Tuesday, October 11, 2011

The Effect of Reinstatement on Agent Liability

The Effect of Reinstatement on Agent Liability as Analyzed Under the
Restatement (Third) of Agency
     Agent A, on behalf of Principal P, has both actual and apparent agency authority conferred at a time when P was fully competent to do so.  At some later time, P becomes incapacitated.  A has the capacity to learn of P’s incapacity, but has no actual knowledge thereof.  During P’s incapacity, in the ordinary course of what would otherwise be P’s line of business and having fully disclosed P’s identity as the principal, A enters into a contract with third-party (“TP”).  At some point thereafter, P regains competency and expressly ratifies A having, during the period of incapacity, entered into the agreement with TP on P’s behalf.  Thereafter, P defaults on the agreement with TP.
     Just to put matters in context, P is a business corporation, and A is its President.  The incapacity came about due to the administrative dissolution of the corporation for failure to have filed its annual report.  Upon discovery of the dissolution, the corporation was, within the time limit imposed by its state of incorporation, reinstated.
     Notwithstanding the fact that A was not aware of P’s incapacity, in entering into the contract with TP, A violated his Warranty of Authority and has potential direct liability on the obligation.  See Restatement (Third) of Agency § 6.04 (2006) (the “Restatement”) (“Unless the third party agrees otherwise, a person who makes a contract with a third party purportedly as an agent on behalf of a principal becomes a party to the contract if the purported agent knows or has reason to know that the purported principal does not exist or lacks capacity to be a party to a contract.”); id. § 6.10.  See also 3 Am.Jur.2d Agency § 295 (2008) (“Generally, one who contracts as an agent in the name of a non-existent or fictitious principal, or a principal without legal status or existence, is personally liable on a contract so made.”).  Still, by ratification after the incapacity was lifted, P agreed to be bound on the contract with TP.  See Restatement § 4.02.  The question is whether P’s ratification of A’s conduct during the period of incapacity cures as to TP the breach of the warranty of authority with the effect that TP is not able to look to A for performance upon P’s default.
     Applying the Restatement, the agent is not liable on the agreement.  This conclusion is dictated by Restatement section 4.02, it addressing the “Effect of Ratification.”  Presuming that the entity ratifies the actions undertaken during the period of incapacity (administrative dissolution), section 4.02(1) provides:
Subject to the exceptions stated in subsection (2), ratification retroactively creates the effects of actual authority.
It is important to consider as well section 4.01(1) of the Restatement, defining “ratification,” it providing:
Ratification is the affirmance of a prior act done by another, whereby the act is given effect as if done by an agent acting with actual authority.
See also Restatement § 4.03 (“A person may ratify an act if the actor acted or purported to act as an agent on the person’s behalf.”).  Official comment (b) to section 4.02 of the Restatement provides in part:
Ratification has an immediate effect on legal relations between the principal and agent, the principal of the third party and the agent and the third party.  Ratification recasts those legal relations as they would have been had the agent acted with actual authority.  Legal consequences thus “relate back” to the time the agent acted.
     Ergo, even if during the period of administrative dissolution the entity could not authorize an agent to undertake an act not relating to its winding up and liquidation (see, e.g., KRS § 14A.7-020(4)), upon reinstatement the ratification of that actor’s actions causes them to have been vested with actual authority.  See Restatement, Ch. 4, Introductory Note; id. § 4.01, comment b (“That is, when a person ratifies another’s act, the legal consequence is that the person’s legal relations are affected as they would have been had the actor been an agent acting with actual authority at the time of the act.”).  Having actual authority to act on the principal’s behalf, and assuming due identification of the principal, the agent is not personally obligated on the agreement. See Restatement § 6.01.

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