Law 2 - Business Law
Chp. 34 - Liability to Third Parties

Lecture Notes

The key points in this chapter include:

1. The scope of an agent’s authority.

2. The liability of a principal and an agent for
contracts with third parties.

3. A principal’s and an agent’s liability for the
agent’s torts.

4. The doctrine of respondeat superior.

5. Methods by which an agency is terminated.

This chapter deals with the liability of principals and agents to third parties in contract and tort and principals’ liability to third parties for agents’ torts. The chapter concludes with a section on the termination of agency relationships.

I. SCOPE OF AN AGENT’S AUTHORITY

A. EXPRESS AUTHORITY
A principal’s liability in a contract with a third
party arises from the authority given the agent
to enter contracts on the principal’s behalf.

1. Equal Dignity Rule
In most states, if the contract being executed is
or must be in writing, the agent’s authority
must also be in writing.

a. Exception—Executive Officer Doing Ordinary
Business
A corporate executive doing ordinary business
does not need written authority from the
corporation.

b. Exception—Agent Acting in the Presence of the
Principal
In this case, the agent does not need to have
written authority.

2. Power of Attorney
A power of attorney can be special or general.
An ordinary power terminates on the
incapacity or death of the person giving it. A
durable power is not affected by the principal’s
incapacity.

B. IMPLIED AUTHORITY
Conferred by custom, can be inferred from the
position an agent occupies, or is implied as
reasonably necessary to carry out express
authority.

C. APPARENT AUTHORITY AND ESTOPPEL
An agent has apparent authority when a
principal, by word or action, causes a third
party reasonably to believe that an agent has
authority, though the agent has no authority.
The principal may be estopped from denying it
if the third party changes position in reliance.

D. EMERGENCY POWERS
If an emergency demands action by the agent,
but the agent is unable to communicate with
the principal, the agent has emergency power.

E. RATIFICATION
A principal can ratify an unauthorized contract
or act, if he or she is aware of all material
facts. Ratification can be done expressly or
impliedly (by accepting the benefits of a
transaction). An entire transaction must be
ratified; a principal cannot affirm only part.

1. Effect of Ratification Without Knowing All the
Facts
If the third party acts in reliance to his or her
detriment on the apparent ratification, the
principal can repudiate but must reimburse the
third party’s costs.

2. Effect of Ratification
Ratification binds the principal to the agent’s
act and treats it as if it had been authorized
from the outset.

3. Effect of No Ratification
There is no contract binding the principal; the
third party’s agreement with the agent is an
unaccepted offer; the agent may be liable to
the third party for misrepresenting his or her
authority.

I1. LIABILITY FOR CONTRACTS
Who is liable to third parties for contracts
formed by an agent.

A. DEFINITIONS

1. Disclosed Principal
A principal whose identity is known by the third
party at the time the contract is made by the
agent.

2. Partially Disclosed Principal
A principal whose identity is not known by the
third party, but the third party knows that the
agent is or may be acting for a principal at the
time the contract is made.

3. Undisclosed Principal
A principal whose identity is totally unknown
by the third party, who also does not know that
the agent is acting in an agency capacity at the
time of the contract.

B. IF AN AGENT ACTS WITHIN THE SCOPE OF HIS
OR HER AUTHORITY

1. Disclosed Principal
If a principal’s identity is known to a third party
when an agent makes a contract, the principal
is liable. The agent is not liable.

2. Partially Disclosed Principal
The principal is liable. In most states, the agent
is also liable (but is entitled to indemnification
by the principal).

3. Undisclosed Principal
The principal and the agent are liable.
Exceptions—

a. The principal was expressly excluded as a
party in the contract.

b. The contract is a negotiable instrument (check
or note).

c. The performance of the agent is personal to
the contract.

d. The third party would not have contracted with
the principal had the third party known his or
her identity, the agent or the principal knew
this, and the third party rescinds the contract.

C. IF THE AGENT HAS NO AUTHORITY
The principal is not liable in contract to a third
party. The agent is liable, for breach of the
implied warranty of authority (not on breach of
the contract), unless the third party knew the
agent did not have authority.

III. LIABILITY FOR AGENT’S TORTS
An agent is liable to third parties for his or her
torts. Is the principal also liable?

A. PRINCIPAL’S TORTIOUS CONDUCT
A principal may be liable for harm resulting
from the principal’s negligence (giving
improper instructions; authorizing the use of
improper materials or tools; establishing
improper rules; or failing to prevent others’
tortious conduct while they are on the
principal’s property or using the principal’s
equipment, materials, or tools).

B. PRINCIPAL’S AUTHORIZATION OF AGENT’S
TORTIOUS CONDUCT
A principal who authorizes an agent to commit
a tortious act may be liable.

C. MISREPRESENTATION

1. Fraudulent Misrepresentation
If a principal has given an agent authority to
make statements and the agent makes false
claims, the principal is liable. If an agent
appears to be acting within the scope of
authority in taking advantage of a third party,
the principal who placed the agent in that
position is liable.

2. Innocent Misrepresentation
When a principal knows that an agent does not
have all the facts but does not correct the
agent’s or the third party’s impressions, the
principal is liable.

D. THE DOCTRINE OF RESPONDEAT SUPERIOR
An employer is liable for harm caused
(negligently or intentionally) to a third party by
an employee acting within the scope of
employment, without regard to the personal
fault of the employer. This is known as virious
liability.

1. Scope of Employment

a. Factors
In determining whether an act is within the
scope of employment, a court considers—

1) the time, place, and purpose of the act.

2) whether the act was authorized by the
employer.
3) whether the act is one commonly
performed by employees on behalf of their
employers.

4) whether the employer’s interest was
advanced by the act.

5) whether the private interests of the
employee were involved.

6) whether the employer furnished the
means by which an injury was inflicted.

7) whether the employer had reason to know
that the employee would do the act in
question.

8) whether the act involved the commission
of a serious crime.

b. Travel and Commuting
The travel of those whose jobs require it is
considered within the scope of employment for
the duration of the trip, including the return. An
employee going to and from work or meals is
usually considered outside the scope of
employment.

2. Employer’s Liability for Torts outside the Scope
of Employment
An employer who knows or should know that
an employee has a propensity for committing
tortious acts is liable for the acts even if they
are outside the scope of employment. Also, an
employer is liable for permitting an employee to
engage in reckless acts that can injure others.

3. Employee’s Liability for His or Her Own Torts
An employee is liable for his or her own torts.
An employee who commits a tort at the
employer’s direction can be liable with the
employer, even if he or she was unaware of
the wrongfulness of the act.

IV. LIABILITY FOR INDEPENDENT
CONTRACTOR’S TORTS
An employer is not liable for physical harm
caused to a third person by the tortious act of
an independent contractor (except in cases of
hazardous activities such as blasting operations,
the transportation of highly volatile chemicals,
and the use of poisonous gases, in which strict
liability is imposed.

V. LIABILITY FOR AGENT’S CRIMES
A principal is not liable for an agent’s crime,
unless the principal participated. In some
jurisdictions, a principal may be liable for an
agent’s violating, in the course and scope of
employment, such regulations as those
governing sanitation, prices, weights, and the
sale of liquor.

VI. LIABILITY FOR SUBAGENT’S ACTS
If an agent is authorized to hire subagents for
the principal (to perform simple, definite duties;
when it is the business custom; or for
unforeseen emergencies), the principal is liable
for the acts of the subagents.

VII. TERMINATION OF AN AGENCY

A. TERMINATION BY ACT OF THE PARTIES

1. Lapse of Time
An agency agreement may specify the time
period during which the agency relationship will
exist. If so, the agency ends when that time
expires. If no definite time is stated, an agency
continues for a reasonable time and can be
terminated at will by either party.

2. Purpose Achieved
An agent can be employed to accomplish a
particular objective. If so, the agency
automatically ends when the objective is
accomplished.

3. Occurrence of a Specific Event
An agency can be created to terminate on the
occurrence of a certain event. If so, the
agency automatically ends when the event
occurs.

4. Mutual Agreement
Parties can cancel their agency by mutually
agreeing to do so.

5. Termination by One Party
Both parties have the power to terminate an
agency, but they may not have the right and
may therefore be liable for breach of contract.

a. Agency at Will—Principal Must Give Reasonable
Notice
To allow the agent to recoup expenses and, in
some cases, to make a normal profit.

b. Agency Coupled with an Interest—Irrevocable
This agency is created for the benefit of the
agent, who acquires a beneficial interest in the
subject matter, and thus it is not equitable to
permit a principal to terminate at will. Also, it
is not terminated by the death of either the

principal or the agent.

c. Not an Agency Coupled with an Interest—May Be
Revocable
An agency coupled with an interest should not
be confused with an agency in which the agent
derives only proceeds or profits (such as a

commission) from the sale of the subject
matter. This is revocable by the principal,
subject to any contract between the parties.

B. TERMINATION BY OPERATION OF LAW

1. Death or Insanity
Death or insanity of either party automatically
and immediately ends an agency. Knowledge
of the death is not required.

2. Impossibility
When the specific subject matter of an agency
is destroyed or lost, the agency terminates.
When it is impossible for the agent to perform
the agency lawfully because of a change in the
law, the agency terminates.

3. Changed Circumstances
When an event occurs that has such an
unusual effect on the subject matter of the
agency that the agent can reasonably infer that
the principal will not want the agency to
continue, the agency terminates.

4. Bankruptcy
Bankruptcy of the principal or the agent usually
terminates an agency. In some circumstances,
as when the agent’s financial status is
irrelevant to the purpose of the agency, the

agency relationship may continue.

5. War
When the principal’s country and the agent’s
country are at war with each other, the agency
is terminated.

C. NOTICE REQUIRED FOR TERMINATION

1. Notice Required
If the parties themselves terminate the agency,
the principal must inform any third parties who
know of the agency that it has ended.

a. Agent’s Authority Continues
An agent’s actual authority continues until the
agent receives notice of termination. An
agent’s apparent authority continues until the
third person is notified (from any source).

b. What the Principal Must Do
The principal is expected to notify directly any
third person who the principal knows has dealt
with the agent. For third persons who have
heard about the agency but have not dealt with
the agent, constructive notice is sufficient.

c. Form of the Notice
No particular form of notice is required unless
the agent’s authority is written, in which case it
must be revoked in writing, and the writing
must be shown to all who saw the written
authority.

2. No Notice Required
If an agency terminates by operation of law,
there is no duty to notify third persons, unless
the agent’s authority is coupled with an
interest.