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Contract formation: authority

When you decide to set up your own business no one tells you just how much paperwork is involved, not just in the start-up phase, but once you are successfully trading and growing your client base. Most entrepreneurs do not go into business with the intention of spending their days signing contracts, so in this article we look at commercial contract formation and who has the authority to enter into a legally binding contract on another party’s behalf and why it matters. It is technical but crucial stuff as you need to know who has the authority to commit you or a contracting third party to a contract.

Legal advice from a specialist commercial contract solicitor should be sought if you are in any doubt about contract formation authority or commercial contracting generally to protect you and your business.

Why is contract formation authority important?

Contract formation authority is important as without it you may not have a contract you can rely on or you may not be able to escape from an agreement that someone without your authority, or the approval of the business, sought to make.

As a contract can be made either verbally or in writing it is essential, especially when you are starting out in business, that you do not get caught out in thinking that you have a contract or a word-of-mouth agreement with someone who does not have the authority to form a contract with you or your business. It is equally vital that your associates or agents know the limits of their authority and whether that includes contract formation authority or not.

Unless you are clear on contract formation authority you risk disputes over whether there is a contract and whether your business and the other contracting party are bound by its terms. Arguing over whether a contract exists or not can be a frustrating business distraction that you do not need, whether you are arguing that a contract was formed or arguing that a third party did not have the authority to form a contract on your behalf. If this is an issue for you, we recommend speaking with our contract dispute solicitors to get clarity on your position.

Your business is at greatest risk of contract formation authority disputes when you are at the start-up stage. That’s because when an entrepreneur is starting out, they are often more inclined to accept things on trust and assume that a third party they are in discussions with actually has the authority to commit to a contract. Alternatively, if office procedures are still a bit new and your business has not got your lines of contract formation authority sorted out you risk an employee or agent committing you to a contract without the authority to do so.

For more information on start-ups and contracts take a look at our other articles:

The parties to a contract

It is a basic point but at the start of every contract the parties to the contract are named. The parties need to be identifiable for the contract to be legally binding. That is the case whether the contracting parties are two individuals, a business to consumer contract or a business-to-business contract. It equally applies to contracts of any nature, whether the contract is a supply chain agreement or service contract or franchise agreement.

In a straightforward contract between two people, the individuals themselves will each enter into the contract. However, that is not always possible and therefore a third-party agent can be authorised to sign the contract as the authorised agent of one party to the contract (referred to as the ‘principal’). A contract signed by an authorised agent on behalf of a principal is binding on both the principal and the third party to the contract.

Where a party to the contract is not an individual, such as a company or partnership or joint venture, the organisation will require an authorised person with authority to enter into a contract on behalf of the organisation to sign a legally binding contract.

Can a third party enter into a contract that binds a business?

A third party can enter into a contract that binds your business. So, that is why it is crucial that you get your lines of authority sorted and that you check that the person you are negotiating with has the contract formation authority to sign the contract and bind the third party you are wanting to enter into business with.

The person or body that has been given the authority to enter into a contract on your behalf is called your agent. If the agent has contract formation authority the contract is binding on you as if you had been the one conducting any negotiations and either verbally agreeing the contract or signing a written contract agreement.

In the context of contract formation authority an agent is widely defined and is not limited to an agent in its true sense, such as a shipping agent. Instead, an agent can include an employee, a contractor or a family member. Agent simply means a person or body who was given actual or apparent contract formation authority on the principal’s behalf.

What are the different types of contract formation authority?

There are different types of contract formation authority. Contract dispute resolution solicitors say that this can catch out the busy entrepreneur who is focussed on their long-term growth strategy and exit plans rather than the legal intricacies of contract formation authority.

Contract formation authority can either consist of:

  • Actual authority (express and implied)
  • Apparent authority
Type of contract formation authorityDetailsExample of the contract formation authority
Actual authority ExpressSpecifically authorised in writing or orally by the principal.‘I authorise you to enter into all supply agreements with a value of less than £10,000’.
Actual authority ImpliedAuthorised due to the agent’s position or course of conduct.The CEO of a company is authorised to do all those things that a CEO would normally be expected to do.
ApparentAuthorised due to a representation by the principal, even if the position is not correct‘My agent is my go-to contract person and I trust them with all my supply agreements’, even though the agent only has actual contract formation authority to enter into supply agreements with a value of less than £10,000 per contract.

Actual contract formation authority

Actual contract formation authority can be given by the principal to their agent expressly or impliedly. Whichever way the contract formation authority was given, the actual contract formation authority is described as the ‘legal relationship between principal and agent created by a consensual agreement to which they alone are parties’ (Freeman and Lockyer v Buckhurst Park Properties (Mangal) Ltd [1964] 2 QB 480).

  • Express actual contract formation authority - Actual authority is given expressly when the specific authorisation is provided in writing or verbally. One example is a board resolution. The Court of Appeal has defined express actual contract formation authority as the ‘express conferring of authority by the principal on the agent to enter into a particular transaction or a class of transactions’ (Ukraine v Law Debenture Trust Corp Plc [2018] EWCA Civ 2026). Therefore, a written or oral statement given by a principal to an agent along the lines of ‘I authorise you to enter into all supply agreements with a value of less than £10,000’ would constitute express actual authority.
  • Implied actual contract formation authority - Authority can also be implied either through the position of the agent or their course of conduct. For example, if the agent is appointed as the managing director of a company, they will have the implied authority to do all the things that are usual for someone in that position. For example, there will be a course of conduct where the agent has acted in a certain way for some time with the agreement of the principal so the agent is deemed to have the necessary authority to act in that way. One memorable legal case on implied actual contract formation authority was the case of celebrity chef, Gordon Ramsey. In Ramsay v Love [2015] EWHC 65 (Ch), Gordon Ramsay argued that his father-in-law had used a signature machine to sign documents on his behalf when his father-in-law did not have the authority to do so and that, as a result, he was not contractually liable to pay the annual rent of £640,000 on a pub in London. Gordon Ramsay was not successful as the court held his father-in-law did have contract formation authority on an implied basis due to their 20-year working relationship during which time the father-in-law had been left to run the business with Gordon Ramsay being aware of his relative’s use of the signature machine.

Apparent contract formation authority

Apparent contract formation authority is more vague than actual contract formation authority. Apparent authority occurs where the authority is perceived by third parties. Apparent contract formation authority can still bind the principal. For example, if a principal describes their agent as having greater authority than the agent actually has and the agent then acts in accordance with that greater authority, the principal will be bound by the agent’s actions.

A third party can only rely on apparent contract formation authority if the third party has not acted in bad faith or dishonestly and their reliance on the contract formation is reasonable. In the case of Stavrinides and others v Bank of Cyprus plc [2019] EWHC 1328 (Ch), a bank customer argued that the bank was bound by the actions of one of its branch relationship managers. The customer alleged the manager had written off three million of their loan. The court held that even if the bank had represented that the relationship manager was authorised to make this type of decision, the customer’s reliance on it was unreasonable due to the customer’s understanding of the bank’s lending processes, the fact that the customer usually dealt with more senior bank staff and had never dealt with the relationship manager in question before, and that the customer knew it would be highly unlikely that a branch relationship manager would be authorised to make this decision.

In summary, an agent can bind a principal using apparent contract formation authority if three elements are satisfied:

  • Representation - The principal needs to representor hold out the agent as having an authority which is larger than the agent's real authority. The person making the representation must have some authority to make the representation.
  • Commitment - The agent needs to commit the principal to a third-party contract through use of apparent authority.
  • Reliance - The third party needs to rely on the apparent contract formation authority of the agent and make a commitment in reliance on the apparent exercise of contract formation authority.

Whether apparent contract formation authority has been exercised or not is a question of fact where there is a dispute over whether there is a binding contract or not. One case on this point is Athena Brands Ltd v Superdrug Stores Plc [2019] EWHC 3503 (Comm), where the High Court was asked to determine if an employee of Superdrug had exercised apparent contract formation authority to enter into a contract with Athena Brands Limited that was binding on Superdrug. It was argued that the Superdrug employee had no authority as a buyer to enter into contracts as their role was limited to product identification and negotiation. The company information provided to suppliers said the buyer had the job of discussing trade terms. The court therefore held that the employer had apparent contract formation authority even though Superdrug believed that their employee had exceeded their authority.

Can an agent hold usual contract formation authority?

In addition to actual and apparent contract formation authority you may read reference to ‘usual authority’. If you come across the term usual authority this should ring some alarm bells as the court has said the meaning of the term usual authority is unclear. Anything that is ambiguous has a greater risk of a commercial contract dispute.

In the case of Ukraine v Law Debenture Trust Corp Plc [2018] EWCA Civ 2026, the Court of Appeal said that use of the term ‘usual authority’ could create confusion because it potentially was either implied or actual authority. Therefore, the use of the term should be avoided by you and if you see it, you should ask for written clarification as to what is meant by usual authority.

The burden of proof and contract formation authority

Where a disagreement arises as to whether the agent was authorised to enter into the contract, it is the responsibility of the person arguing that the agent was authorised to prove it. Usually, in a contractual dispute of this nature, it is the third party to the contract who must show that the agent did indeed have the authority to bind the principal.

Ratification of a contract formed without contract formation authority

A contract which has been entered into by an agent who did not have the authority to do so will be invalid and non-binding on the principal. That is the case whether the agent lacked authority or exceeded their authority. However, the agent’s actions can be ratified by the principal at a later date. This can resolve legal difficulties which could otherwise arise in such a situation. It is particularly useful if there has been a simple oversight in the authority wording or a misunderstanding as to the extent of the agent’s authority. Ratification will deem the contract to be enforceable as if the agent had contract formation authority from the outset.

Can silence amount to contract formation authority?

We have all had our emails ignored at one time or other, but the question has been asked whether silence or failure to respond to an email or communication amounts to contract formation authority. The general rule is that silence on the part of a principal does not give contract formation authority, unless the principal took some act that made the other party to the contract believe that the principal had given the agent either implied or express authority.

In the case of MVV Environment Devonport Ltd v NTO Shipping GMBH & Co KG [2020] EWHC 1371 (Comm) (4 June 2020), a party alleged that a shipping agent had acted as the agent of a company and had contract formation authority on their behalf partially because the company had been copied into a series of emails and had not raised an objection or clarified that the shipping agent was not their agent and had no contract formation authority on their behalf. The court held the shipping agency had no actual or apparent authority to enter into a contract on behalf of the company as silence should not infer implied authority.

Companies and partnerships and contract formation authority

When considering the authority of individuals to sign documents and make decisions on behalf of corporations, various statutes apply. The relevant provisions depend on the type of corporation and the nature of the document. Given the potential impact of either being bound to a contract or having no valid contract, it is always best to take legal advice from your commercial solicitor on corporations and contract formation authority because of the potential complexities and the need to look at the specific nature of the organisation and the contract. For example, the table below does not cover the position if the agreement is a deed as opposed to a standard business contract.

 Type of business organisationApplication of contract formation authority
Companies registered under the Companies Act 2006A company registered under the Companies Act 2006 has its own legal personality. Any person authorised by the company can enter into a contract on behalf of that company in accordance with Part 4 of the Companies Act 2006. The authority must be given under the company’s articles of association. The articles are a public document. Every director and the company secretary are authorised signatories. It is important to note that a director who binds the company without the proper authority risks being liable for any loss incurred by the company BUT, provided that a third party is acting in good faith, a company will be bound by the actions of an agent even if the agent exceeds a limitation in the articles of association.
Limited liability partnerships (LLPs)An LLP, like a company, is a body corporate with its own legal personality. Certain member details must be registered at Companies House, although the agreement which governs the relationship between the LLP members (and any limitations on the authority of those members) is private. Each member is an agent of, and can bind, the LLP. In usual business dealings, a third party may assume that any member of the LLP is authorised to act on behalf of and bind, the LLP, unless the third party knows otherwise.
General partnershipsA general partnership does not have its own legal personality. The law says liability rests with each of the partners. The agreement which governs the relationship between the partners (and any limitations on the authority of those partners) is private. Every partner acts as an agent of the partnership and of the other partners. A third party can assume that a partner has the authority to bind the partnership and the other partners unless the third party knows otherwise.
Limited partnershipsA limited partnership does not have its own legal personality. The law says liability rests with the general partner. The general partner runs the day-to-day business of a limited partnership and acts as its agent. The limited partners have no active role and would lose their limited liability status if they breached this. The general partner has a wide scope to bind the partnership and the other partners. However, the private partnership agreement may set out restrictions on the authority of the general partner.

Tips on avoiding disputes on contract formation authority

Whether you are the agent, the principal or the third party, there are various ways in which you can protect yourself from contract formation authority disputes.

Contract formation authority personProtection measures
AgentEnsure that the scope of your authority is made clear, preferably in writing. Always bear in mind that if you are acting as a director of a company, you may be liable for the loss incurred by the company if you enter into a transaction on the company’s behalf without the relevant authority, including if you are a party in your own right to the transaction.
PrincipalEnsure that the scope of the agent’s authority is made clear, preferably in writing. Review your relationship and the scope of the agent’s authority on a regular basis to ensure that there has been no change. Major transactions should always receive board approval prior to the documents being signed and authorisation given by the board as to who can enter into the documents on behalf of the company.
Third partyPrior to entering into an agreement, request evidence of the agent’s contract formation authority. For example, a copy of the power of attorney, letter of authority, relevant partnership agreement or board meeting minutes. If dealing with a Companies Act company or an LLP, check the publicly available documents to ensure that the names of directors or the members are as you would expect. If dealing with an overseas company, obtain a legal opinion that the company has entered into any documentation correctly and that the person signing has the authority to do so. Although the assumption is usually that an agent can bind its principal, third parties often must act in good faith. Rather than risk this being called into question, it makes sense to check out the facts beforehand to minimise the risk of a future contract dispute over contract formation authority.

For more information commercial disputes and minimising litigation risk take a look at our article: How to avoid commercial disputes and minimise litigation risk.

What next?

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