Contracting and the dangers of dealing with a single director

During the “cut and thrust” of contract negotiations, the hubris of establishing a commercial venture or simply with the sale and purchase of a property, it is often (wrongly) assumed that a director of a company has authority to act and contract on behalf of a company.

This important aspect of company law was addressed in the case of Autumn Tree Ltd v Bishop Warden Property Holdings Ltd  [2017] NZHC 2838 concerning the validity of a sale of a property in Auckland in August 2017 and subsequently clarified in the Court of Appeal last year.

Where a sole director constitutes the board of the company, he will have the full powers of the board to conduct the business of the company (Section 128 of  the Companies Act 1993) and ultimately bind the company. However, this is not necessarily the case in circumstances where a director is one of a number of directors constituting the board of that company.

A single director on a board formed of a number of directors enjoys only “very limited” customary authority.

This often comes as a shock to third parties entering into or conducting commercial negotiations as generally speaking, third parties rely on the common law “indoor management rule”  (“presumption of regularity”) as affirmed in section 18 (1) of the Companies Act 1993 where a person engaging with a company is entitled to do so in the belief or the assumption that the company’s internal corporate governance requirements  have been complied with thereby empowering that director to conduct the affairs of the company (unless they have information or knowledge to the contrary).

The Court of Appeal concluded that “One of two directors of a property development company does not customarily  have authority to unilaterally to enter into a significant property transaction”.

Although a contracting third party’s reliance on an apparent authority of a director will only be defeated by an actual knowledge of a defect in the authority, to be perfectly safe, it is essential for a third party to ensure that the director (with whom a party is negotiating or contacting), has express authority to enter into the agreement. This is especially true where a third party does not have  an ongoing relationship with the company.

In addition, it is important to consider whether the transaction constitutes a major transaction under Section 129 of the Companies Act 1993 which would then trigger the need for a special resolution of shareholders to be executed.

It is understandable for these compliance and governance issues to be overlooked but asking probing questions, seeking affirmative evidence of authority etc. may save a lot of hardship in time to come.