(1) Where an agent acts without authority or exceeds its authority, its acts do not affect the legal relations between the principal and the third party.
(2) However, where the principal causes the third party reasonably to believe that the agent has authority to act on behalf of the principal and that the agent is acting within the scope of that authority, the principal may not invoke against the third party the lack of authority of the agent.
1. Lack of authority
Paragraph (1) expressly states that where an agent acts without authority, its acts do not bind the principal and the third party to each other. The same applies to the case where the agent has been granted authority of limited scope and acts exceeding its authority.
As to the liability of the false agent vis-à-vis the third party, see Article 2.2.6.
1. Principal B authorises agent A to buy on its behalf a specific quantity of grain but without exceeding a certain price. A enters into a contract with seller C for the purchase of a greater quantity of grain and at a higher price than that authorised by B. On account of A’s lack of authority, the contract between A and C does not bind B, nor does it become effective between A and C.
2. Apparent authority
There are two cases in which an agent, though acting without authority or exceeding its authority, may bind the principal and the third party to each other.
The first case occurs whenever the principal ratifies the agent’s act and is dealt with in Article 2.2.9.
The second case is that of so-called “apparent authority” and is dealt with in paragraph (2) of this Article. According to this provision a principal, whose conduct leads a third party reasonably to believe that the agent has authority to act on its behalf, is prevented from invoking against the third party the lack of authority of the agent and is therefore bound by the latter’s act.
Apparent authority, which is an application of the general principle of good faith (see Article 1.7) and of the prohibition of inconsistent behaviour (see Article 1.8), is especially important if the principal is not an individual but an organisation. In dealing with a corporation, partnership or other business association a third party may find it difficult to determine whether the persons acting for the organisation have actual authority to do so and may therefore prefer, whenever possible, to rely on their apparent authority. For this purpose the third party only has to demonstrate that it was reasonable for it to believe that the person purporting to represent the organisation was authorised to do so, and that this belief was caused by the conduct of those actually authorised to represent the organisation (Board of Directors, executive officers, partners, etc.). Whether or not the third party’s belief was reasonable will depend on the circumstances of the case (position occupied by the apparent agent in the organisation’s hierarchy, type of transaction involved, acquiescence of the organisation’s representatives in the past, etc.).
2. A, a manager of one of company B’s branch offices, though lacking actual authority to do so, engages construction company C to redecorate the branch’s premises. In view of the fact that a branch manager normally would have authority to enter into such a contract, B is bound by the contract with C since it was reasonable for C to believe that A had actual authority to enter into the contract.
3. A, Chief Financial Officer of company B, though lacking authority to do so, has, with the acquiescence of the Board of Directors, repeatedly entered into financial transactions with bank C on behalf of B. On the occasion of a new transaction which proves to be disadvantageous to B, B’s Board of Directors raises against C the objection of A’s lack of authority. C may defeat this objection by claiming that B is bound by A’s apparent authority to enter into the financial transaction on B’s behalf.