A theme running through many apparent-authority cases is the question of who loses: for example, the LLC whose property was used to secure unauthorized, personal borrowings by a member or manager, or the bank that in good faith made the loan to the malefactor? Often the recipient of the funds has used the money for personal matters and is essentially judgment proof.
Such a fact pattern confronted the Mississippi Supreme Court in In re Northlake Development L.L.C. v. BankPlus, 60 So.3d 792, 2011 Miss. LEXIS 234 (Miss. May 5, 2011). George Kiniyalocts, along with his attorney and business partner Michael Earwood, formed Kinwood Capital Group, LLC, a Mississippi member-managed LLC.
Without authority, Earwood secretly signed a deed as Kinwood’s “Managing Member” that purported to transfer Kinwood’s real estate to Northlake Development, L.L.C., which was formed and owned by Earwood. Northlake then obtained a loan from BankPlus, secured by a deed of trust to the real estate. Earwood’s partner in his two-person law firm provided a title certificate to BankPlus.
The denouement was predictable. Earwood put most of the proceeds to his personal use and Northlake later filed for bankruptcy. Earwood signed Northlake’s bankruptcy petition and listed the real estate as Northlake’s property.
Kiniyalocts learned of the bankruptcy, appeared, and contested BankPlus’s deed of trust. The bankruptcy court invalidated both Kinwood’s deed to Northlake and Northlake’s deed of trust to BankPlus. BankPlus appealed to the District Court, lost, and appealed again to the Fifth Circuit. BankPlus argued on appeal that the Kinwood deed to Northlake was not void but rather was voidable, and that BankPlus’s deed of trust was enforceable because the bank had taken the deed of trust from Northlake in good faith and without notice that the Kinwood deed was unauthorized.
The Fifth Circuit found there was no controlling Mississippi precedent and certified to the Mississippi Supreme Court the question of whether the unauthorized deed to Northlake was “‘(i) voidable, such that it is subject to the intervening rights of a subsequent bonafide purchaser for value and without notice, or (ii) void ab initio, i.e., a legal nullity?’” Id. at *4 (citation omitted).
The Mississippi Supreme Court began by noting that under Kinwood’s Operating Agreement Earwood had no actual authority to transfer the property, and then turned to the question of Earwood’s apparent authority.
The court reasoned that Earwood knew he had no authority to convey the real estate to Northlake, that Earwood’s knowledge was imputed to Northlake, and that Northlake therefore took the property with knowledge that Earwood had no authority to sign the deed. Earwood therefore had no apparent authority to transfer the property to Northlake. Id. at *6-7.
The court thus arrived at the certified question, i.e., whether the unauthorized conveyance was voidable, which would mean that it was an effective transfer of title unless and until Kinwood repudiated it. If so, the BankPlus deed of trust would survive.
The court concluded that Earwood’s deed was not voidable, reasoning as follows:
- If an agent acts for its principal without legal authority, the agent’s action generally will not affect the legal relationship between the principal and third parties.
- A principal may, at its election, ratify an agent’s unauthorized act and thereby become bound by it. Absent such an election, there is no change to the legal relationship between the principal and the third party.
- The principal ratifies an agent’s act by taking action to show its assent that the agent’s act affects the principal’s legal relations.
- Kinwood took no action to ratify Earwood’s transfer of the property, and therefore the legal relationship between Kinwood and BankPlus was unchanged by Earwood’s purported transfer of the real estate.
“So where no actual or apparent authority exists to transfer a principal’s property, we decline to characterize the deed as voidable. Rather, it is void unless and until later ratified.” Id. at *10. Kinwood could have ratified Earwood’s deed to Northlake, but did not, and Kinwood’s rights in the property were therefore unaffected. Id.
So BankPlus loses. Northlake, its borrower, is bankrupt, and BankPlus cannot go after Kinwood’s real estate. BankPlus can presumably assert a fraud claim against Earwood and its law firm, but the value of that claim would depend on their net worth, which may be problematic.
BankPlus might have been able to avoid this problem if it had traced the title from Northlake back to Kinwood, and then inquired as to the authorization of Earwood’s deed. However, it likely relied on the certificate of title provided by Earwood’s law firm. It’s not clear whether BankPlus knew that Earwood was the sole owner of Northlake. If it knew, then its reliance on a title certificate from his law firm was questionable.
These apparent-authority cases are troubling because they involve two innocent parties, one of whom will be damaged by the unauthorized acts of the agent of one of the two. For an apparent-authority case where the LLC lost to the bank after its manager encumbered the LLC’s property, see my blog post, here, about Pitman Place Development, LLC v. Howard Investments, LLC, No. ED94456, 2010 Mo. App. LEXIS 1635 (Mo. Ct. App. Nov. 23, 2010).