Business Law: The Principal-Agent Relationship

Business Law: The Principal-Agent Relationship

People, especially business owners, routinely hire or designate other people to perform tasks on their behalf. Agency law provides the set of rules governing the way in which this relationship operates. Agency is a legal term of art that refers to the  relationship between a principal and an agent.[1]

Creating an Agency Relationship

An agency relationship is a fiduciary relationship, where one person (called the “principal”) allows an agent to act on his or her behalf. The agent is subject to the principal’s control and must consent to her instructions.[2]. Classic examples of agency relationships include employer/employee, lawyer/client, and corporation/officer.[3]

All that is required to create an agency relationship is the manifestation of assent by both sides. This manifestation can be oral or in writing. Examples of written agency agreements include attorney retainer agreements. Agency relationships can also arise from circumstances even without explicit agreement. Whether an implied agency arose is a question of fact for a jury or judge to determine if the issue comes up a trial.

Types of Authority

An agent can act with two types of authority, actual and apparent.

1.    Actual authority exists when the agent takes an action on behalf of the principal and he reasonably believes that the principal wants this action taken.[4] Actual authority includes “express” authority, where the principal tells the agent exactly what to do, and “implied” authority, where the agent takes actions reasonably necessary to accomplish the objective of the agency.[5] Principals can also limit agents’ authorities or revoke them as they choose. For example, a principal who initially tasked an agent with purchasing a piece of real property may amend the instructions to limit the agent’s authority to leasing the property instead.[6]

2.    Apparent authority exists when the agent takes actions for the principal with a third party that the third party reasonably believes the agent has the authority to take.[7] For example, assume that Principal employs Agent to manage his business. Principal tells Agent he can’t buy more than $500 worth of goods from any supplier. Principal tells or implies to a vendor, however, that Agent has unlimited authority to buy from him. Agent buys $1,000 worth of goods from the vendor. Agent has apparent authority to make this purchase because the vendor reasonably believed, based on Principal’s conduct, that Agent had the authority to purchase more than $500 worth on Principal’s behalf.  

Duties of Principals and Agents

Agents are required to act up to the following duties and standards:

1.    Duty of loyalty: An agent owes his principal a general duty of loyalty. This means that the agent must subordinate his interests to those of the principal if they fall within the agency relationship. An example of a breach of this duty occurred when an employee in charge of determining what to bid on construction projects began working for a different construction company as an independent contractor doing the same type of work. The employee did not tell his current employer and, in fact, submitted bids for both companies on the same jobs. After a bench trial, the trial judge determined that the employee had breached his duty of loyalty.[8]  

2.    Duty to act in accordance with the express and implied terms of a contract: For example, if the contract provides that the agent, a marketer, will call 5 large clothing companies on behalf of the principal, then that marketer has a duty to make those 5 phone calls and ONLY those 5 phone calls.[9]

3.    Duty of care, competence, and diligence: This requires that the agent behave with the proper amount of care required by the situation.[10]

4.    Duty of good conduct: This requires that the agent act in a way that does not injure the principal’s endeavor. The agent must make a reasonable attempt to provide the principal with relevant facts and information. If the agent has access to the property of the principal, the agent cannot make it appear as if the property is her own and may not commingle the property with anyone else’s. The agent must also keep track of how the principal’s property (money), is being spent.[11]

5.    Duty to comply with the principal’s lawful instructions

Principals also owe agents a number of duties:

1.    Duty to act in accordance with the express and implied terms of a contract: If the principal breaches this duty, the agent can recover based on a breach of contract claim.[12] In one example, a seller decided to subdivide a large piece of property into separate lots. He hired an agent to plot and map the new development and they agreed to split the profit 50/50. The agent spent time and money starting this new venture, but then the seller changed his mind and terminated the contract. The court held there was a breach of contract and the agent was entitled to whatever benefits he would have received under the agreement.[13]

2.    Duty to indemnify the agent: As an example, a landowner hired two agents to dig a ditch, but did not tell the agents that a phone line ran where the trench was going to be dug. The agents severed the line and the phone company sued them. The principal/landowner was required to indemnify the agents for this liability.[14]

3.    Duty to deal fairly and in good faith with the agent: The principal must refrain from taking actions that could foreseeably result in loss for the agent, when the agent is not at fault.[15]

Principal’s Liability for Agent’s Action in Contract and Tort

A principal is liable for contractual arrangements entered into by the principal with third parties if the agent had express, implied or apparent authority to enter into those agreements.

            A principal can also be held directly liable for a tort committed by the agent if the principal directs the agent to commit a tort. Alternatively, a principal can be held vicariously liable for an agent’s actions if the agent is an employee of the principal and is acting within the scope of his employment.[16] For example, if an agent is hired to make deliveries for a principal and negligently gets into an accident while making a delivery, then the principal can be held liable for any injuries a third party suffered as a result of that accident.[17]

Compensation of Agents

Most agents do not work for free, even though one can become an agent by agreeing to do something gratuitously.[18] When the agent is compensated, the terms of the contract will control how much the agent will be paid for his services. Where the extent of the compensation is not spelled out by the parties, the trial court may determine reasonable compensation.

For example, in Howard v. Gobel, the principal hired an agent to oversee the construction of the Illinois State Capitol building. A dispute arose as to whether the agent was entitled to a fixed sum determined at the beginning of the project or reasonable compensation determined after the project was completed. The court held that there was no meeting of the minds as to what the parties had contracted for. The agent was entitled to reasonable compensation for his work on the project.[19]

Agency law does not exist in a vacuum and it is impacted by developments in business, tort, and contract law. Agency is a subset of these areas of law that is used to describe a special relationship between to people where the agent is authorized to act on behalf of a principal.