Pastors, and other church leaders, who sign contracts and other legal documents in their own name with no indication that they are signing in a representative capacity on behalf of their church may be personally liable for the transaction. This risk was addressed in a recent case in Michigan. Michigan Conference, 2007 WL 2379904 (Mich. App. 2007)
A church’s senior pastor (Pastor Tim) took out a loan at a local bank for $63,000, secured by a mortgage on church property, with a local bank. As part of the application process, Pastor Tim presented a statement, purportedly signed by members of the church’s board of trustees, approving the loan. The next year, Pastor Tim applied for and received an $85,000 loan from a second bank. The proceeds were used to pay off the previous bank loan, which was in default.
When the second loan went into default, Pastor Tim was removed from his position as pastor. The second bank threatened to foreclose on the loan by selling the church’s property. The church responded by asking a court to suspend all foreclosure actions for the following two reasons: (1) Pastor Tim was without authority to sign the loan and mortgage documents, and (2) the bank engaged in fraud in failing to investigate Pastor Tim’s authority to sign.
The court barred the bank from proceeding with foreclosure until the church’s claims were resolved. Meanwhile the bank obtained a default judgment against Pastor Tim for the full amount of the unpaid loan.
According to the church board’s written authorization, the original loan was intended for building repairs. However, Pastor Tim’s successor testified that when he arrived at the church he found the property to be in a state of complete disrepair, and its insurance, telephone, and electric service cancelled for nonpayment. It was later disclosed that of the two bank loans that Pastor Tim had secured, only about $4,400 had been spent on the church. Not all of the rest of the money could be accounted for, but the church had issued checks (1) to Pastor Tim and members of his family; (2) for the tuition expenses of one of Pastor Tim’s grandchildren; (3) for Pastor Tim’s rent and car insurance; and (4) for attorneys’ fees.
The church was affiliated with a denomination whose bylaws (“Discipline”) specified that sales and mortgages of church property had to be authorized by a vote of the church’s membership. A denominational officer testified that Pastor Tim did not have the authority to obtain the loan or sign the mortgage document, despite the fact that he signed a statement for the bank stating that he was authorized to do so.
The church did not have an accountant or treasurer at the time Pastor Tim secured the church loans. A church member testified that the pastor did not “go by” the bylaws or Discipline, and did not handle finances “the way previous pastors had done.”
Pastor Tim’s sister and brother-in-law were both church trustees, and his sister handled the finances. The sister testified that the church’s financial responsibilities were taken from her by Pastor Tim when she asked him “too many questions about finances.” She was unaware of either loan that Pastor Tim had secured.
An officer of the second bank testified that he did not know why the loan was issued when the church’s credit score showed a significant level of risk. However, he explained that churches generally are higher risk, and that it is common for community banks to lend money to churches. He could not explain why the bank failed to follow many of its own standards, in that the property was not appraised, and the church’s articles of incorporation and bylaws were not obtained.
The trial court ruled that Pastor Tim did not have actual authority to enter into a mortgage, but that he had “apparent authority” to do so. It also ruled that the bank had not committed fraud in approving the loan. The church appealed.
The court’s ruling
The appeals court agreed that Pastor Tim had apparent authority to sign the loan and mortgage documents on behalf of the church, and therefore the church was obligated to pay the loan balance. The court noted that “the actions of an agent can bind a principal when the agent acts with either actual or apparent authority.” It defined apparent authority as follows:
Apparent authority arises when acts and appearances lead a third party reasonably to believe that an agency relationship exists. Apparent authority must be traceable to the principal and cannot be established by the acts and conduct of the agent. The question here is whether an ordinarily prudent person, conversant with mortgage lending, would be justified in assuming that [the pastor] had the authority to enter into the mortgage with [the bank].
The court concluded that this test was met under the facts of this case:
Evidence showed that the church did not comply with denominational rules regarding board meetings, finances, or officers. The pastor, openly, with the church board’s knowledge and tacit approval, disregarded the Discipline of the higher church body. Information filed with the state of Michigan … listed [Pastor Tim] as [the church’s] resident agent, president, and sole director. Before applying for the bank mortgage, [Pastor Tim] had entered into a loan on behalf of the church with another bank, with purported authorization from the church’s board of trustees. The bank was aware of the previous mortgage. Before this second bank loan was approved, the pastor signed an authorization stating that there was no conflict with the church’s bylaws or charter.
As a result, the court rejected the church’s contention that it was not liable for the loan because of Pastor Tim’s lack of authority.
Next, the court agreed with the trial court that the church could not avoid its legal obligation to pay the loan on the basis of the bank’s fraud in approving it without further investigation into Pastor Tim’s authority. The church insisted that there was evidence that the bank failed to follow reasonable commercial practices in processing the mortgage loan, failed to require copies of the church’s bylaws or articles of incorporation, and ignored other red flags. That may have been true, the court concluded, but the church had failed to “present any evidence of a misrepresentation that would support an action for fraud.”
Relevance to church leaders
This case is instructive for the following three reasons.
1. Apparent authority. This case illustrates a very important point: A church may be legally obligated by contracts entered into without authorization by its pastor or a church officer if there is a history of the pastor or officer entering into unauthorized contracts that the church honored. If the dollar amount of a contract is small, there may be little concern. But this establishes a pattern that may be carried over to a higher cost transaction that the church may have no choice but to accept. In some cases, if there is not a pattern of accepting unauthorized contracts, the church may be able to repudiate the contract, but this has the potentially undesirable effect of transferring liability to the pastor or officer. Obviously, this is no way to handle contracts. Here are some suggestions that will reduce the risk of such problems:
- Review the church’s organizational documents to determine if the pastor or any other officer is authorized to unilaterally enter into contracts or other legal transactions on behalf of the church. Church leaders should have a clear understanding of such authority. In most cases, there should be no unilateral authority conferred upon a pastor or any other church officer to engage in legal transactions on behalf of the church, since such authority violates one of the cardinal rules of internal control.
- Usually, a church’s organizational documents do not give the pastor or any other officer unilateral authority to enter into contracts. This may result in future problems if pastors or other church officers assume they are authorized to execute contracts for the purchase of some items on behalf of the church. When church leaders routinely accept such contracts, the church is in effect investing the pastor or officer with apparent authority to enter into unauthorized contracts. This may not be a concern for small cost items, but it may be a problem for larger cost items. As a result, a church should consider two options:
First, amend the organizational documents to give the pastor or some other designated officer limited authority to unilaterally execute contracts on behalf of the church for items of nominal value. For example, some church bylaws authorize the pastor to purchase items up to $50 or some other amount without prior approval by the congregation or board. Such a provision can reduce the risk of establishing a pattern of church acceptance of unauthorized contracts.
Second, if the church elects not to amend its organizational documents, then it needs to periodically caution the pastor and other officers that they have no authority to unilaterally enter into contracts on behalf of the church, and instruct them to seek appropriate approval before entering into any contract. A failure to do so will facilitate unauthorized transactions for which the church may ultimately be liable as a result of the apparent authority that its silent acceptance of prior unauthorized transactions has created.
- If a pastor or other officer makes an unauthorized purchase of a product or service of substantial cost, church leaders should recognize that the church has no legal obligation to accept the contract if it has not invested the pastor or officer with apparent authority by its practice of routinely accepting unauthorized contracts. The church may either repudiate the contract, or ratify it. Repudiation means that the church refuses to accept the purchased product or service. In such a case, the pastor or officer will be personally liable for paying the purchase price. Ratification is an acceptance of the contract by accepting the purchased product or service without objection. If the church accepts the product or service that was acquired by the pastor or officer in an unauthorized transaction, then the church will be legally obligated to honor the contract.
- Review the governing documents of a parent denominational agency (national and regional) to see if they address the authority of affiliated churches to enter into contracts. As this case demonstrates, denominational documents sometimes impose conditions on certain contracts (i.e., sales of church property), and it is important for church leaders to be familiar with such conditions.
KEY POINT. A church’s acceptance of unauthorized transactions may induce others to reasonably assume that church officers have authority that they lack, which may have the effect of imposing liability on the church for future unauthorized transactions on the basis of apparent agency. Unauthorized transactions should not be viewed as minor transgressions that can be ignored. Rather, they should be viewed as paving the way to apparent agency and potential liability for significant, unauthorized transactions.
2. Internal control. This church in this case was guilty of a number of breaches of internal control that facilitated the pastor’s unauthorized transactions. These included the following:
- The church did not have a treasurer or an accountant.
- A church trustee had limited responsibility for certain financial matters, but when she raised questions she was peremptorily dismissed.
- The pastor intentionally disregarded the provisions of denominational bylaws governing church mortgages.
- The church loans, which were purportedly for maintenance and improvements of church property, were used primarily for the personal benefit of the pastor and his family. If the church failed to report all of these benefits as taxable income to the pastor, this would have three potentially serious consequences: (1) The church’s tax- exempt status under section 501(c)(3) of the federal tax code would be jeopardized. (2) The failure of the church to report any of these benefits as taxable income to the pastor would make them “excess benefit transactions,” regardless of the amount, exposing the pastor to substantial excise taxes under section 4958 of the tax code of up to 225 percent of the amount of the excess benefits. (3) Church board members who approved the excess benefit transaction would be subject to an additional penalty of up to 20 percent of the amount of the excess benefits, up to a maximum penalty for all board members of $20,000. The point is obvious. There are now substantial risks that make sloppy internal control and accounting practices unacceptable.
3. Personal liability. Had the pastor not entered into the previous loan and mortgage with the first bank, the court likely would have concluded that he lacked both actual and apparent authority to sign the documents associated with the second loan. As a result the church would not have been liable on this loan, and so the bank’s sole recourse would have been to proceed against the pastor.
The takeaway point here is that signing legal documents is serious business that may result in personal liability to the signer. This risk, however, can be managed. Church leaders should refrain from signing contracts or any other legal documents unless they are certain that:
- the contract has been properly authorized;
- they are authorized to sign on behalf of the church;
- the church is clearly identified in the contract as the party to the agreement; and
- the minister or other church leader signs in a “representative capacity” (for example, as “authorized agent” or “president”).
In no event should ministers assume that they are authorized to enter into contracts on behalf of their church simply by virtue of their position. One court observed:
The mere proclaiming of [oneself] as the religious superior of the congregation may suffice to establish that fact in spiritual matters of his church, but it does not effect legal superiority in secular matters. There must be clear and convincing evidence of congregational acknowledgement of and acquiescence in the concept of legal superiority and authority over church business and property matters.
Example. A corporate officer signed a check in the amount of $43,000 on behalf of his company. The company’s name was imprinted on the check, so there was no doubt that it was an obligation of the company. However, the officer’s signature did not indicate that he was signing in a “representative capacity”—that is, as a representative of the company rather than in his personal or individual capacity. A bank dishonored the check on the basis of insufficient funds, and the recipient sued the officer directly. The officer insisted that he could not be personally liable for the amount of the check, since the company’s name had been imprinted on it. The court disagreed. It referred to a state law specifying that an authorized representative who signs his or her name to an instrument “is personally obligated if the instrument names the [company] represented but does not show that the representative signed in a representative capacity.” In summary, the officer was personally liable for payment of the check even though the company’s name was imprinted on it, since the officer did not indicate clearly that he was signing in a representative capacity. Hind-Marsh v. Puglia, 665 So.2d 1091 (Fla. App. 1995).
This article first appeared in Church Finance Today, July 2008.