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

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

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.