Cannabis Contracts 101: Authority and Why it Matters

03 Apr Cannabis Contracts 101: Authority and Why it Matters

Cannabis contracts are – in the simplest sense – binding agreements between two parties. But how you get to something being “binding” can be complicated. And in the cannabis industry, where things move a mile a second and people often overlook basic contract requirements, the results can be disastrous. Today I want to focus on a concept known as “authority” and explain why I think it is so critical for the cannabis industry.

What is the deal with authority in cannabis contracts?

When an individual who is (a) an adult, (b) not under duress, and (c) of sound mind enters into a contract, there is almost no question it is binding. [Yes, we are talking about cannabis contracts and federal illegality is an issue, but let’s put that to the side for a second.]

But what about contracts with entities as parties? While you’ve probably heard of things like corporate personhood, and seen contract definitions of “person” to include entities, in reality entities are legal creations and cannot physically sign contracts or do anything else. Companies act through employees or other authorized people, commonly referred to as “agents.”

The thing about agents is that they need to be authorized to take certain actions on behalf of a company. If they are not so authorized, then they have no legal ability to bind the company and their signature on a contract is not binding — with some key “catches” that I discuss below.

How does an agent get authority?

There are a few ways that agents are given authority to act on behalf of a company. Officers of a corporation are given authority by the shareholders in governing documents like bylaws. A president or CEO, for example, will usually have broad authority to sign contracts on behalf of a company. Other people, like employees or contractors, will be given authority (if at all) in their employment or other contracts.

Generally, the lower one gets on the corporate hierarchy, the less authority one has. A person working in procurement may be given authority to execute purchase agreements, but not to enter into a merger agreement. So a good employment agreement will clearly limit an employee or agent’s actual authority.

Even CEOs and presidents are often restricted in what kinds of things they may do. For example, shareholders or directors of a company may not want a CEO to purchase Lamborghinis with company funds, so they may require that the CEO obtains consent of the shareholders or directors prior to making purchases over $X. The shareholders may even place additional restrictions on the board of directors so that there is a hierarchy of consents that must be obtained before the CEO is authorized to pull the trigger one or (usually) many types of contracts.

What about “apparent” authority

Where the rubber can often hit the road is when a company’s employee or agent enters into a transaction for which they had no authority. For example, say the CEO of a company enters into a purchase contract for a distribution van costing $75,000, but the company’s governing agreements required board approval for purchases over $50,000. Say the CEO didn’t get board approval and the board wants to unwind the transaction. The van’s seller understandably won’t want to unwind the transaction and litigation will probably ensue.

So who wins in these cases? The answer depends on a concept known as “apparent authority,” where a third party reasonably (the key word) infers that the person is an authorized agent of the entity they are trying to bind. In the example given above, the van seller will argue it inferred that the CEO of the company had authority to buy a van. And the seller will argue that its inference was reasonable since CEOs are the highest corporate officers and generally have such authority. And unless the seller had knowledge of the CEO’s restriction in the company’s governing documents — which, for private companies, are not public records — he’ll have a pretty good chance of prevailing.

The policy behind apparent authority is self-evident. We don’t want a system where a transacting party with no reason to believe the other signor lacked authority to suddenly be forced to unwind transactions.

What can companies do to avoid apparent authority problems?

Both sides of a transaction can take steps to avoid the issues mentioned above. A company can make sure that its agents are fully aware of an understand the limits on their authority. This of course won’t completely eliminate the risks when it comes to high-level officers, but it will at least help.

On the other hand, the other side to a contract can:

• Verify that the person signing for the company is who they claim to be – some corporate officers will be listed on the state’s secretary of state database;
• Include a representation in the contract that the person is authorized, and make sure their title is clearly identified;
• In bigger transactions, request the company’s governing documents and/or a resolution from the board of directors allowing the signor to sign; and
• Refusing to sign a contract with someone who does not appear to be authorized, depending on the circumstances. With respect to this last point, a company that wants to acquire a business will want to make sure, for example, that the signing party is the CEO, President, or something similar, and not a mailroom employee.

None of these issues are ironclad, but they can help avoid some painful issues later down the road.

What about ratification?

To address one last point, what happens if someone without authority signs a contract on behalf of a company, and the company wants to remain “in” the contract despite the signor’s lack of authority? In that case, the company’s board of directors, shareholders, or other persons with authority can “ratify” the agreement. This is usually done via a written resolution or at a meeting.

You might be asking whether this is strictly necessary or just overkill – i.e., why can’t the company just leave things where they stand and move forward without yet another piece of paper? Proper ratification is a critical step in the corporate governance process, and can avoid a lot of pitfalls down the road. Ratification also helps to clarify what the signing employee or agent can and can’t do, and to reinforce the limits of their authority.

Conclusion

Even something as simple as who should sign a contract for a company can be extremely complicated. But thinking critically through these issues can avoid expense, wasted time, and even litigation.