CHAPTER
TWENTY-FOUR
Principal-Agent
Relationship
What Is an Agent?
• Principal-agent relationship
– One person called the principal grants authority to
another person to:
• Act in place of and bind the principal in dealing with third
parties.
• The principal-agent relationship is primarily used in business
relationships.
– The principal-agent relationship can also be used for personal
purposes.
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Classification of Agents
• General agent: an agent with the authority to perform
acts that relate to all business matters of the principal.
– The agent is in complete control of the principal’s business
affairs.
• Special agent: an agent authorized to perform one or
more limited acts for the benefit of the principal.
– A real estate broker is an example of a special agent.
• Gratuitous agent: an agent who is not paid for his or her
service.
– A gratuitous agent has the same power to bind a principal as an
agent who is paid.
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Who May Serve as
Principal and Agent
• Principal:
– A principal must have the legal competence to enter a
contract to appoint an agent. A minor may appoint an
agent, but the contract may be disaffirmed by the
minor.
• Agents:
– Agents act on behalf of the principal. Thus, anyone,
even a minor or mentally incompetent person, can be
appointed as an agent.
• Some states will prohibit a person declared mentally
incompetent from serving as an agent.
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Relationships Similar to Agencies
• Employer-employee:
– An employee is different from agent in that an
employee cannot act in place of the employer.
– A employee is subject to the employer’s control in the
means of carrying out assignments. An agent acts on
behalf of the principal but is not controlled by the
principal in how the assignment is carried out.
• Independent contractor:
– An independent contractor is usually retained to
accomplish a specific task. Unlike an employee, the
independent contractor is not subject to the direction
and control of the employer.
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Creation of the Principal-Agent
Relationship
• By contract:
– A principal may appoint an agent through an oral or
written contract.
• Generally, the terms of the agency agreement should be
spelled out in writing to prevent any misunderstanding.
• One form of principal-agent contract is known as power of
attorney.
– A general power of attorney gives the agent the power to
perform any act that can lawfully be performed by the principal.
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Creation of the Principal-Agent
Relationship (continued)
• By appearance:
– If third parties are led to believe that a person is an agent
because it appears a principal-agent relationship exists, an
agency by estoppel is created.
• The principal is estopped (prevented) by law from denying a
principal-agent relationship exists.
• By ratification:
– If a person attempts to act as an agent for another, and that
person approves the unauthorized act, a principal-agent
relationship has been ratified (accepted by the person for whom
the act was performed).
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Creation of the Principal-Agent
Relationship (continued)
• By necessity:
– An emergency can require a person to act as an
agent and thus may create a principal-agent
relationship by necessity.
• If time permits and the principal is available, the agent must
consult with the principal.
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Obligations of the Agent to
the Principal
• Usually, the agent’s duties are spelled out in the contract
between the principal and the agent. However, the law
also requires of the agent:
– Obedience: the agent must follow all lawful instructions of the
principal.
– Loyalty: the agent must act in the best interests of the
principal and not in the agent’s own interest.
– Reasonable skill: the agent is expected to exercise the
degree of skill that he or she claims to possess.
– Accurate accounting: the agent must maintain accurate and
up-to-date records.
– Communication: the agent has a duty to communicate any
information concerning the principal’s affairs to the principal.
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Obligations of the Principal to
the Agent (continued)
• The principal’s obligations to the agent:
– Compensation: the agent is entitled to be paid for work done
according to the contract.
– Reimbursement: the agent, even a gratuitous agent, is entitled to
be reimbursed for any expenses in carrying out the principal’s
business.
– Indemnification: the principal must make payment for any
personal loss suffered by the agent while carrying out the lawful
instructions of the principal.
– Safe working conditions: the principal must provide reasonably
safe working conditions for the agent.
– Cooperation: the principal has a duty to assist the agent in every
way possible to allow the agent to carry out his or her duties.
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Termination of the Principal-Agent
Relationship
• Fulfillment of purpose/lapse of time: the agency
will end upon completion of the act the agent
was hired to perform.
– If the agent is hired for a specified period of time, the
agency ends at the expiration of the specified time.
• Mutual agreement: the principal and agent may
agree to end their relationship.
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Termination of the Principal-Agent
Relationship (continued)
• Revocation of authority: – generally, a principal may
revoke an agent’s authority at any time.
– This revocation may be with or without cause, and it terminates
the principal-agent relationship.
• If the discharge is for cause the agent may not recover damages.
• If the agent is wrongfully discharged, the agent can collect unpaid
compensation owed to the point he/she was discharged.
– The agent may also seek to recover damages when wrongfully
discharged.
– If the agent has an interest in the act to be performed, the agent
must consent to the termination.
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Termination of the Principal-Agent
Relationship (continued)
• Renunciation by the agent: an agent may refuse
to continue to work with a principal.
– If the principal suffers damages, the principal may sue
the agent to recover those damages.
• By operation of law: certain situations will cause
the principal-agent relationship to terminate by
operation of law.
– Death or mental incompetence of the principal or
agent
– Bankruptcy of the principal and sometimes the agent
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Termination of the Principal-Agent
Relationship (continued)
• Subsequent destruction or illegality
– A principal-agent relationship will also terminate:
• If the purpose for which the agency was created becomes
illegal.
• If property that would be the subject of a transaction is
destroyed (e.g., if a house is destroyed by fire, a real estate
broker contract to sell it becomes meaningless).
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Notifying Third Parties of
Termination
• Third parties must be notified that the principalagent relationship has been terminated.
– Otherwise, a third party may presume that the
principal-agent relationship continues.
– Thus, the principal will be bound by acts of the agent
until the third parties have been notified.
• Those who have dealt regularly with the agent should be
notified personally or in writing that the agency has been
terminated.
• Other third parties can be notified by public notice such as by
a newspaper circulated in the area.
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