In the world of commerce, businesses routinely rely on the apparent authority of LLC managers to sign contracts on behalf of their LLCs. Generally that works well. But what happens if an LLC disavows an agreement, claiming the manager who signed the contract had neither actual nor apparent authority?
The Missouri Court of Appeals was recently faced with this scenario in Pitman Place Development, LLC v. Howard Investments, LLC, No. ED94456, 2010 Mo. App. LEXIS 1635 (Mo. Ct. App. Nov. 23, 2010).
Background. According to the court’s statement of the facts, the LLC was formed by three members, one of whom was the sole manager. The LLC’s operating agreement gave the manager authority to manage the LLC’s business, but the consent of the members was required for the manager to cause the LLC to encumber its property or to borrow more than $50,000. The manager, however, wanted to borrow $525,000, and at this point the facts get ugly.
The manager gave the bank a copy of the LLC’s operating agreement, but omitted the pages that limited his authority. On request of the bank’s loan processor, on the day of the loan closing the manager faxed the omitted pages to the bank, but only after fraudulently altering the key provisions. The alterations increased the limit of his authority from $50,000 to $750,000 and authorized him to encumber the LLC’s property. The $525,000 loan was closed, and portions of the loan proceeds were later used by the manager for his own purposes. When the other two members learned what had happened, the LLC sued the bank to set aside the loan and deed of trust.
The trial court found after a bench trial that the manager acted with apparent authority when he executed the loan documents, and enforced the note and deed of trust against the LLC. The LLC contended on appeal that apparent authority was lacking because neither of the other two LLC members took any action to create the appearance that the manager had authority.
Apparent Authority. The Missouri rule is that to establish apparent authority, it must be shown that a principal has either manifested consent to the agent’s exercise of authority or knowingly permitted the agent to assume the exercise of authority. Additionally, the party relying on the apparent authority must have known the facts and believed in good faith that the agent had authority, and must have changed its position in reliance on the appearance of authority. Id. at *12. The Missouri rule is consistent with the Restatement of Agency. Restatement (Second) of Agency § 27 (1958).
The court found that the lender relied on the express language of the LLC’s operating agreement. “Pitman cloaked Burghoff with apparent authority when it manifested its consent for Burghoff to act as ‘Manager’ of Pitman in the Operating Agreement, and gave the ‘Manager’ general authority to enter into transactions such as the Rockwood Bank loan transaction.” Pitman Place, 2010 Mo. App. LEXIS 1635, at *14. Although the manager lacked actual authority and acted to defraud the LLC, the court relied on prior rulings that the act of an agent with apparent authority, even if in furtherance of a fraud on the principal, will bind the principal. Id.
The LLC argued that the manager had no apparent authority here because he fraudulently created the appearance of authority. The court acknowledged that an agent cannot create its own authority and that it was troubled by the manager’s “fraudulent and dishonest conduct.” Id. at *11, 19. But in the end the court found that the LLC’s general statements of authority in the operating agreement vested the manager with the apparent authority to carry out the loan transaction. The LLC was therefore responsible for the manager’s acts and agreements with the bank as if the acts were the LLC’s own. Id. at *19.
The court glosses over the fact that by fraudulently deleting the operating agreement’s limits on his authority, the manager essentially was creating his own authority. The court implicitly treats the fraudulent pages of the operating agreement as a detail that does not impair the members’ broad grant of authority.
Statutory Defense. The LLC also contended that even if the manager did have apparent authority to bind the LLC under agency common law principles, the manager’s conduct did not bind the LLC because the execution of the loan documents was not apparently for carrying on in the usual way of business or affairs of the LLC, as required by the Missouri LLC Act. Id. at *20. The statute provides, in relevant part, that “the act of any manager for apparently carrying on in the usual way of the business or affairs of the limited liability company of which he is a manager binds the limited liability company,” and that an “act of a member or manager which is not apparently for the carrying on the usual way of the business or affairs of the limited liability company does not bind the limited liability company unless authorized in accordance with the terms of the operating agreement.” Mo. Rev. Stat. § 347.065.
The court did not address why the manager’s lack of authority under this statute, if it applied, would trump the manager’s apparent authority. Instead, the court found in the language of the operating agreement and in the LLC’s past practices sufficient evidence that the loan transaction was “carrying on in the usual way of business.” Pitman Place, 2010 Mo. App. LEXIS 1635, at *23-24. The court accordingly rejected the LLC’s argument, and after affirming the trial court’s other rulings, affirmed the lower court’s judgment. Id. at *42.
Protective Steps. What else could the Pitman members have done to prevent the manager from fraudulently having apparent authority in excess of the limits in the operating agreement? Perhaps they could have written their operating agreement so that the language granting broad authority to the manager had the limitations tightly woven into it. If the manager had provided altered versions of those pages, retaining only the broad granting language, what result? Or if the agreement had no broad grant of authority to the manager but instead simply granted certain enumerated, limited powers, what result if the altered pages added some additional powers?
In any event, there are other, practical steps that could be taken to forestall chicanery. For example, the Missouri LLC Act allows an LLC’s articles of organization, which must be filed to create the LLC, to optionally contain provisions from the LLC’s operating agreement. Mo. Rev. Stat. § 347.039.2. The organizers of an LLC could include in the articles of organization the limits on the manager’s authority. Articles of organization are publicly available, and banks and title companies can and often do obtain a copy from the Secretary of State prior to closing a real estate or loan transaction. That would make them aware of the limits on the manager’s authority expressed in the articles.
Alternatively, the LLC could file a memorandum with the county where its real estate is located, referencing the LLC’s real estate and describing the limits on the manager’s authority. Any transaction involving the LLC’s real estate would almost certainly involve a title company and a title search, which would then address the manager’s authority.
The LLC could also require signatures in addition to the manager’s on all checks, or all checks above a limit, in the banking resolutions when it sets up its bank accounts. Once in place, those resolutions would require additional signatures from members other than the manager to change the authorized account signatories. That would result in oversight of withdrawals from the LLC’s bank account.
A structural approach would be for the LLC to have two or more managers, and in their operating agreement’s grant of authority require that the managers act jointly.
These measures are often not adopted, frequently because they are inconsistent with the trust most LLC organizers have in their managers. LLC organizers won’t usually appoint someone to be their manager unless they have substantial trust in them. Lawyers, though, can’t assume that the other (non-client) parties will always act benevolently, and must write agreements to cover contingencies including bad acts. The Pitman Place case is a good example of why lawyers must try to anticipate unauthorized or improper acts by the other parties.