Whether you are aware of it, agency relationships exist all around you. From an employee who acts as an agent for his employer to your mother who acts as your agent when she picks up your dry-cleaning, agents have varying responsibilities and authority.

In this chapter we’ll examine the important role agents play, what distinguishes them from employees, and key steps to protect the principal. No matter what you do in life, you will utilize agents and serve as an agent.

First, let’s look at some key definitions:

The following figure illustrates the basic agency relationship. As shown, the principal authorizes the agent to act on its behalf. The principal could be a business that authorizes an employee to sign a contract. The agent then signs the contract on behalf of the principal. The agent is not a party to the contract. Only the principal and third party are parties.

When the law is concerned about the agency relationship, it usually focuses on the relationship the principal and third party are thrust into by the agent. The agent can obligate the principal by making contracts or acting on the principal’s behalf with third parties.

Confusion often comes in determining whether someone is acting as an employee or an independent contractor. There is a simple test that usually helps determine that status. An employee is directed in his action and efforts by the employer. An independent contractor is hired to do a job, but not told how to do it. Keep in mind that in general, an employee is not authorized to obligate his employer to contracts—unless he has specific authority to do that.

For example, an employee who works for a company may be sent to a foreign country to enter into negotiations with the government there because of special language skills he has. In general, this employee has no authority to commit his employer to a contract. However, in this instance he does for the specific intent of contracting with this government. Once that purpose is accomplished, he no longer has authority to enter contracts. And he never has authority to enter alternative contracts.

In contrast, an independent contractor is bound by contract to produce a certain result. But the actual performance of how that result is achieved is left to the discretion of the independent contractor.

Let’s say Marcia wants to build a house. She could hire an independent contractor to serve as the general contractor for the home. Marcia knows she needs an electrician, plumber, drywaller, and so on, but she expects the general contractor to hire the right firms at the right time to complete construction. She does not tell him how and when to do it, but hires him for his expertise.

In its simplest form an agent is one who is authorized to act on behalf of another. But, as with many things in the law, there are multiple subsets of agents. Those include …

There are four basic ways to create an agency relationship: appointment, conduct, ratification, and operation of law. Let’s take a closer look at each.

Agency by appointment usually involves an express appointment. That means the principal expressly authorizes the agent to act in a specific manner for the principal. Most often, the principal gives the agent oral authorization. If the authority is in writing, it is called a power of attorney, and the agent is called an agent in fact.

Agency by conduct develops when a third party is led to believe the agent has authority to act based on the actions of the principal. This form of authority is also called apparent authority. The principal can’t contradict the appearance of authority it created. For there to be apparent authority, the third party must “reasonably” believe that such authority actually exists.

For example, if a principal has allowed an agent to sign contracts for services with a third party for months and has honored each of those contracts, it cannot suddenly stop honoring those contracts without advance notice to the third party.

If an agent acts in a way that he is not authorized to, the principal can choose to ratify the agent’s action and follow through on the contract. Or he can deny the contract. But once the principal takes steps to fulfill the unauthorized contract, he can’t later change his mind.

In addition to an intent to ratify, these three elements must be present on the part of the principal:

Once a principal has ratified an authorized act, it’s as if the agent had the authority to act from the beginning.

In the case of each type of agency, the third party is the person with the burden to show the agent was in fact an agent.

In rare instances the law may enforce an agency relationship. This usually occurs if there is an emergency and the agent must act without first receiving approval. For example, if an employee hits a motorist with a company truck, the employee can contact 911 without permission of the employer.

The fact that someone is an agent with authority is the first step in the analysis. The courts will look at the express words of the principal or what its words and conduct imply when determining the scope of the agent’s authority:

Express authority is given orally or in writing to do a specific task.

Incidental authority is the authority to perform any reasonable act necessary to execute the express authority given to the agent. For example, if an agent is authorized to hire someone, he is also authorized to take any steps necessary to complete the employment process.

Customary authority is the authority to do anything that is customary in the community to complete the authorized act. For example, if the agent is authorized to sign a contract, then he is authorized to make arrangements for payment.

Apparent authority is the authority an agent has when the principal’s act or words lead a third party to believe that the authority exists. Thus, it is critical for principals to clear up any misconceptions immediately.

When an agent acts within its authority to enter a contract, the principal is bound by that contract. If for any reason, the principal fails to honor the contract, the third party can seek to have it enforced in court.

If the agent does not have authority to act, the court will place the burden to determine the level of authority on the third party. Thus, if the agent had no authority and the third party had no reasonable belief that the agent had authority, the alleged contract will be voided. The courts will also require a third party to exercise due diligence to ensure that he or she contracted with an authorized party. Third parties must also discover the limits of the agent’s authority.

Finally, if the agent is acting in a manner adverse to the principal, the third party is on notice that there are problems with the agency. The best way for a third party to determine the authority of the agent is to ask the principal. Once the principal admits there is authority, she can’t change her mind.

During the agency relationship, the agent and principal owe certain duties to each other. These duties provide limitations on how the agent can act while in that role.

While the agent is acting on behalf of the principal, he has certain duties to the principal. Those include …

♦ Loyalty. An agent must act for the best interests of the principal. The agent also may not act for his or her secret benefit. While an agent for the principal, the agent must put the principal’s interests first. For example, the agent cannot sell property he or she owns to the principal without disclosing that he or she owns the property.

An agent cannot act for both parties to a transaction unless both know of the relationships and agree. Think of a real-estate transaction. The realtor cannot represent both the buyer and seller unless both parties know and agree to the dual representation. Otherwise, a conflict of interest will be assumed. An agent cannot accept secret commissions or gifts from third persons because of his role as agent. An agent also cannot knowingly deceive the principal or aid the principal’s competitors.

♦ Obedience and performance. An agent has a duty to obey all lawful instructions. Lawful is the key here. If the principal asks the agent to act in a way that is against the law, the agent can refuse. Otherwise, the principal can expect the agent to obey and perform as instructed. If the agent doesn’t, the agent is liable to the principal for failing to obey and perform its responsibilities.

♦ Reasonable care. An agent must use the care a reasonable person would use. If the agent fails to, the agent is liable to the principal for any damages. The agent must utilize any special skills he has on behalf of his principal. “Reasonable care” in this instance is similar to the standard for torts as discussed in Chapter 25.

♦ Accounting. An agent must account to the principal for all property or money the principal entrusts to her. Toward this end, the agent must keep the principal’s money separate from her own. This is why attorneys are required to have trust accounts for client funds and not intermingle client funds with firm assets.

♦ Information. An agent must keep the principal informed of all facts related to the agency.

The duties and liabilities of the agent continue after the termination of the agency. At that point the agent continues to owe a duty until he has completed the tasks he was assigned during the agency.

The principal also owes duties to the agent. Those include …

♦ Honoring any employment contract. If there is a contract, the agent is allowed to work for the principal for the duration of the contract terms. The only exception occurs if the contract provides an early termination procedure.

♦ Compensation. The agent is entitled to payment for the services rendered. This amount can either be set in a written contract or determined by the reasonable value of the services. There are two variations on compensation:

An agency relationship can be terminated in many ways. The two primary ways are by act of the parties and operation of law.

Usually, either party can terminate the agency relationship at any time. However, if there is a written contract between the agent and principal, the terms of that contract will govern how the agency can be terminated.

The agency relationship can be terminated by law if any of the following happens to either the agent or principal: death, insanity, bankruptcy, or impossibility of performance of the agency. An agent can also be released if war erupts between the countries of the agent and principal.

If there is an agency relationship, the question turns to who is liable to a third party if the relationship between the third party and the principal sours. The answer, as with many things in the law, is “it depends.” It depends on whether the third party knows the principal and whether the principal authorized the agent’s action.

Let’s explore the nuances of liability.

If the agent acts within his or her authority, the third party knows who the principal is, and the contract is ratified, the agent will not be liable for the contract. Remember, authorized agency actions can include those that were originally unauthorized, but the principal chose to ratify anyway.

However, if the agent acts outside his or her authority and that action is not ratified by the principal, the agent is liable to the third party. The third party can then proceed against the agent for any losses she has suffered. An agent who acts beyond the scope of his or her authority is always treading in dangerous waters.

An agent’s liability also depends on the amount of disclosure regarding the principal:

Regardless of whether the principal is disclosed, the agent can choose to assume liability on a contract. The easiest way to think of this is when the principal is from outside the area and the agent is a broker or other agent from the local area. If the third party expresses concern about being paid by the principal, and the agent says “Don’t worry about it,” the agent has assumed liability for payment.

If an agent commits a tort, a civil wrong that harms another, while in his agency role, that agent is still liable for his negligence. For example, if Bob is a driver for a company and is involved in a car accident, he can be sued for his negligence that led to the accident. The same holds true if the agent commits a crime. He will be responsible personally for that criminal act. (See Chapter 25 for more on torts.)

The principal is always liable for properly executed and authorized contracts made between an agent and third party. The question comes when the agent acts without authorization.

If the principal is disclosed, the principal is liable on the contract. If the principal is partially disclosed, the third party can sue either the agent or the principal if the agent acted with authorization. If the principal is undisclosed but the agent is authorized, the principal is liable on the contract. Again, the third party can sue either the principal or agent. In this last case, the agent and principal share joint and several liability once the third party learns of the undisclosed principal.

If the third party has made a payment to the agent for a debt owed to the principal, that payment is deemed made to the principal. It is the responsibility of the principal to collect payment from his or her agent.

A principal is also bound by statements made by the agent to the third party on his or her behalf. It doesn’t matter that the agent misspoke or had bad information. The third party can rely on the information.

A principal is deemed to know whatever information the agent has. So, for example, if an agent enters a contract to buy a retail location knowing there is mold on the premises, the principal is deemed to know that fact and cannot void the contract later based on the mold.

The principal may be held liable for the torts or crimes of the agent if certain criteria are met. The innocent employer or principal is guilty of the agent’s or employee’s wrongdoing under vicarious liability or the doctrine of respondeat superior.

The theory is that the business should pay for the harm caused by its agents or employees in the course of conducting business. The hope is the employer or principal will be more careful when it hires employees in the future and will maintain the necessary liability insurance for its protection. Generally, these theories apply when an agent was negligent, committed an intentional tort, engaged in a fraudulent act, or violated a government regulation during the course of their employment or agency.

The principal can also be liable if a court determines it negligently hired or retained employees. This is raised when the third party believes the employer should have known the employee would be incompetent, violent, dangerous, or criminal. This is why many employers now require background checks before completing the hiring process. All the third party needs to show to prevail is that the employer knew, or would have known if he or she had exercised ordinary care, that the applicant would create a risk of harm to others in the job. The employer must have also been able to foresee the injury to the third party.

For example, if the employer learns through a background check the potential employee has a violent drinking problem, it may be reasonably foreseeable that the employee would assault a customer at some point in the future. Conducting checks on the potential hire’s work experience, background, character, and qualifications can provide protection to the employer. The fact that the potential employee has a criminal background is not sufficient on its own to create the tort of negligent hiring.

Negligent retention is similar to negligent hiring. For negligent retention, the third party must show the principal continued to employ the agent once it knew of the problems with that agent.

Negligent supervision and training alleges that the principal did not properly train or oversee the agent/employee.

Usually, a principal is only liable for the crimes of the agent that occur at its direction. If the principal is an owner who has employed an independent contractor, the principal is generally not liable for contracts signed by the independent contractor, torts of the employees of the independent contractor, or damage caused by the independent contractor. An exception occurs when the work the independent contractor engages in is inherently dangerous or the independent contractor is not disclosed. For example, if James hires an independent contractor to demolish with dynamite a building he owns, James will be liable for any damage. If the independent contractor is undisclosed, James is liable for the torts and contracts.