There’s a common phrase in the business world; “acting on behalf of” seems to find it’s way into a number of business documents and legal contracts. What does it really mean to be acting on behalf of? Who’s liable for what in these situations? Today’s post will detail some of the basics behind agency law and some of the principles that determine liability when you act on behalf of another person or business.
Determining the Agency Relationship
The term “agency” refers to a legal relationship between two parties, the agent and the principal. The agent is the legal representative of the principal, which may be a person or entity. The agency relationship is established once one person has the legal authority to act on behalf of the principal. In order to have legal authority to act on behalf of the principal, the principal must have contractual capacity (i.e. sane and of legal age), and both parties (the agent and principal) must consent to create the agency relationship. There is generally no writing or other formality that is required to create an agency relationship.
What Duties does the Agent Owe the Principal (and vice versa)?
Generally an agent owes the principal duties of loyalty, obedience, and reasonable care. Loyalty means the agent must act in the best interest of the principal, and avoiding secret profits and other conflicts of interest. Obedience means the agent must act reasonably within the set of instructions the principal provides. And reasonable care means that the agent acted rationally under the circumstances.
A principal, on the other hand, owes the agent reasonable compensation, reimbursement of expenses, indemnification, and cooperation with the agent’s efforts. The principal must compensate the agent for acts made on behalf of the principal and pay the agent back for any out-of-pocket expenses the agent incurs while acting on behalf of the principal. The principal must indemnify, or hold the agent harmless, for any harm that occurred as a result of the agency relationship. Last, the principal must cooperate with the agent in order to accomplish the agent’s ultimate task.
Determining Legal Authority
There are three forms of legal authority in agency law: actual, apparent, and ratified. An agent acting with any form of authority is capable of binding the principal in contract to a third party.
Actual authority is the clearest, strongest authority in agency law. Either through express statements or conduct, or implied through reasonable inferences, a principal asks an agent to, or grants authority to, act on behalf of the principal. For example, your boss may ask you to call Office Depot and order ink for his printer. You would have actual authority to act on behalf of the boss.
Apparent authority occurs when a third party believes that another person is the agent, and acting on behalf of, the principal. The third party’s belief must be based on the principal’s statement or conduct. For example, if John Doe is appointed president of ACME—a position that generally carries with it authority to act on behalf of ACME—then third parties are entitled to assume there is apparent authority to act on behalf of ACME even though there may not be actual authority. This protects third parties from being deceived by misleading statements or conduct by the principal.
Ratified authority means that the agent acted without authority but the principal later approved, or ratified, the acts. The principal can approve the acts by affirmative or silent approval. For example, an employee who does not have the authority to do so, writes a demand letter to a customer. If the principal learns of the employee’s act but fails to do anything to remedy the situation, then the employee’s act is said to be ratified.
How Can This Effect You and Your Business?
With partnerships, each partner (or owner) has authority to act on behalf of the partnership by default. This means that partners in a partnership must be extremely careful when delineating authority within the business. You can grant specific authority to one or more partners if it is expressly granted within the partnership agreement. It’s also important to stay up-to-date on your co-partners’ decisions within the partnership—since you may be on the hook for one of your co-partner’s actions. Check out partnership basics and best practices here.
In the corporate context, the law of agency applies differently. With corporations, shareholders are not necessarily officers and directors of that corporation, and so shareholders typically do not have agency authority automatically. So, partners in a partnership must be careful to delineate authority and keep abreast of their co-partners’ decisions.
A third party dealing with an agent of a business can rely upon the agency relationship and enforce the obligations that result from the agent’s actions, even if the agent’s actions were imprudent decisions on the business’ behalf. If the agent acts within the scope of his authority, the business will be bound by the actions.
Being aware of the basic legal principles behind agency law is important because of the significant contractual obligations and other liabilities that may result from your actions as an agent or principal.