Module 32: Agency

Overview

Agency is a relationship in which one party (agent) is authorized to act on behalf of another party (principal). The law of agency is concerned with the rights, duties, and liabilities of the parties in an agency relationship. Important to this relationship is the fact that the agent has a fiduciary duty to act in the best interest of the principal. A good understanding of this module is important because business structures (Module 25) apply the concepts of agency frequently.

A. Characteristics

B. Examples of Principals and Agents

C. Methods of Creation

D. Duties (Obligations) and Rights

E. Liability to Third Parties

F. Termination of Principal-Agent Relationship

Key Terms

Multiple-Choice Questions

Multiple-Choice Answers and Explanations

Simulation

Simulation Solution

The CPA exam emphasizes the creation and termination of the agency relationship, the fiduciary duties that the agent owes to the principal, the undisclosed as well as the disclosed principal relationship, unauthorized acts or torts committed by the agent within the course and scope of the agency relationship and principal’s liability for agent’s unauthorized contracts. Before beginning the reading you should review the key terms at the end of the module.

A. Characteristics

1. Agency is a relationship between two parties, whereby one party (agent) agrees to act on behalf of the other party (principal) with respect to third parties. A contract is not required but is frequently present.
a. Agent is subject to control of principal
b. Agent is a fiduciary and must act for the benefit of principal
c. Agent’s specific authority is determined by the principal but generally agent has authority to bind the principal contractually with third parties

B. Examples of Principals and Agents

1. Employer (principal) and Employee (agent)
a. Employee is a type of agent in which employee’s physical conduct is subject to control by employer
b. Business structures (e.g., corporations, partnerships, limited partnerships) are principals; their various employees are agents.
(1) Employees include corporate officers, but not directors, general partners, and other employees such as professional support staff.
c. Some older CPA questions may use the terms master (principal) and servant (agent)
d. The employer/employee relationship is the most commonly tested principal-agent relationship on the CPA Exam
2. Independent contractor distinguished from employee/agent
a. Not subject to control of employer as to methods of work
b. Not subject to regular supervision as an employee
c. Employer controls results only (independent contractor controls the methods)
d. Typically an independent contractor is paid by the job, while an employee is paid a salary or an hourly wage on a continuous basis.
e. Often independent contractors provide their own tools/supplies for a job, while an employee usually has tools/supplies provided by the principal.
f. The distinction is important because generally employer is not liable for torts committed by independent contractor, but the employer can be held liable for the torts of an agent (see Section B.3. of this outline)
(1) Unless independent contractor is employed to do something inherently dangerous (e.g., blasting)
(2) Unless employer was negligent in hiring independent contractor
g. Independent contractor may also be an agent in certain cases
EXAMPLE
An attorney represents a client in tax court.
3. Special agency situations
a. Power of attorney: A person authorizes another person to act as his/her representative.
EXAMPLE
Catherine recognizes that she is not as mentally sharp as she once was and is fearful that she may one day lack capacity to manager her own affairs. Catherine executes a power of attorney giving James, her adult son, power of attorney.
(1) Principal, in writing, grants authority to agent
(a) Only principal need sign because the principal is the only party relinquishing a legal right, and the law needs evidence of the principal’s intent to do so.
(b) This is similar to the idea of needing the signature of the party to be charged from contract law.
(2) Agent need not be an attorney but anyone with capacity to be agent
(3) Power of attorney may grant general authority or restricted authority
b. Broker—special agent acting for either buyer or seller in business transactions (e.g., real estate broker)
c. Exclusive—only agent the principal may deal with for a certain purpose during life of the contract (e.g., real estate broker who has sole right to sell property except for personal sale by principal)
d. Del credere—a sales agent who, prior to the creation and as a condition of the agency, guarantees the accounts of the customers to his/her principal (if the customers fail to pay)
(1) Guarantee is not within the Statute of Frauds (i.e., it is not required to be in writing)
e. E-agent is computer program or electronic method to take some action without specific human review
EXAMPLE
P authorizes an online search to find the lowest price of a certain product found through online stores.
f. A general agent is an agent with a broad range of powers; a special agent is one that engages in only one specific type of transaction for the principal.
EXAMPLE
Cathy hires Nancy, a licensed real estate agent, to sell Cathy’s house. Nancy is a special agent.
g. Subagent: An agent who is hired by another agent.
(1) Generally, agents have no authority to hire subagents unless principal so authorizes
h. Relationship resembling agency
(1) Agency coupled with an interest—agent has an interest in subject matter through a security interest
(a) For example, mortgagee with right to sell property on default of mortgagor
1] Agreement stipulating agent is to receive profits or proceeds does not by itself create an agency coupled with an interest
(b) Principal does not have the power to terminate agency coupled with an interest
(c) Actually not an agency relationship because one who creates this relationship surrenders power—fact patterns may still use terms of principal and agent

C. Methods of Creation

1. Contract
a. Generally the agency contract need not be in writing in situations where the agent enters into agreements which themselves fall under the Statute of Frauds
EXAMPLE
A, in his capacity as agent of P, signs a contract for the sale of goods costing $600. Even though the sales contract must normally be in writing under the UCC version of the Statute of Frauds, the agency agreement between A and P need not be expressed in writing.
(1) But if agency contract cannot be completed within one year, it must be in writing
EXAMPLE
P agrees to pay A as his agent and to keep him as his agent for two years; this agreement needs to be in writing under the Statute of Frauds.
(2) In some states, agency contract needs to be written if agent is to buy or sell a specific piece of real estate named in agency contract
b. Capacity
(1) Principal must be able to give legal consent
(a) Minors (person under age of majority, that is, 18 or 21) can, in most jurisdictions, appoint an agent, but minor may disaffirm agency
(b) If act requires some legal capacity (e.g., legal age to sell land), then principal must meet this requirement or agent cannot legally perform even if s/he has capacity. Capacity cannot be increased by appointment of an agent.
(2) An agent must merely have sufficient mental and physical ability to carry out instructions of his/her principal
(a) Can bind principal even if agent is a minor or legally unable to act for self
(b) Principal will be responsible for contract that the minor agent entered into on principal’s behalf. Principal cannot use minor’s lack of capacity as a defense.
c. Consideration is not required to enter into a valid principal-agency relationship. When consideration is missing, this is known as a gratuitous agency.
2. Agency can also be implied by the conduct or lack of conduct by either the principal or agent that allows third parties to reasonably believe an agency exists; this is agency by estoppel.
EXAMPLE
Marcus put up a sign outside of Paula’s restaurant that says, “Valet parking for Paula’s $10.00.” Paula’s never hired Marcus or asked Marcus to do this, but Paula knew that parking was a problem, so she decided not to say anything. Third parties (customers in this case) can reasonably believe that Marcus is Paula’s agent, creating agency by estoppel.
3. An agent must merely have sufficient mental and physical ability to carry out instructions of his/her principal
a. Can bind principal even if agent is a minor or legally unable to act for self
b. Corporations, unincorporated associations, and partnerships may act as agents
c. A mental incompetent or an infant of tender years may not be an agent

D. Duties (Obligations) and Rights

1. Principal’s duties (obligations) to agent
a. Most of the principal’s duties to the agent are determined by the employment agreement (principal/agent) contract that the principal and agent enter into.
b. Compensate agent as per agreement, or, in the absence of an agreement, pay a reasonable amount for the agent’s service
c. Reimburse agent for reasonable expenses, unless their agreement states otherwise, and indemnify agent against loss or liability for duties performed at the principal’s direction which are not illegal
d. Duty to cooperate with agent and assist him/her perform duties as agreed to between principal and agent
e. Inform agent of risks (e.g., physical harm, pecuniary loss)
f. May have remedies of discharging agent, restitution, damages, and accounting, or an injunction
g. Principal does not owe agent any fiduciary duties; only the agent is a fiduciary in the principal-agent relationship.
2. Agent’s duties (obligations) to principal
a. Agent is a fiduciary and must act in the best interest of the principal and with loyalty
b. Carry out instructions of principal exercising reasonable care and skill
c. Account to the principal for profits and property that rightfully belong to the principal and not commingle funds
EXAMPLE
Agent makes authorized purchase order from Mega Corp. As a token of its appreciation, Mega provides two tickets to a sporting event for agent. The gift of tickets needs to be disclosed to the principal, otherwise the agent is breaching a fiduciary duty.
d. Duty not to compete or act adversely to principal
(1) Includes not acting for oneself unless principal knows and agrees
e. Give any information to principal that s/he would want or need to know
f. After termination, must cease acting as agent

E. Liability to Third Parties

1. When a third party (typically a customer, client, or business associate) suffers a loss as a result of the principal’s and/or agent’s actions, who is responsible for the loss?
2. Before determining liability, ask why the third party is suing. Was the third party’s loss due to breach of contract or the commission of a tort?
3. Contract liability is based on two issues:
a. What authority did the agent have to enter into the contract with the third party?
b. Was the principal disclosed to the third party?
4. The authority that the agent has depends on from whom the agent received the authority
a. Actual authority comes from the principal
(1) Express actual authority is explicit power that the principal gives to the agent to enter into a contract.
(2) Implied actual authority arises from express authority.
EXAMPLE
King owns several hardware stores and hires Smith to manage one of the stores. King tells Smith that Smith is in charge of the personnel at his store, but that King is the exclusive purchaser of inventory for sale.
Analysis: Smith has express authority to hire/fire employees for the store he manages. Smith has implied authority to enter into contracts that a manager would normally have in this situation, such as selling merchandise. That is an example of implied authority. Smith has no actual authority to buy inventory for the store.
b. Apparent authority comes from a third party’s reasonable, but mistaken, belief that the agent has actual authority to enter into the contract.
(1) Apparent authority occurs where the principal’s words, actions, lack of words, or lack of action allows a reasonable third party to believe that the agent has actual authority to enter into a contract for the principal.
(2) Focus on whether the third party’s belief is reasonable.
EXAMPLE
King owns several hardware stores and hires Smith to manage one of the stores. King gives Smith authority to purchase up to $500 of inventory for the store. King never informed the companies that sold to the store of the dollar limit on Smith’s authority. Over several years Smith has made several purchases of Abbot deck stain to resell at the store. While the purchases were always for several hundred dollars, none of the purchases exceeded $500. King always paid Abbot when he was billed. Recently, Smith made a purchase for $600 of Abbot deck stain.
Analysis: Even though Smith did not have actual authority to purchase more than $500 of deck stain, Smith is cloaked with apparent authority. King’s failure to inform Abbot of the limitation and the fact that King has approved of similar past purchases allows Abbot to reasonably believe that Smith has authority.
EXAMPLE
Marcus put up a sign outside of Paula’s restaurant that says, “Valet parking for Paula’s $10.00.” Paula’s never hired Marcus or asked Marcus to do this, but Paula knew that parking was a problem, so she decided not to say anything. Third parties (customers in this case) can reasonably believe that Marcus is Paula’s agent, creating agency by estoppel.
Analysis: Even though Marcus is not an agent, third parties can reasonably assume that Marcus is an agent and therefore has authority to park cars as well; this is apparent authority.
c. No authority occurs where the agent has neither actual nor apparent authority
5. Disclosure of the principal to the third party
a. Disclosed principal occurs when the third party knows of the existence of the principal and knows the identity of the principal
b. Partially disclosed principal occurs when the third party knows of the existence of the principal, but does not know the identity of the principal
c. Undisclosed principal is when the third party does not know of the existence of the principal.
6. Principal’s contract liability to third parties
a. If agent acts with authority, either actual or apparent, the principal is liable, regardless of disclosure status.
b. If agent acts with no authority, then the principal is not liable, unless the principal ratifies the contract
(1) Ratification occurs when a principal chooses to be bound by the terms of an unauthorized contract. Ratification is valid when all of the following are true:
(a) Third party knew of the principal’s existence at the time the contract was entered into
(b) The principal has knowledge of all the material facts of the contract
(c) Third party does not withdraw from contract prior to ratification
(2) Ratification must be for the entire contract (i.e., the principal cannot choose to be bound by just part of the contract). Therefore ratification cannot occur when the principal is undisclosed since the third party was unaware of the existence of the principal.
(3) Ratification can be explicit or implied from the principal’s actions
7. Agent’s contract liability to third parties
a. If the principal is disclosed and agent has authority, either actual or apparent, agent has no liability.
b. If the principal is partially disclosed or undisclosed, the principal is personally liable, regardless of authority.
c. If the agent acts without authority, then the agent is personally liable.
(1) Exception: If the principal ratifies the contract, the agent is relieved of personal liability
8. Tort liability arises when the conduct of the agent creates a loss for third party.
9. Torts can arise from
a. Careless conduct or negligence, or
b. Purposeful conduct: Intentional tort
10. The agent is always personally liable for the tort
11. The principal’s liability for the agent’s tort depends upon whether the agent’s tort was committed in the scope of employment.
12. If the agent’s tort occurred in the scope of employment, then the principal is liable for the tort under the doctrine of respondeat superior
13. Scope of employment means that the agent is engaged in the performance of the agency relationship
a. Generally, if the tort occurs during working hours, at the workplace, while doing the tasks that the agent is employed to perform, then the tort is in the scope of employment.
b. Torts that occur slightly outside the work environment are still considered in the scope of employment; these are known as detours.
c. Torts that occur substantially outside the work environment are still considered outside the scope of employment; these are known as frolics.
EXAMPLE
Valdez, an employee of Cocoa Corp., is, is having a cup of coffee at work. Juan accidently spills some coffee on a client during a business meeting. Juan’s tort is clearly in the scope of employment. Therefore, Juan and/or Cocoa Corp. may be held liable for the damages the client suffered.
EXAMPLE
Juan Valdez is having a business meeting at Cocoa Corp.’s, his employer’s, office with a client who is from a foreign country. After the meeting concludes, the client expresses concern about being able to tell the cab driver his next destination. Juan grabs a cup of coffee and escorts the client out of the building to hail a cab and assist the client with the cab driver. While hailing the cab, Juan inadvertently spills coffee on the client. This is a mere detour and Juan’s tort would be in the scope of employment. Juan and/or Cocoa Corp. may be held liable for the damages the client suffered.
EXAMPLE
After work, Juan Valdez, stops in the Beanery Café to grab a cup of coffee. Juan happens to see a client sitting at another table and goes over to say hello. Juan then accidently spills the coffee on the client. This is a frolic. Juan has left the workplace and he is on personal time. This was not a business meeting, just a casual or social occurrence. Juan is outside the scope of employment. Only Juan is liable for the damages the client suffered.
d. The issue is not whether the principal authorized the particular activity that the employee engaged in; rather does the agent’s activity fall within the scope of employment.
EXAMPLE
Assume in the previous example, where Juan escorted the client out of the building, that the employer has a policy that employees cannot leave the office building without permission during working hours. Juan will still be considered in the scope of employment because his actions were related to work and Juan is furthering the interests of the principal by assisting a client.
14. Intentional torts are normally outside the scope of employment.
EXAMPLE
If, in any of the previous examples, Juan purposefully dumped coffee on the client, then Juan’s tort is outside the scope of employment. Only Juan would be liable for the damages.
a. Most intentional torts are also crimes.
b. Intentional torts which are foreseeable and relate to the job are normally in the scope of employment.
EXAMPLE
A bouncer at a bar pushes an unruly patron in an attempt to get the patron off the premises. This intentional tort, battery, is in the scope of employment. The bouncer and/or the bar can be held liable for any damages
c. Intentional torts committed to primarily benefit the principal are usually in the scope of employment.
15. If an agent commits a tort in the scope of employment, then the principal and agent are jointly and severally liable.
a. Joint liability means that the injured third party can sue both the principal and the agent in the same lawsuit
b. Several liability means to separate liability; thus the injured third party could choose just to sue the principal or just to sue the agent.
NOW REVIEW MULTIPLE-CHOICE QUESTIONS 1 THROUGH 24

F. Termination of Principal-Agent Relationship

1. Termination occurs either by the actions of the parties (principal and/or agent) or by operation of law.
2. Acts of the parties
a. By agreement
(1) Time specified in original agreement (e.g., agency for one year)
(2) Mutual consent to terminate
(3) Accomplishment of objective (e.g., agency to buy a piece of land)
b. Principal or agent may terminate agency
(1) Party that terminates is liable for breach of contract if termination is before specified period of time
(a) One still has power to terminate relationship even though s/he has no right to terminate (i.e., results in breach of contract)
EXAMPLE
A and P agree to be agent and principal for six months. P terminates A after two months. P is liable to A for breach of contract for the damages that this wrongful termination causes A. However, P does have the power to remove A’s authority to act on behalf of P.
(2) If either party breaches duties owed, other party may terminate agency without liability
(3) If no time is specified in agency, then either party may terminate without liability
c. Agency coupled with an interest is irrevocable
(1) Refers to cases in which agent has actual interest in property involved in this agency, see B.3.h. of this outline.
3. Termination by operation of law: The law automatically ends the principal-agent relationship
a. If subject of agreement becomes illegal or impossible
b. Death, insanity, or court determined incompetence of either party
(1) Exception is an agency coupled with an interest
c. Bankruptcy of principal terminates the relationship
(1) Bankruptcy of agent does not affect unless agent’s solvency is needed for performance
d. If subject matter necessary for the performance of the relationship is destroyed
4. Notice of termination to third parties
a. Termination eliminates any actual authority that the agent had.
b. Apparent authority could still exist, if third parties are unaware that the principal-agent relationship was terminated.
c. To eliminate apparent authority, notice of the termination must be provided to third parties.
(1) Constructive notice (e.g., publishing in a newspaper or a trade journal) is sufficient to third parties who have not previously dealt with agent
EXAMPLE
P fired A, who had been P’s agent for a few years. P published in the newspaper that A was no longer his agent. A subsequently made a contract with X purporting to bind P to the contract. X had never dealt with P and A before but was aware that A had been P’s agent. X was not aware that A had been fired because he had not read the notice. X cannot hold P to the contract because of the constructive notice. X does not have to read it for the constructive notice to be valid.
(2) Actual notice (e.g., orally informing or sending a letter, etc.) must be given to third parties who have previously dealt with agent unless third party learns of termination from another source
EXAMPLE
A, while acting as an agent of P, had previous dealings with T. P fires A but A makes a contract with T purporting to act as P’s agent. T can still hold P liable unless he received actual notice of termination.
EXAMPLE
Same as above except that the principal gave constructive notice. T may hold P liable.
EXAMPLE
Same as above except that although P only gave constructive notice through a trade journal, T happened to read it. This qualifies as actual notice. Therefore, unlike above, T may not hold P liable.
d. Notice is not required when termination occurs due to operation of law
EXAMPLE
A, while acting as an agent of P, had previous dealings with T. P is declared incompetent in a judicial proceeding and T is unaware of P’s incapacity. No notice was given of P’s incapacity. T may not hold P liable on the contract. The moment P was declared incompetent the agency terminated due to operation of law. At that moment, A lost all authority, including apparent authority.
NOW REVIEW MULTIPLE-CHOICE QUESTIONS 25 THROUGH 27

KEY TERMS

Actual authority. The power given by a principal to an agent that allows the agent to enter into contracts upon the principal’s behalf.

Agent. A party who works on behalf of another party known as the principal.

Apparent authority. When a third party reasonably believes that an agent has actual authority even though the agent lacks actual authority.

Disclosed principal. A principal who is known by the third party.

Fiduciary duties. The obligations that an agent owes to a principal that require the agent to act in the best interests of the principal.

Independent contractor. A party who works for another party, but is not subject to the control of the other party; therefore an independent contractor generally does not create liability for the other party.

Joint and several liability. When a principal and agent can both be held liable by the third party or the third party may choose to sever liability and only hold either the principal or the agent liable.

Partially disclosed principal. When the third party knows of the existence of the principal, but does not know the principal’s identity.

Principal. The party for whom the agent acts.

Ratification. When a principal approves of a contract that was entered into by an agent lacking authority. Ratification means that the principal is now liable for the contract.

Respondeat superior (Latin). Literally means that the superior should be held responsible. When an agent commits a tort in the scope of employment, then the principal is liable for the agent’s tort.

Scope of employment. Agent’s actions that occur substantially in the work environment.

Third party. Term in principal/agent law that applies to a party who is interacting with either the principal or the agent. The principal and agent are the first two parties.

Undisclosed principal. When the third party to a contract does not know that a principal exists.

Multiple-Choice Questions (1–27)

A. Characteristics

1. Noll gives Carr a written power of attorney. Which of the following statements is correct regarding this power of attorney?

a. It must be signed by both Noll and Carr.

b. It must be for a definite period of time.

c. It may continue in existence after Noll’s death.

d. It may limit Carr’s authority to specific transactions.

2. A principal and agent relationship requires a

a. Written agreement.

b. Power of attorney.

c. Meeting of the minds and consent to act.

d. Specified consideration.

3. Lee repairs high-speed looms for Sew Corp., a clothing manufacturer. Which of the following circumstances best indicates that Lee is an employee of Sew and not an independent contractor?

a. Lee’s work is not supervised by Sew personnel.

b. Lee’s tools are owned by Lee.

c. Lee is paid weekly by Sew.

d. Lee’s work requires a high degree of technical skill.

4. Generally, a disclosed principal will be liable to third parties for its agent’s unauthorized misrepresentations if the agent is an

Employee Independent Contractor
a. Yes Yes
b. Yes No
c. No Yes
d. No No

5. Which of the following terms best describes the relationship between a corporation and the CPA it hires to audit corporate books?

a. Employer and employee.

b. Employer and independent contractor.

c. Master and servant.

d. Employer and principal.

6. Harris, while delivering parts to a customer for his employer, negligently ran into and injured Wolfe. Harris had been asked by his employer to make these deliveries even though Harris was using his personal pickup truck. Neither Harris nor the employer had insurance to cover this injury. Which of the following is correct?

a. Wolfe can hold Harris liable but not the employer because Harris was driving his own vehicle.

b. Wolfe can hold the employer liable but not Harris because the employer had asked Harris to make the deliveries.

c. Wolfe can hold either Harris or the employer or both liable.

d. Wolfe can hold either Harris or the employer liable but not both.

7. Chiron employed Sherwin as a mechanic. Chiron has various rules that all employed mechanics must follow. One day a customer was injured severely when her car’s brakes failed. It was shown that her car’s brakes failed because Sherwin did not follow one of the specific rules of Chiron. Which of the following is correct?

a. Sherwin is liable to the customer but Chiron is not because the accident was caused by Sherwin breaking one of Chiron’s specific rules.

b. The customer should sue Sherwin for fraud, not negligence, because Sherwin broke a rule of the employer.

c. The customer can hold Chiron liable but not Sherwin, because her contract to get the car repaired was with Chiron.

d. The customer may choose to recover damages from both Chiron and Sherwin.

8. Pine, an employee of Global Messenger Co., was hired to deliver highly secret corporate documents for Global’s clients throughout the world. Unknown to Global, Pine carried a concealed pistol. While Pine was making a delivery, he suspected an attempt was being made to steal the package, drew his gun and shot Kent, an innocent passerby. Kent will not recover damages from Global if

a. Global discovered that Pine carried a weapon and did nothing about it.

b. Global instructed its messengers not to carry weapons.

c. Pine was correct and an attempt was being made to steal the package.

d. Pine’s weapon was unlicensed and illegal.

9. When an agent acts for an undisclosed principal, the principal will not be liable to third parties if the

a. Principal ratifies a contract entered into by the agent.

b. Agent acts within an implied grant of authority.

c. Agent acts outside the grant of actual authority.

d. Principal seeks to conceal the agency relationship.

10. Trent was retained, in writing, to act as Post’s agent for the sale of Post’s memorabilia collection. Which of the following statements is correct?

I. To be an agent, Trent must be at least twenty-one years of age.

II. Post would be liable to Trent if the collection was destroyed before Trent found a purchaser.

a. I only.

b. II only.

c. Both I and II.

d. Neither I nor II.

11. Blue, a used car dealer, appointed Gage as an agent to sell Blue’s cars. Gage was authorized by Blue to appoint subagents to assist in the sale of the cars. Vond was appointed as a subagent. To whom does Vond owe a fiduciary duty?

a. Gage only.

b. Blue only.

c. Both Blue and Gage.

d. Neither Blue nor Gage.

12. Which of the following under agency law is not a type of authority that an agent might have?

a. Actual express.

b. Actual implied.

c. Resulting.

d. Apparent.

13. Which of the following actions requires an agent for a corporation to have a written agency agreement?

a. Purchasing office supplies for the principal’s business.

b. Purchasing an interest in undeveloped land for the principal.

c. Hiring an independent general contractor to renovate the principal’s office building.

d. Retaining an attorney to collect a business debt owed the principal.

14. Frost’s accountant and business manager has the authority to

a. Mortgage Frost’s business property.

b. Obtain bank loans for Frost.

c. Insure Frost’s property against fire loss.

d. Sell Frost’s business.

15. Ames, claiming to be an agent of Clar Corporation, makes a contract with Trimon in the name of Clar Corporation. Later, Clar Corporation, for the first time, learns what Ames has done and notifies Trimon of the truth that Ames was not an agent of Clar Corporation. Which of the following statements is incorrect?

a. Clar Corporation may ratify this contract if it does so with the entire contract.

b. Trimon may withdraw from the contract before Clar attempts to ratify it.

c. Clar Corporation may ratify this contract by performing under the contract without stating that it is ratifying.

d. Trimon may enforce this contract even if Clar Corporation does not wish to be bound.

16. Which of the following generally may ratify a contract that was agreed to by his/her agent without authority from the principal?

image

17. Beele authorized McDonald to be his agent to go to Denver and purchase some real estate that would be suitable to open up a branch office for Beele’s business. He tells McDonald not to pay more than $125,000 for the real estate. McDonald contacts York to buy some real estate she owns. York calls Beele and Beele tells York that McDonald is his agent to buy the real estate. Nothing is mentioned about the $125,000 limitation. After negotiations between McDonald and York, McDonald signs a contract purchasing the real estate for $140,000. McDonald signed it indicating on the contract that he was signing as agent for Beele.

Further facts show that the real estate is worth $140,000. Which of the following is correct?

a. There is a fully enforceable contract between Beele and York for $140,000.

b. Beele may enforce the contract with York for $125,000.

c. There is no contract between Beele and York because McDonald did not have authority to purchase the real estate for $140,000.

d. York may require that Beele pay $140,000 because the real estate was worth $140,000 not $125,000.

18. Young Corp. hired Wilson as a sales representative for six months at a salary of $5,000 per month plus 6% of sales. Which of the following statements is correct?

a. Young does not have the power to dismiss Wilson during the six-month period without cause.

b. Wilson is obligated to act solely in Young’s interest in matters concerning Young’s business.

c. The agreement between Young and Wilson is not enforceable unless it is in writing and signed by Wilson.

d. The agreement between Young and Wilson formed an agency coupled with an interest.

19. Which of the following statement(s) concerning agency law is (are) true?

I. A contract is needed to have an agency relationship.

II. The agent owes a fiduciary duty to the principal.

III. The principal owes a fiduciary duty to the agent.

a. I and II only.

b. I and III only.

c. II only.

d. I, II, and III.

E. Liability to Third Parties

20. Easy Corp. is a real estate developer and regularly engages real estate brokers to act on its behalf in acquiring parcels of land. The brokers are authorized to enter into such contracts, but are instructed to do so in their own names without disclosing Easy’s identity or relationship to the transaction. If a broker enters into a contract with a seller on Easy’s behalf,

a. The broker will have the same actual authority as if Easy’s identity has been disclosed.

b. Easy will be bound by the contract because of the broker’s apparent authority.

c. Easy will not be liable for any negligent acts committed by the broker while acting on Easy’s behalf.

d. The broker will not be personally bound by the contract because the broker has express authority to act.

21. An agent will usually be liable under a contract made with a third party when the agent is acting on behalf of a(n)

Disclosed principal Undisclosed principal
a. Yes Yes
b. Yes No
c. No Yes
d. No No

22. When a valid contract is entered into by an agent on the principal’s behalf, in a nondisclosed principal situation, which of the following statements concerning the principal’s liability is correct?

The principal may be held liable once disclosed The principal must ratify the contract to be held liable
a. Yes Yes
b. Yes No
c. No Yes
d. No No

23. Which of the following rights will a third party be entitled to after validly contracting with an agent representing an undisclosed principal?

a. Disclosure of the principal by the agent.

b. Ratification of the contract by the principal.

c. Performance of the contract by the agent.

d. Election to void the contract after disclosure of the principal.

24. Able, as agent for Baker, an undisclosed principal, contracted with Safe to purchase an antique car. In payment, Able issued his personal check to Safe. Able could not cover the check but expected Baker to give him cash to deposit before the check was presented for payment. Baker did not do so and the check was dishonored. Baker’s identity became known to Safe. Safe may not recover from

a. Baker individually on the contract.

b. Able individually on the contract.

c. Baker individually on the check.

d. Able individually on the check.

F. Termination of Principal-Agent Relationship

25. Thorp was a purchasing agent for Ogden, a sole proprietor, and had the express authority to place purchase orders with Ogden’s suppliers. Thorp placed an order with Datz, Inc. on Ogden’s behalf after Ogden was declared incompetent in a judicial proceeding. Thorp was aware of Ogden’s incapacity. Which of the following statements is correct concerning Ogden’s liability to Datz?

a. Ogden will be liable because Datz was not informed of Ogden’s incapacity.

b. Ogden will be liable because Thorp acted with express authority.

c. Ogden will not be liable because Thorp’s agency ended when Ogden was declared incompetent.

d. Ogden will not be liable because Ogden was a nondisclosed principal.

26. Generally, an agency relationship is terminated by operation of law in all of the following situations except the

a. Principal’s death.

b. Principal’s incapacity.

c. Agent’s renunciation of the agency.

d. Agent’s failure to acquire a necessary business license.

27. Bolt Corp. dismissed Ace as its general sales agent and notified all of Ace’s known customers by letter. Young Corp., a retail outlet located outside of Ace’s previously assigned sales territory, had never dealt with Ace. Young knew of Ace as a result of various business contacts. After his dismissal, Ace sold Young goods, to be delivered by Bolt, and received from Young a cash deposit for 20% of the purchase price. It was not unusual for an agent in Ace’s previous position to receive cash deposits. In an action by Young against Bolt on the sales contract, Young will

a. Lose, because Ace lacked any implied authority to make the contract.

b. Lose, because Ace lacked any express authority to make the contract.

c. Win, because Bolt’s notice was inadequate to terminate Ace’s apparent authority.

d. Win, because a principal is an insurer of an agent’s acts.

Multiple-Choice Answers and Explanations

Answers

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Explanations

1. (d) A power of attorney is written authority conferred to an agent. It is conferred in a formal writing. A power of attorney can be general or it can grant the agent only restricted authority. Answer (a) is incorrect because the power of attorney must be signed only by the person granting such authority. Answer (b) is incorrect because the power of attorney does not have to be for a definite, specified time period. Answer (c) is incorrect because the death of the principal constitutes the termination of an agency relationship by operation of law.

2. (c) The relationship between a principal and agent is based upon the consent of both parties, also involving a meeting of the minds. Answer (d) is incorrect because specified consideration is not needed to create an agency relationship; the relationship between the principal and the agent need not be contractual. Answer (a) is incorrect because although the principal and agent relationship may be written, a written agreement is not required. Answer (b) is incorrect because power of attorney is not needed to create an agency relationship.

3. (c) An employee is generally subject to control as to the methods used to complete the work. An independent contractor is typically paid for the completion of the project rather than on an hourly, weekly, or monthly basis. Answer (a) is incorrect because supervision by Sew Corp. personnel shows an employment relationship. Answer (b) is incorrect because independent contractors typically provide their own tools. Answer (d) is incorrect because the work of both employees and independent contractors can require a high degree of skill.

4. (b) Generally, principals are liable for the unauthorized misrepresentations of employees because the employees are subject to the control or supervision of the principal. Principals are not responsible for the misrepresentations of an independent contractor since the principal does not control the independent contractor’s actions.

5. (b) The main factors that are used to determine whether a party is an independent contractor or an agents are the amount of control that the principal exercises over the party; an auditor is not subject to the control of the corporation. The auditor is probably paid by the job; this is another characteristic of an independent contractor relationship. Besides the legal reasoning provided above, answers (a) and (c) are virtually the same, and they cannot both be correct. Answer (d) does not make sense since an employer and a principal are the same entity.

6. (c) Since Harris was acting within the scope of his employment when he negligently injured Wolfe, both Harris and his employer are liable. Wolfe can recover from either one or both. Answer (a) is incorrect because both are liable since Harris was acting within the scope of the employment. The ownership of the vehicle does not change this. Answer (b) is incorrect because Harris is liable for his own tort even though the employer can also be held liable. Answer (d) is incorrect because Wolfe may recover the full damages from either or may recover a portion of the damages from both.

7. (d) Because the repairs Sherwin did were within the scope of the employment, the employer is also liable. This is true even if the employer was diligent in creating excellent rules that were not followed by an employee. Answer (a) is incorrect because the failure to properly repair the vehicle is a negligent act that was in the scope of employment. In such situations, both the principal and agent can be held liable. Answer (b) is incorrect because there was no fraud present here. Fraud requires an intentional misrepresentation of material facts. There is no evidence of such conduct present here. Answer (c) is incorrect because the customer may recover from both under tort law. Additionally, the contract has no bearing on a matter involving a tort.

8. (d) In general, the employer is not responsible for the crimes of the employee unless the employer aided or permitted the illegal activity, even if the activity was within the scope of the employment. Answer (a) is incorrect because if the employer did nothing to instruct the employee about the use of the weapon, this could help establish negligence on the part of the employer and would not prevent the use of the doctrine of respondeat superior, which makes employers liable for the tortious acts of their employees within the scope of the employment. Answer (b) is incorrect because the employer is liable for torts of the employee committed within the course and scope of the employment even if the employee was violating the employer’s instructions. Answer (c) is incorrect because even if the employee’s suspicions were correct, the shooting of an innocent passerby should establish at least negligence for which the employer and the employee are liable.

9. (c) A principal, whether disclosed, partially disclosed, or undisclosed is liable on contracts where the agent has actual or apparent authority, or where the principal ratifies an agent’s contract. Actual authority includes express or implied authority projected by the principal to the agent. Apparent authority of an agent is authority perceived by a third party based on the principal’s representations. Therefore, apparent authority can exist only where there is a disclosed or a partially disclosed principal. It follows, then, that an undisclosed principal will not be liable to third parties if the agent acts outside the grant of actual authority. Answer (a) is incorrect because when a principal ratifies a contract it is liable for the terms of the contract. Answer (b) is incorrect because when agents act with any type of authority, then the principal is liable. Answer (d) is incorrect because whether the principal tried to hide the agency relationship is irrelevant to determine the principal’s liability. The critical issue is did the agent act with some type of authority.

10. (d) An agent must merely have sufficient mental and physical ability to carry out instructions of his/her principal. An agent can bind the principal even if the agent is a minor. If the memorabilia collection was destroyed before Trent found a purchaser, Post would not be liable to Trent. Upon the loss or destruction of the subject matter on which the agency relationship is based, the agency relationship is terminated.

11. (c) The fiduciary duty is an important duty owed by agents to their principals. Gage as Blue’s agent was authorized by Blue to appoint subagents to assist in the sales transactions. Since Gage did appoint Vond as a subagent, legally Bond is an agent both of Blue and Gage. Therefore, Vond owes a fiduciary duty to both Blue and Gage making (a), (b), and (d) all incorrect.

12. (c) Resulting authority is not one of the types of authority that an agent might have. Answer (a) is not chosen because actual express authority is a common type of authority and consists of all authority expressly given by the principal to his/her agent. Answer (b) includes the authority that can be reasonably implied from the express authority and the conduct of the principal. Answer (d) is not chosen because even though a party was never authorized by a principal to be an agent, if the principal leads a third party to believe that the party did have authority, this is apparent agency.

13. (b) An agency agreement normally does not need to be in writing. Exceptions to this general rule include agency contracts that cannot be completed within one year and agreements whereby the agent is to buy specific real estate for the principal. This question incorporates the latter. Typical agency agreements need not be in writing; these would include purchasing office supplies, retaining an independent contractor to do renovation work, or hiring an attorney to collect a business debt.

14. (c) An agent has implied authority to do what is customary for agents of that type to do under the circumstances. It would be customary for one who is a principal’s accountant and business manager to have authority to insure the principal’s property against fire loss. Answers (a), (b), and (d) are incorrect because they involve authority that is beyond customary, ordinary authority.

15. (d) Since Ames had no express, implied, or actual authority, Trimon cannot enforce the contract. Apparent authority is not present either; there are no facts present to show that Trimon was reasonable to believe Ames’ unsubstantiated claim. Answer (a) is not chosen because ratifications under agency law require that the contract be ratified in its entirety or not at all. Answer (b) is not chosen because until Clar ratifies the contract in its entirety, Trimon may withdraw from the contract since Ames had no authority to make the contract. Answer (c) is not chosen because ratification can be accomplished by actions as well as words.

16. (b) When the third party is aware that there is a principal, that principal, fully disclosed or partially disclosed, may generally ratify the contract when he or she is aware of all material facts and if ratification of the entire contract takes place. Since a third party would not know of the existence of an undisclosed principal, ratification is not possible in that circumstance.

17. (a) Since Beele authorized McDonald to be his agent, the secret limitation has no effect on York. York may enforce the contract for the full $140,000. Answer (b) is incorrect because Beele authorized McDonald to be his agent. Even though his agent was instructed to pay at most $125,000 in the contract, this was a secret limitation that did not limit York who was unaware of it. Answer (c) is incorrect because McDonald was given authority to purchase real estate on Beele’s behalf. The limitation on the dollar amount was not known by York and therefore does not limit her. Answer (d) is incorrect because although York can enforce the contract against Beele, it is because Beele gave authority to McDonald rather than how much the real estate is worth.

18. (b) As a fiduciary to the principal, an agent must act in the best interest of the principal. Therefore, the agent has an obligation to refrain from competing with or acting adversely to the principal, unless the principal knows and approves of such activity. Answer (c) is incorrect because the Statute of Frauds would not require that the described agency relationship be contained in a signed writing since it is possible for the contract to be performed within one year. Answer (d) is incorrect because the mere right of the agent to receive a percentage of proceeds is not sufficient to constitute an agency coupled with an interest. In order to have an agency coupled with an interest, the agent must have either a property interest or a security interest in the subject matter of the agency relationship. Answer (a) is incorrect because in all agency relationships, except agencies coupled with an interest, the principal always has the power to dismiss the agent. However, the principal does not necessarily have the right to terminate the relationship. In certain situations the dismissed agent could sue for breach of contract.

19. (c) In an agency relationship, the agent owes a fiduciary duty to the principal but the principal does not owe a fiduciary duty to the agent. Also, even though there is often a contract between the principal and agent, this is not a requirement, for example, when the agent consents to act for the principal as a friend.

20. (a) When the principal is undisclosed in an agency relationship, the agent generally has the same authority as if the principal were disclosed. The main difference is in the liability of the agent to third parties. Answer (b) is incorrect because the principal is liable on the contract because of the express authority given to the agent to make the contract on behalf of the principal. Apparent authority exists when the principal represents the agent to third parties to be his/her agent. In this case, the principal wished to be undisclosed. Answer (c) is incorrect because principal can be held liable for negligence committed by the agent within the course and scope of the agency. Answer (d) is incorrect because the agent can be held liable on the contract by third parties when the principal is undisclosed.

21. (c) An agent is liable to a third party on a contract when the principal is undisclosed or partially disclosed. If the principal is fully disclosed, the agent is not liable.

22. (b) When an agent enters into a contract with a third person on behalf of an undisclosed principal, the agent is personally liable, unless the third person discovers the existence and identity of the principal and chooses to hold the principal to the contract instead of the agent. Ratification is the approval after the fact of an unauthorized act done by an agent or of an act done by someone who is not yet an agent. Undisclosed principals cannot ratify unauthorized acts of the agent.

23. (c) When a third party contracts with an agent representing an undisclosed principal, the agent is liable for performance of the contract. The third party is not entitled to disclosure of the principal. Answer (b) is incorrect because ratification of a contract by the principal is the approval required after the fact related to an unauthorized act by the agent or one not yet an agent. Answer (d) is incorrect because the third party generally is not allowed the option of voiding the contract after disclosure of the principal.

24. (c) One who issues a personal check is liable on it; however, any party or principal who is not disclosed on the check is not liable on the negotiable instrument. Answers (a) and (b) are incorrect because the third party can elect to hold either the agent or the principal liable when the agent makes a contract for an undisclosed principal. Answer (d) is incorrect because the party who signs a check is liable on it.

25. (c) The declaration of Ogden’s incapacity constitutes the termination of the agency relationship by operation of law. When an agency relationship is terminated by operation of law, the agent’s authority to enter into a binding agreement on behalf of the principal ceases. There is no requirement that notice be given to third parties when the agency relationship is terminated by operation of law. In this case, Ogden will not be liable to Datz because Thorp was without authority to enter into the contract. Answer (a) is incorrect because insanity of the principal terminates the agency relationship even though the third parties are unaware of the principal’s insanity. Answer (b) is incorrect because Thorp’s authority terminated upon the declaration of Ogden’s incapacity. Answer (d) is incorrect because an undisclosed principal is liable unless the third party holds the agent responsible, the agent has fully performed the contract, the undisclosed principal is expressly excluded by contract or the contract is a negotiable instrument. However, Ogden will not be liable as Thorp was without authority to enter into the agreement.

26. (c) An agency relationship is terminated by operation of law if the subject of the agreement becomes illegal or impossible, the principal or the agent dies or becomes insane, or the principal becomes bankrupt. Answers (a), (b), and (d) are incorrect because they will cause the termination of an agency relationship by operation of law. Answer (c), agent’s renunciation of the agency, will not cause the termination of an agency relationship.

27. (c) When the agency relationship is terminated by an act of the principal and/or agent, third parties are entitled to notice of the termination from the principal. Failure of the principal to give the required notice gives the agent apparent authority to act on behalf of the principal. Specifically, the principal must give actual notice to all parties who had prior dealings with the agent or principal. Constructive or public notice must be given to parties who knew of the existence of the agency relationship, but did not actually have business dealings with the agent or principal. Since Bolt Corp. did not give proper constructive notice to Young Corp., Ace had apparent authority to bind the principal and, therefore, Young Corp. will win. Accordingly, answer (a) is incorrect. Answer (b) is incorrect because although Ace lacked express authority, apparent authority was present due to the inadequacy of Bolt’s notice. Answer (d) is incorrect because a principal is not an absolute insurer of his agent’s acts. A principal is liable for his agent’s torts only if the principal expressly authorizes the conduct or the tort is committed within the scope of the agent’s employment.

Simulation

Task-Based Simulation 1

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Situation

Lace Computer Sales Corp. orally contracted with Banks, an independent consultant, for Banks to work part time as Lace’s agent to perform Lace’s customers’ service calls. Banks, a computer programmer and software designer, was authorized to customize Lace’s software to the customers’ needs, on a commission basis, but was specifically told not to sell Lace’s computers.

On March 15, Banks made a service call on Clear Co. to repair Clear’s computer. Banks had previously called on Clear, customized Lace’s software for Clear, and collected cash payments for the work performed. During the call, Banks convinced Clear to buy an upgraded Lace computer for a price much lower than Lace would normally charge. Clear had previously purchased computers from other Lace agents and had made substantial cash down payments to the agents. Clear had no knowledge that the price was lower than normal. Banks received a $1,000 cash down payment and promised to deliver the computer the next week. Banks never turned in the down payment and left town. When Clear called the following week to have the computer delivered, Lace refused to honor Clear’s order.

Items 1 through 5 relate to the relationships between the parties. For each item, select from List I whether only statement I is correct, whether only statement II is correct, whether both statements I and II are correct, or whether neither statement I nor II is correct.

List I
A. I only
B. II only
C. Both I and II
D. Neither I nor II
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Simulation Solution

Task-Based Simulation 1

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Explanations

1. (B) Statement I is incorrect because normally an agency agreement need not be in writing unless the agency contract cannot be completed in one year. Statement II is correct because Lace authorized Banks to be Lace’s agent.

2. (A) Statement I is correct because Banks was given actual, express authority by Lace to perform Lace’s customers’ service calls and to customize Lace’s software to the customer’s needs. As an extension to this actual, express authority, Clear can also rely on what is customary and ordinary for such an agent to be able to do under implied authority. Statement II is incorrect because Banks did not have express authority to sell the computer. In fact, Banks was told not to sell Lace’s computers.

3. (B) Banks breached his/her fiduciary duty to Lace and breached his/her duty to follow instructions when s/he sold the computer. This, however, does not automatically terminate their agreement. Statement II is correct because Banks had dealt with Clear before as Lace’s agent. Therefore, Clear must receive actual notice to terminate the apparent authority.

4. (D) Statement I is incorrect because Banks had apparent authority to sell the computer even though Banks did not have actual authority to do so. Statement II is incorrect because Lace is bound by the contract with Clear. Any modification of the contract must be made by both parties to the contract, not just one.

5. (A) Statement I is correct because since Lace was a disclosed principal, only Lace, the principal, is liable under the contract to Clear, the third party. Banks, the agent, is not. For the same reason, statement II is incorrect.

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