for filing taxes, making regulatory submissions, or negotiating with the Internal Revenue Service (IRS).

Key aspects of express authority include:

• It often appears in documented contracts (e.g., a power of attorney).
• It must be obeyed and performed within the specified scope.
• A third party dealing with the agent can rely significantly on the agent’s express authority unless circumstances raise doubts about authenticity.

Implied Authority

Implied authority arises from the reasonable inferences an agent derives from an express grant of authority. If the agent is instructed to complete a certain task, implied authority covers all steps normally necessary to achieve that goal. For instance, if a company appoints a purchasing manager to acquire raw materials, that manager has implied authority to negotiate quantity discounts, coordinate shipping arrangements, or manage other details typically associated with procurement operations.

Key considerations for implied authority:

• The authority is confined to acts incidental or necessary to carry out the express authority.
• Activities covered by custom or industry practice also typically fit under implied authority.
• If an act strays beyond what is customary or necessary, it may not be considered implied authority.

Apparent Authority

Apparent authority is a critical concept because it creates legally binding obligations for the principal even without explicit or implicit delegation. Apparent authority arises from a principal’s representations—direct or indirect—that lead a third party to believe reasonably that the agent is authorized to act.

Elements of Apparent Authority

1. Representation by the Principal: The principal’s actions or communications (or in some cases, omissions) must enable the agent to appear authorized. For example, if a principal regularly allows an employee to make large purchases, a supplier might justifiably infer that the employee has authority to place such orders.
2. Reasonable Reliance by a Third Party: The third party must rely on what they perceive as the agent’s authority. If the third party has reason to question that authority (e.g., contradictory statements by the principal), reliance may not be reasonable.
3. Change in Third Party’s Position: The third party often must have acted upon their belief—possibly by entering into a contract or providing products/services—creating a legally binding transaction.

From an exam perspective, remember that the principal can be bound by an agent’s actions even if the agent lacked actual authority, so long as the above components are met. This underscores the importance for principals to communicate clearly with third parties and manage how agents present themselves in business dealings.

Authority by Ratification

Ratification allows a principal to become bound by an agent’s unauthorized act if the principal later approves or accepts the benefits of the transaction. This concept effectively backdates the agent’s authority to the time of the initial act—treating it as if the agent acted with full authority from the start.

Requirements for Ratification

1. Knowledge: The principal must have full knowledge of all material facts pertaining to the agent’s act.
2. Intent to Ratify: The principal must perform an intentional act affirming or accepting the transaction. This could be an explicit approval or an implied acceptance (e.g., retaining benefits from the contract).
3. Capacity: The principal must have the legal capacity to execute the contract or transaction. If they were incompetent or non-existent at the time of the transaction, they cannot ratify retroactively.
4. Timely Action: Ratification should occur within a reasonable time before the third party withdraws or circumstances materially change.

Impact of Ratification

Ratification transforms an initially unauthorized act into a valid one, binding the principal as though the agent had the necessary authority from the beginning. For instance, if an agent, without authority, purchases office equipment on the principal’s behalf, the principal could still confirm the purchase after-the-fact and thus be held responsible for the payment obligation.

Comparing Actual, Apparent, and Ratified Authority

Below is a helpful summary table distinguishing these three main types of authority:

Practical Examples and Case Studies

1. Express Authority – Lease Agreement

   • Scenario: A principal tells a real estate agent, “Find us a new office space in Midtown and sign a three-year lease if it’s under $25 per square foot.”
   • Result: The agent has express authority to negotiate and sign the lease under those specified terms. Any contract within that rent threshold binds the principal.

2. Implied Authority – Corporate Purchasing

   • Scenario: A food manufacturer hires a purchasing manager to order raw materials. The manager, with no explicit instructions, arranges standard shipping contracts and obtains short-term financing for inventory from recognized vendors.
   • Result: These additional steps are within the scope of implied authority, as they are necessary or customary for fulfilling purchasing duties.

3. Apparent Authority – Lavish Office Space

   • Scenario: A principal’s vice president has never been instructed to lease properties, but the company’s website and organizational chart describe the individual as “Director of Operations.” The vice president meets with a property owner, who sees that official title, and signs an office lease.
   • Result: If the property owner reasonably believed the vice president had authority to act (based on the principal’s representations of the role), the principal could be held liable through apparent authority—even if the principal never expressly authorized the deal.

4. Ratification – Unexpected Purchase

   • Scenario: An agent, without telling the principal, purchases new laboratory equipment for the company. The principal later learns about the purchase and sells products produced with the new equipment, reaping the benefit of improved productivity.
   • Result: By retaining the benefits and not objecting, the principal effectively ratifies the unauthorized act, incurring full liability for the purchase.

Diagram of Agency Authority

Below is a simple Mermaid diagram illustrating how an agent’s authority can stem from different sources and how a principal’s actions or acceptance can bind or validate the agent’s dealings.

    flowchart LR
	    A["Principal"] --> B["Agent"]
	    B["Agent"] --> C["Contract with Third Party"]
	    A["Principal"] -- Express or Implied --> B
	    A["Principal"] -- Apparent Authority (via Representation) --> C
	    A["Principal"] -- Ratification (Post-Transaction) --> C

• The lines from “Principal” to both “Agent” and “Contract with Third Party” show how authority can be derived either directly (express/implied) or indirectly (apparent authority).
• The arrow labeled “Ratification (Post-Transaction)” points from “Principal” to the contract, indicating that the principal can bind themselves to a contract the agent entered into without authority by affirming it after the fact.

Common Pitfalls and Best Practices

• Pitfall: Principals failing to monitor how agents present themselves. If third parties reasonably perceive the agent to have expanded authority, the principal is often bound under apparent authority.

• Pitfall: Agents misunderstanding or exceeding their implied authority, leading to liabilities that surprise principals.

• Pitfall: Principals remaining silent or accepting benefits from an agent’s unauthorized action, inadvertently ratifying a transaction.

• Best Practice: Principals should clearly define an agent’s scope of authority in agreements or instructions, reducing ambiguity.

• Best Practice: If a principal detects an agent might be overstepping authority, immediate notice to third parties can prevent apparent authority claims.

• Best Practice: Where an agent’s authority is revoked or changed, principals should update relevant third parties promptly.

Key Takeaways

1. Actual Authority: Focuses on what the principal and agent have explicitly or implicitly agreed upon.
2. Apparent Authority: Centers on third-party perceptions and the principal’s representations, binding the principal even without the principal’s direct grant of power.
3. Ratification: Retroactively binds a principal to an otherwise unauthorized act, provided the principal has full knowledge of the material facts and decides to accept the contract’s benefits.

Understanding these distinctions is paramount for avoiding unintended legal obligations and safeguarding the principal’s interests. As a CPA candidate, mastery of authority issues will prepare you for questions concerning common law business structures, contractual liability, and the broader law of agency concepts as tested in the Regulation section of the CPA Exam.

References and Further Exploration

• Restatement (Third) of Agency
• Uniform Commercial Code (UCC), especially for transactions involving sales, security interests, and other commercial dealings
• Richard D. Freer & Douglas K. Moll, “Principles of Business Organizations” (textbook covering agency law fundamentals)
• For additional case studies and practice questions, consult AICPA-released Regulation section sample exams and business law case anthologies.

Quiz: Authority of Agents and Principals

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