Law 1 Business Law
Chapter 31 - Agency Formation and Duties

The key points in this chapter include:

1. The difference between employees and
independent contractors.

2. The formation of an agency relationship.

This chapter covers aspects of agency relationships, including how they are formed and the duties involved. An agency relationship involves two parties: the principal and the agent. Agency relationships are essential to a corporation, which can function and enter into contracts only through its agents.

I. AGENCY RELATIONSHIPS
In an agency relationship, the parties agree that
the agent will act on behalf and instead of the
principal in negotiating and transacting business
with third persons.

A. EMPLOYER-EMPLOYEE RELATIONSHIPS
Normally, all employees who deal with third
parties are deemed to be agents. Statutes
covering workers’ compensation and so on
apply only to employer-employee relationships.

B. EMPLOYER–INDEPENDENT CONTRACTOR
RELATIONSHIPS
Those who hire independent contractors have
no control over the details of their physical
performance. Independent contractors can be
agents.

C. CRITERIA FOR DETERMINING EMPLOYEE
STATUS
The greater an employer’s control over the
work, the more likely it is that the worker is an
employee. Another key factor is whether the
employer withholds taxes from payments to the
worker and pays unemployment and Social
Security taxes covering the worker.

II. FORMATION OF THE AGENCY
RELATIONSHIP
Consideration is not required. A principal must
have capacity to contract, but anyone can be
an agent. An agency can be created for any
legal purpose

A. AGENCY BY AGREEMENT
Normally, an agency must be based on an
agreement that the agent will act for the
principal. Such an agreement can be an
express written contract or can be implied by
conduct.

B. AGENCY BY RATIFICATION
A person who is not an agent (or who is an
agent acting outside the scope of his or her
authority) may make a contract on behalf of
another (a principal). If the principal approves
or affirms that contract by word or by action,
an agency relationship is created by ratification
(see Chapter 34).

C. AGENCY BY ESTOPPEL

1. The Principal’s Actions
When a principal causes a third person to
believe that another person is his or her agent,
and the third person deals with the supposed
agent, the principal is estopped to deny the
agency relationship.

2. The Third Party’s Reasonable Belief
The third person must prove that he or she
reasonably believed that an agency relationship
existed and that the agent had authority—that
an ordinary, prudent person familiar with
business practice and custom would have been
justified in concluding that the agent had
authority.

D. AGENCY BY OPERATION OF LAW
A court may find an agency relationship in the
absence of a formal agreement. This may
occur in family relationships or in an
emergency, when the agent’s failure to act
outside the scope of his or her authority would
cause the principal substantial loss.

III. DUTIES OF AGENTS AND PRINCIPALS
The principal-agent relationship is fiduciary.

A. AGENT’S DUTIES TO PRINCIPAL

1. Performance
An agent must use reasonable diligence and
skill (the degree of skill of a reasonable person
under similar circumstances), unless an agent
claims special skills (such as those of an
accountant), in which case the agent is
expected to use those skills.

2. Notification
An agent must notify the principal of all
matters concerning the agency. Notice to the
agent is considered to be notice to the principal.

3. Loyalty
An agent must act solely for the benefit of the
principal (not in the interest of the agent or a
third party).

a. Confidentiality
Any information or knowledge acquired
through the agency relationship is confidential.
It cannot be disclosed during the agency
or after its termination.

b. Agent’s Loyalty Must Be Undivided
An agent employed by a principal to buy
cannot buy from himself or herself, and an
agent employed to sell cannot become the
purchaser, without the principal’s consent.

4. Obedience
When an agent acts on behalf of the principal,
the agent must follow all lawful instructions of
the principal. Exceptions include emergencies
and instances in which instructions are not
clearly stated.

5. Accounting
An agent must keep and make available to the
principal an account of everything received and
paid out on behalf of the principal. An agent
must keep separate accounts for the principal’s
funds.

B. PRINCIPAL’S DUTIES TO AGENT

1. Compensation
A principal must pay an agent for services
rendered (unless the agent does not act for
money). Payment must be timely. If no amount
has been agreed to, the principal owes the
customary amount for such services.

2. Reimbursement and Indemnification
A principal must (1) reimburse the agent for
money paid at the principal’s request or for
necessary expenses and (2) indemnify an agent
for liability incurred because of authorized acts.

3. Cooperation
A principal must cooperate with and assist an
agent in performing his or her duties. The
principal must do nothing to prevent
performance.

4. Provide Safe Working Conditions
A principal must provide safe working
conditions.

IV. REMEDIES AND RIGHTS OF AGENTS
AND PRINCIPALS
If one party violates his or her duty to the
other, remedies available to the party not in
breach arise out of contract and tort law, and
include damages, termination of the agency,
injunction, and accounting.

A. AGENT’S RIGHTS AND REMEDIES AGAINST
PRINCIPAL
For every duty of the principal, an agent has a
corresponding right. Breach of a duty by the
principal follows normal contract and tort
remedies. If the relation is not contractual, an
agent has no right to specific performance (but
can recover for past services and future
damages).

C. PRINCIPAL’S RIGHTS AND REMEDIES AGAINST
AGENT

1. Constructive Trust
A court imposes a constructive trust if an agent
retains benefits or profits that belong to the
principal or takes advantage of the agency to
obtain property the principal wants to buy. The
court declares that the agent holds money or
property on behalf of the principal.

2. Avoidance
If an agent breaches an agency agreement
under a contract, the principal has a right to
avoid any contract entered into with the agent.

3. Indemnification
A principal can be sued by a third party for an
agent’s negligence, and in certain situations the
principal can sue the agent. The same is true if
the agent violates the principal’s instructions.

3. The duties of agents to principals and principals
to agents.

4. The rights and remedies of agents against
principals and principals against agents.