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It is an age-old practice for people to establish comfortable working relationships with others for commercial reasons. Benefits such as ease of business transactions, trust, and compatibility are just some of the many benefits that derive from such relations. External from these sorts of associations are those agreements that are established through informal channels but which have a history of being honoured. The problem with these scenarios is what happens when the relationship turns sour and informal agreements become disputed?
Let’s give an example of the aforementioned scenario. John has been doing business for over eighteen years with the company XYZ. The accepted practice for business transactions was that he either contact Steven or be contacted by him in order to formalise a goods and services transaction. However, what John did not know was that Steven was not the business owner nor was he a Director or Shareholder of XYZ. This position was held by Bob exclusively. After the order was put through, and the goods or services were delivered or rendered, Bob would effect payment of those invoices. This became the established business practice between John and XYZ.
Somewhere along the line, XYZ defaulted on one of the contracts and refused to honour the agreement. John then followed legal process for payment and XYZ defended it claiming that XYZ was not bound by that agreement because the transaction was entered into by someone who was unauthorised to enter into the agreements. Does John have any basis to hold XYZ liable for those transactions?
Like all complex legal situations, the answer to the question is not a simple one. That being said, John may be covered under the laws and authority relating to representation, estoppel, and the abolishment of the doctrine of constructive notice. I shall briefly dissect each of these concepts below.
A company in terms of the laws of South Africa can only perform actions for which it has authority to do so. This authority can usually be seen from the Memorandum of Incorporation (“MOI”) and Company Resolutions that are issued by it. However, Section 20(7) of the Company’s Act is what allows John a potential breathing space to enforce his claim. It reads that:
A person dealing with a company in good faith, other than a director, prescribed officer or shareholder of the company, is entitled to presume that the company, in making any decision in the exercise of its powers, has complied with all of the formal and procedural requirements in terms of this Act, its Memorandum of Incorporation and any rules of the company unless, in the circumstances, the person knew or reasonably ought to have known of any failure by the company to comply with any such requirement.”
This Section abolished the law relating to the doctrine of constructive notice. This Doctrine effectively imposed an obligation on third parties contracting with companies to check the said Company’s registered constitutional documentation in order to ensure that the proposed transaction complied with its formation documents. Following the creation of this Doctrine, the English Courts developed the so-called “Turquand Rule which mitigated its harsh effects. The Turquand Rule allowed a Party to assume that internal arrangements were properly followed where the person purporting to act on behalf of the company does so in a manner which is consistent with its incorporation documents. The Rule in Turquand envisaged some principles of Estoppel as well as certain legal maximas. What the legal authority and change in legislation has done is not only to reverse the onus to some extent but also to place the assumption of risk and loss on the shoulders of companies such as XYZ, not by the John’s of the world.
Estoppel, or the law of ostensible authority, is a common law principle that has been adopted by the Courts to similar situations as described above. For a company to be estopped from refuting accountability, the following factors must be present in any given scenario:
(1) A representation was made that the agent (e.g. Steven) had authority to act on behalf of the Company;
(2) This representation was made by someone who had actual authority (e.g. Bob) to manage the business;
(3) The third party (e.g. John) was induced by the representation to enter into the contract and relied upon said representation; and
(4) The incorporating documents (e.g. the MOI) did not deprive the company (e.g. XYZ) of entering into similar contracts or to delegate authority to act as agent for these sorts of contracts.
The Turquand Rule was adopted into South African law, and applies equally to close corporations and financial institutions as it does to companies. Sole proprietors, trade unions and partnerships have also been held accountable in the past.
The aforementioned position indicates that an Attorney handling John’s case would be able to hold XYZ liable for payment in terms of those contracts if, through consideration of the established business practice, it could be seen that despite Steven’s representations, Bob either expressly ratified those representations or through necessary implication ratified them (e.g. through payment of invoices authorised by Steven in favour of John). However, this position needs to be considered in the context of each scenario and is situation-dependent.
If you are in a similar situation to John, please consult with an Attorney to learn about your rights and obligations.