Business Law: The Principal-Agent Relationship (2023)

Business Law: The Principal-Agent Relationship

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

Creating an Agency Relationship

Anagency 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 theprincipal’s control and must consent to her instructions.[2].Classic examples of agency relationships include employer/employee,lawyer/client, and corporation/officer.[3]

All thatis required to create an agency relationship is the manifestation of assent byboth sides. This manifestation can be oral or in writing. Examples of writtenagency agreements include attorney retainer agreements. Agency relationshipscan also arise from circumstances even without explicit agreement. Whether animplied agency arose is a question of fact for a jury or judge to determine ifthe issue comes up a trial.

Types of Authority

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

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

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

Duties of Principals and Agents

(Video) Business Law: The Principal Agent Relationship

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

1.Duty of loyalty: Anagent owes his principal a general duty of loyalty. This means that the agentmust subordinate his interests to those of the principal if they fall withinthe agency relationship. An example of a breach of this duty occurred when anemployee in charge of determining what to bid on construction projects beganworking for a different construction company as an independent contractor doingthe same type of work. The employee did not tell his current employer and, infact, 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 toact in accordance with the express and implied terms of a contract: Forexample, if the contract provides that the agent, a marketer, will call 5 largeclothing companies on behalf of the principal, then that marketer has a duty tomake those 5 phone calls and ONLY those 5 phone calls.[9]

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

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

5.Duty tocomply with the principal’s lawful instructions

Principals also owe agents a numberof duties:

1.Duty toact in accordance with the express and implied terms of a contract: If theprincipal breaches this duty, the agent can recover based on a breach ofcontract claim.[12] In one example, a sellerdecided to subdivide a large piece of property into separate lots. He hired anagent to plot and map the new development and they agreed to split the profit50/50. The agent spent time and money starting this new venture, but then theseller changed his mind and terminated the contract. The court held there was abreach of contract and the agent was entitled to whatever benefits he would havereceived under the agreement.[13]

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

3.Duty todeal fairly and in good faith with the agent: The principal must refrainfrom taking actions that could foreseeably result in loss for the agent, whenthe agent is not at fault.[15]

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

Aprincipal is liable for contractual arrangements entered into by the principalwith third parties if the agent had express, implied or apparent authority to enterinto those agreements.

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

Compensation of Agents

(Video) Methods of forming a Principal Agent Relationship

Mostagents do not work for free, even though one can become an agent by agreeing todo something gratuitously.[18]When the agent iscompensated, the terms of the contract will control how much the agent will bepaid for his services. Where the extent of the compensation is not spelled outby the parties, the trial court may determine reasonable compensation.

Forexample, in Howard v. Gobel, the principalhired an agent to oversee the construction of the Illinois State Capitolbuilding. A dispute arose as to whether the agent was entitled to a fixed sumdetermined at the beginning of the project or reasonable compensationdetermined after the project was completed. The court held that there was nomeeting of the minds as to what the parties had contracted for. The agent wasentitled to reasonable compensation for his work on the project.[19]

Agencylaw 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 usedto describe a special relationship between to people where the agent is authorizedto act on behalf of a principal.


[1] Restat 3d of Agency, § 1.01 (3rd 2006)

[2] Id.

[3] § 1.01 cmt. c

[4] § 2.01

[5] § 2.02

(Video) Duties Owed Between a Principal and Agent

[6] cmt. c

[7] § 2.03

[8] WallSys. V. Pompa, 324 Conn. 718 (2017)

[9] § 8.07

[10] § 8.08

[11] §§ 8.09-.12

[12] § 8.13

(Video) Understanding Principal Agent Relationship

[13] Cloev. Rogers, 121 P. 201 *** (1912).

[14] AmericanTel & Tel. Co. v. Leveque, 30 Ill. App. 2d 120 (1961).

[15] Restat3d of Agency, § 8.15 (3rd 2006)

[16] Restat 3d of Agency, § 2.04; 7.03 (3rd2006)

[17] Seee.g., Newspapers, Inc. v. Love, 380 S.W.2d 582 (1964) (the employer was notheld liable in this case, but the court states that it is possible to a hold aprincipal liable in this situation).

[18] Restat 3d of Agency, § 1.01 cmt. d (3rd2006)

[19] Howard v. Gobel, 62 Ill. App.497 (1895)

(Video) Scope of the Agent-Principal Relationship


What is the legal definition of the principal-agent relationship? ›

A principal-agent relationship is created when the agent is given authority to act for the principal. An agreement made by an agent is binding on the principal so long as the agreement was within the authority actually granted to the agent or reasonably perceived by a third party.

What is a principal-agent relationship provide an example? ›

A good example would be an insurance agent. Generally, in a business relationship, the principal and agent relationship requires being either an employee/employer relationship or an ind ependent contractor. � Fiduciary: A person who undertakes to act on behalf of and primarily for the benefit of another.

How is a principal-agent relationship formed? ›

To reiterate, an agency relationship is formed between two parties when one party, the agent, agrees to represent the other party, the principal. A principal-agent relationship is fiduciary in nature, meaning that it is based on trust.

What are the duties of the principal in an agency relationship? ›

A principal's primary duties to his/her agent include:
  • To compensate the agent as agreed; and.
  • To indemnify and protect the agent against claims, liabilities, and expenses incurred in the agent correctly discharging the duties assigned by the principal.

How does the agency principal relationship work? ›

The agent represents the principal in their actions, conduct and dealings. So, they can enter into contracts and transactions on behalf of the principal. This also means that the principal is often liable for the actions of the agent. For example, real estate agents are agents for the person selling the property.

What is an example of a principal agent problem? ›

Examples of principal-agent problems

In economics, moral hazard occurs when one person takes more risks because someone else bears the cost of those risks. You take out health insurance, and because someone else is responsible if you're injured, you decide to pick up BASE jumping.

What is principal agent theory in business? ›

Principal agent theory, which emerged in the 1970s from a number of economists and theorists, describes the pitfalls that often arise when one person or group, the “agent,” is representing another person or group, known as the “principal.”

What are the 4 types of agents? ›

The Four Main Types of Agent
  • Artists' agents. An artist's agent handles the business side of an artist's life. ...
  • Sales agents. ...
  • Distributors. ...
  • Licensing agents.

What are the four 4 Characteristics of an agent? ›

Another definition: An agent is a computer software system whose main characteristics are situatedness, autonomy, adaptivity, and sociability.

What are the 3 types of principal? ›

What are the types of principal? Principals are categorized based upon whether their identity is disclosed to third parties with whom the agent interacts on their behalf. A principal can be classified as Disclosed, Partially-disclosed, or Undisclosed.

What are the 5 types of agents? ›

The five types of agents include: general agent, special agent, subagent, agency coupled with an interest, and servant (or employee).

Which theory identify the relationship between principal and agent? ›

Agency theory is a principle that is used to explain and resolve issues in the relationship between business principals and their agents. Most commonly, that relationship is the one between shareholders, as principals, and company executives, as agents.

What are five ways by which a principal-agent relationship can be terminated? ›

Below are common rules for terminating the agency relationship: Withdrawal by a Party, Termination by the Principal, Renunciation by Agent, Death or Incapacity of Agent, Death or Incapacity or Bankruptcy of the Principal.

What are the 3 types of agent authority? ›

There are three different ways in which the insurer authorizes the agent to represent it.
  • Express Authority. Express authority is the authority that an agent has in writing in the contract with the insurer that the agent represents. ...
  • Implied Authority. ...
  • Apparent Authority.

What are the three elements of an agency relationship? ›


Parsing this definition reveals three primary elements of an agency relationship: (1) consent by the principal and the agent; (2) action by the agent on behalf of the principal; and (3) control by the principal.

What are three 3 important duties the owed by the agent to the principal? ›

Agents generally have the following duties to the principal: Loyalty, Care, Obedience, and Accounting.

What are the three duties of the principal to the agent? ›

Principal's Duties
  • Compensation.
  • Indemnification.
  • Good faith and fair dealing.
  • Acting according to contract.
Sep 27, 2021

Who controls the agency relationship? ›

An agency relationship is created when one person (the principal) consents to another person (the agent) acting on his behalf, subject to the P's control, and the A agrees to do so. Agency most often comes up in relationship to business matters of some sort. At common law this relationship was called “master-servant.”

What are the benefits of an agency relationship? ›

It creates a healthy trust worthy work relation between the two. Keeping relationship outside the work also helps in bringing more motivation towards work and agency becomes as active as their client.

What is a principal-agent relationship quizlet? ›

In a principal-agent relationship, the parties have agreed that the agent will act on behalf and instead of the principal in negotiating and transacting business with third parties. The term fiduciary is at the heart of agency law.

Who is the principal in an agency relationship real estate? ›

The Client is also known as the Principal. A customer may also be the third party in an agreement. Sole Agency is also known as Single Agency. A service agreement is a written contract that establishes the relationship between the parties as to the services to be performed by the brokerage.

What is a principal-agent relationship in politics? ›

The principal–agent problem refers to the conflict in interests and priorities that arises when one person or entity (the "agent") takes actions on behalf of another person or entity (the "principal").

What is the principal-agent relationship in healthcare? ›

The relationship between provider and patient in the health care market is often characterized as a principal-agent relationship. The principal (the patient) appoints an agent (a health provider) to advise the principal in making decisions about treatment or to make decisions on the principal's behalf.

What is meant by principal agent theory? ›

Principal agent theory, which emerged in the 1970s from a number of economists and theorists, describes the pitfalls that often arise when one person or group, the “agent,” is representing another person or group, known as the “principal.”

What does a principal-agent do? ›

"The principal agent must act proactively to avoid potential dis- putes. This requires regular monitoring of the execution of the works, liaison with all stakeholders, and dealing with all claims competently and within the time constraints of the standard form contract used.

What is an agency relationship in business? ›

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.[

What are the three parties in an agency relationship? ›

As these questions suggest, agency law often involves three parties—the principal, the agent, and a third party. It therefore deals with three different relationships: between principal and agent, between principal and third party, and between agent and third party.

What is an example of a principal-agent problem? ›

Examples of principal-agent problems

In economics, moral hazard occurs when one person takes more risks because someone else bears the cost of those risks. You take out health insurance, and because someone else is responsible if you're injured, you decide to pick up BASE jumping.


1. Principal-Agent Relationship
2. Introduction to Agency Law
(Matt Davis)
3. How the Principal - Agency Relationship Ends
(The Business Professor)
4. Types of Principal in an Agency Relationship
(The Business Professor)
5. Business Law Agency Video
(Professor Fin)
6. Relationship between Principal and sub-agent (Business Law)
(Study For Dreams)
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