Mercantile Credit v Garrod: Apparent Authority in a Partnership

Mercantile Credit Co Ltd v Garrod [1962] 3 All ER 1103 decides when a partnership is bound by the act of one partner who has exceeded a limit the partners agreed between themselves.

The answer is that the partnership is bound where the act appears to be in the ordinary course of the firm's business, unless the third party knew of the restriction or knew that the partner lacked authority. An internal agreement restricts the partner; it does not restrict the firm's liability to an outsider who knew nothing of it.

The facts

Parkin and Garrod were partners in a business letting garages and repairing cars. The partnership agreement expressly provided that the firm would not buy and sell cars.

Garrod was the sleeping partner. He had contributed most of the capital and took no part in the day-to-day running of the business.

Parkin, without Garrod's knowledge and in breach of the agreement, sold a car to Mercantile Credit for £700. He had no title to it. When that emerged, the finance company sued both partners for the money.

Garrod's defence was that the sale was outside the firm's business by the express terms of the partnership agreement, so he was not liable.

The decision

The court held both partners liable.

The test is objective. Section 5 of the Partnership Act 1890 provides that every partner is an agent of the firm, and that acts done in carrying on in the usual way business of the kind carried on by the firm bind the firm, unless the partner had no authority and the person dealt with either knows that or does not know or believe them to be a partner.

The question is therefore what an outsider would reasonably understand the firm's business to include, not what the partners agreed among themselves. A business occupied with garages and car repairs would appear to an outsider to be one in which buying and selling cars was an ordinary activity. The sale looked like the firm's business, so it bound the firm.

Mercantile Credit did not know of the restriction. The restriction accordingly operated only between the partners, giving Garrod a claim against Parkin for breach of the partnership agreement and no defence against the finance company.

The principle

The case is an application of a rule that runs through the whole of agency law: a principal is bound by the apparent authority of its agent, and apparent authority is determined by what the principal held out and not by what it privately instructed.

Three elements carry the outcome.

The objective standard. The court asks how the transaction would appear to a reasonable third party dealing with a firm of this kind. Evidence about what the partners intended is relevant to their dispute with each other and not to the outsider's claim.

The third party's knowledge. Actual knowledge of the restriction defeats the claim, as does knowledge that the partner had no authority. Constructive knowledge is not enough; an outsider is not required to investigate the internal terms of a partnership.

Nothing turns on the partner being inactive. Garrod took no part in the business and was liable in full. A sleeping partner carries the same liability as an active one, which is the point most often missed and is the practical reason the case is set.

Why the rule is as it is

The allocation is a choice between two innocent parties, and it goes to the one who could have prevented the loss.

The partners chose each other, agreed the restriction and could have monitored compliance. The third party could have done none of those things and had no means of discovering the restriction, since partnership agreements are private documents.

Putting the loss on the firm also has the right incentive effect: it makes partners careful about whom they admit and about what authority they permit in practice, rather than about what a document says.

The remedy for the injured partner is not absent, merely internal. Garrod could recover from Parkin under the partnership agreement, and that claim was worth whatever Parkin was worth — which is usually the real reason the case matters, since the partner who exceeded authority is frequently not good for the money.

How to limit a partner's authority effectively

The case implies its own answer, and it is worth stating because it is the practical lesson.

Notice to the third party is the only reliable method. A restriction communicated to those dealing with the firm operates against them, because it defeats the appearance of authority.

Public notice works for the general position — the London Gazette route on retirement, and equivalent publicity — and is unreliable for a restriction on a continuing partner, since nobody reads it in advance of a routine transaction.

Narrowing the firm's apparent business works better than restricting a partner inside a broad one. A firm that presents itself as a garage and repair business only, and does not trade in vehicles at all, makes a vehicle sale look less like its ordinary business.

Choosing the entity is the structural answer. A limited liability partnership or a company changes the liability position entirely, and the reason firms use them is substantially this.

Joint and several liability, which is what makes it bite

The case is about whether the firm is bound. What makes the outcome severe for Garrod is a separate rule about how partnership liability is distributed.

Under the Partnership Act 1890 partners are jointly liable for the firm's debts and obligations incurred while they are partners, and jointly and severally liable for wrongs. The practical effect is that a claimant may pursue any partner for the whole amount and is not required to divide the claim or to exhaust one partner before moving to another.

A claimant therefore sues the partner who can pay. Garrod had contributed most of the capital and was the solvent partner, which is why the finance company's claim against him was worth bringing and the claim against Parkin was not.

Partners who have paid more than their share can seek contribution from the others, and that right is only as good as the other partners' means. The combination — unlimited liability, joint and several exposure, and a right of contribution against someone who has already failed — is the reason general partnerships have been largely displaced by limited liability partnerships for any business of scale.

The information problem underneath the rule

Stated generally, the case resolves an asymmetry that runs through commercial law.

An outsider dealing with a firm can observe what the firm appears to do. It cannot observe the internal agreement, the division of responsibilities, or whether the person in front of it has exceeded an instruction. Requiring the outsider to verify would make routine transactions impossible, because every counterparty would have to inspect constitutional documents before contracting.

The law's answer across several areas is the same: the party who created the appearance bears the risk that the appearance was misleading. The rule in company law on the authority of directors, the rules on agency generally, and this partnership rule are the same principle applied in three settings.

That generality is useful in an answer. A candidate who identifies the case as an instance of apparent authority, rather than as a rule peculiar to partnerships, is showing where it sits.

Where it sits with the related cases

Section 5 also covers the reverse case. A partner acting on an authority the firm did give, in a transaction outside the firm's apparent business, binds the firm because actual authority existed. Apparent authority extends liability; it does not replace actual authority.

A partner acting outside both does not bind the firm, and the third party's claim lies against that partner personally. This is the one route by which a firm escapes, and it requires the transaction to fall outside anything an outsider could reasonably take the firm's business to include — a garage partnership selling a consignment of textiles, instead of selling a car.

Holding out works in the opposite direction. A person who is not a partner but is represented as one, or knowingly allows themselves to be so represented, can be liable to a third party who relied on that appearance, which is the same principle reaching a person outside the firm altogether.

Knowledge acquired afterwards does not assist. The test is applied at the time of the transaction, so a third party who learns of the restriction later is unaffected.

How it is examined

The case appears wherever a partner has done something the partnership agreement forbade.

State the test from section 5 in its objective form. Establish what the firm's business appears to be to an outsider, using the facts given about how it presents itself. Ask whether the transaction falls within that appearance. Then ask what the third party knew, since actual knowledge is the only route to the firm escaping. Conclude on the firm's liability, and note separately the injured partner's internal claim.

Where the facts make the firm's apparent business genuinely uncertain, argue it from what the firm did and displayed and not from what it was called. A trading name, signage, advertising, the premises and the transactions the firm had previously carried out all bear on the appearance, and a court will take them together.

The error to avoid is arguing from the partnership agreement outwards. The agreement decides the partners' rights against each other and decides nothing about the firm's liability to someone who never saw it.