Agency
Introduction
An agency relationship exists when one party (the principal) authorizes another party (the agent) to act on the principal's behalf in dealings with third parties. Agency law governs everything from everyday business transactions to complex corporate dealings. Understanding how agency relationships are formed, the rights and duties they create, and how they affect third-party liability is essential for the REG exam.
Formation of Agency Relationships
An agency can be created through:
- Agreement — the most common method; may be oral or written (no consideration is required to form an agency)
- Ratification — a principal approves an agent's previously unauthorized act, retroactively creating an agency
- Estoppel — a principal's conduct leads a third party to reasonably believe an agency exists
- Operation of law — law imposes an agency in certain emergency situations (e.g., a spouse authorized to act in a medical emergency)
An agency agreement generally does not need to be in writing. The major exception is the equal dignities rule: if the contract the agent is authorized to execute must be in writing under the Statute of Frauds, the agency authorization must also be in writing (a power of attorney).
Types of Authority
A principal's liability to third parties depends on whether the agent acted with authority:
Actual Authority
Actual authority is the power the principal has explicitly or implicitly granted to the agent.
| Type | Description | Example |
|---|---|---|
| Express | Explicitly stated in words (oral or written) | Gies Co.'s board resolution authorizing the CEO to sign contracts up to $500,000 |
| Implied | Reasonably necessary to carry out express authority, based on custom or the agent's position | The CEO's authority to hire staff needed to perform an authorized contract |
Apparent Authority
Apparent authority arises when a principal's conduct causes a reasonable third party to believe the agent has authority — even if no actual authority exists. The key is the principal's actions, not the agent's claims.
Example: MAS Inc. has always allowed its sales manager to negotiate and sign contracts with vendors. MAS Inc. secretly revokes this authority but does not notify vendors. When the sales manager signs a new contract with a vendor, MAS Inc. is bound because the vendor reasonably relied on the sales manager's apparent authority.
Authority by Ratification
A principal may ratify an unauthorized act if:
- The agent purported to act on behalf of the principal
- The principal had knowledge of the material facts
- The principal ratifies the entire transaction (no partial ratification)
- The principal had capacity to have authorized the act originally
Ratification is retroactive — it relates back to the time of the original act.
:::tip Exam Tip
Ratification requires the principal to know all material facts. A principal who ratifies without full knowledge may later rescind the ratification.
:::
Agent's Duties to the Principal
An agent owes fiduciary duties to the principal:
| Duty | Description |
|---|---|
| Loyalty | Act solely in the principal's interest; avoid self-dealing and conflicts of interest |
| Obedience | Follow the principal's reasonable and lawful instructions |
| Care (Reasonable Diligence) | Exercise the skill and care that a reasonable person would use in similar circumstances |
| Accounting | Keep accurate records of all transactions involving the principal's property or funds |
| Notification | Inform the principal of all material facts relevant to the agency |
Example: BIF Partners appoints an agent to purchase commercial real estate. The agent learns that the seller is willing to accept a much lower price than what the principal authorized. The agent has a duty of notification — she must inform BIF Partners of this material fact rather than pocketing the difference.
Principal's Duties to the Agent
| Duty | Description |
|---|---|
| Compensation | Pay the agent the agreed-upon compensation (or reasonable value if no amount was agreed) |
| Reimbursement | Repay the agent for authorized expenses incurred on the principal's behalf |
| Indemnification | Hold the agent harmless for losses suffered while acting within the scope of authorized duties |
| Cooperation | Not unreasonably interfere with the agent's performance of duties |
Liability to Third Parties
Types of Principals
A principal's liability to third parties depends on how much the third party knows about the principal's existence and identity:
| Type | Third Party's Knowledge | Principal Liable? | Agent Liable? |
|---|---|---|---|
| Disclosed | Knows principal's identity | Yes (if agent had authority) | Generally no |
| Partially Disclosed | Knows a principal exists but not the identity | Yes (if agent had authority) | Yes |
| Undisclosed | Does not know a principal exists | Yes (if agent had authority) | Yes |
When the principal is undisclosed, the agent is always liable on the contract because the third party believed it was dealing with the agent personally. If the principal is later discovered, the third party may elect to hold either the principal or the agent liable — but not both.
Example: Illini Security authorizes an agent to lease office space without revealing that Illini Security is the actual tenant. The landlord believes the agent is leasing for himself. This is an undisclosed principal situation — both Illini Security and the agent are potentially liable on the lease.
Tort Liability
A principal is liable for the torts of an agent committed within the scope of employment under the doctrine of respondeat superior (vicarious liability). Key factors in determining scope of employment include:
- Whether the act was authorized by the principal
- The time, place, and purpose of the act
- Whether the act was commonly performed by employees
- Whether the agent was serving the principal's interests at the time
Independent Contractors vs. Employees
The distinction between an employee and an independent contractor is critical because respondeat superior generally applies only to employees.
| Factor | Employee | Independent Contractor |
|---|---|---|
| Control | Principal controls how work is performed | Principal controls only the result |
| Tools/Equipment | Provided by principal | Provided by contractor |
| Schedule | Set by principal | Set by contractor |
| Payment | Regular wages or salary | Per project or contract |
| Tax treatment | Principal withholds taxes | Contractor pays own taxes (Form 1099) |
A principal who hires an independent contractor is generally not liable for the contractor's torts. Exceptions include: (1) the work is inherently dangerous, (2) the principal retains control over the manner of work, or (3) the duty is nondelegable by law.
Example: Kingfisher Industries hires MSA Records (an independent contractor) to perform demolition work at a construction site. Demolition is considered inherently dangerous activity. Kingfisher Industries may be vicariously liable for injuries caused by MSA Records' negligence despite MSA Records' independent contractor status.
Termination of Agency
By Act of the Parties
- Mutual agreement of the principal and agent
- Revocation by the principal (but the principal may be liable for breach of contract)
- Renunciation by the agent (the agent may be liable for breach)
- Expiration of the agreed-upon term or accomplishment of the agency's purpose
By Operation of Law
- Death of either the principal or agent
- Incapacity of either party
- Bankruptcy of the principal (or of the agent if it affects the agency)
- Illegality — the subject matter of the agency becomes illegal
- Destruction of the subject matter
An agency coupled with an interest (where the agent has a property interest in the subject matter) is irrevocable — it cannot be terminated by the principal's revocation, death, or incapacity.
Notice Requirements Upon Termination
When an agency is terminated by act of the parties, the principal must give:
- Actual notice to third parties who have previously dealt with the agent
- Constructive notice (e.g., publication) to third parties who knew of the agency but had not dealt with the agent
Failure to give proper notice allows the agent to continue binding the principal through apparent authority.
Summary
| Topic | Key Rule |
|---|---|
| Formation | Agreement, ratification, estoppel, operation of law; generally no writing required |
| Actual authority | Express or implied; granted by the principal |
| Apparent authority | Created by the principal's conduct toward third parties |
| Agent's duties | Loyalty, obedience, care, accounting, notification |
| Disclosed principal | Principal liable; agent generally not liable |
| Undisclosed principal | Both principal and agent liable |
| Respondeat superior | Principal liable for employee torts within scope of employment |
| Independent contractors | Generally no vicarious liability (exceptions for inherently dangerous work) |
| Termination | By parties or by operation of law; coupled with an interest is irrevocable |