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Methods of Forming Principal Agent Relationship

Cite this article as: Jason Mance Gordon, "Methods of Forming Principal Agent Relationship," in The Business Professor, updated January 11, 2015, last accessed April 2, 2020, https://thebusinessprofessor.com/knowledge-base/methods-of-forming-principal-agent-relationship/.
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Methods of Forming a Principal Agent Relationship
This video explains the various ways to form a Principal - Agent relationship.

Next Article: Duties of a Principal to an Agent


What is required to form a principal-agent relationship?

An agency relationship is created in the following manners:

Express Agreement – A principal and agent may expressly agree to form an agency relationship. The agreement can be oral or in writing. The principal must simply confer the authority upon the agent to act on her behalf. The subject matter of the agency relationship must be legal. The agency has the express authority granted in the agency agreement and the implied authority to undertake tasks incidental to that objective.

  • Note: If the duties of the agent include executing a contract subject to the statute of frauds, the agency relationship may need to be in writing to be enforceable. An express agency relationship is often created pursuant to a legal document known as a “power of attorney”. The power of attorney may create a general or special agency relationship.

Implied Agency – An agency may be implied from the facts or circumstances surrounding an individual’s actions on behalf of another. If the principal acts in a way that demonstrates an intent for an individual to act on her behalf, this may imply an agency relationship. The parties to an agency relationship do not need to understand the law of agency or understand what it means to be a principal or agent.

Ratification – Ratification is a contract principle. If an individual undertakes actions on behalf of another, these actions may be outside of any express or implied authority. If, however, the principal acknowledges and accepts the agent’s actions, this is known as “ratification” of the agency relationship. The principal ratifies the agent’s actions, after the fact.

  • Note: Agency by ratification is only possible when the principal is fully disclosed.

By Estoppel – If a third-party reasonably relies on an agent’s representation that she has authority to act on behalf of the principal, the principal may be bound by the actions of the agent. Generally, the principal must act or fail to act in a manner that causes a third party to reasonably believe that an agency relationship exists, when in fact there is no agency. Agency by estoppel is based upon principles of fairness. It would be unfair to detriment a third party who reasonably believed that the agent had authority to act on behalf of the principle, and the principal was the source or cause of that belief.

  • Note: Agency by estoppel is only possible with fully-disclosed principals.
  • Example: Bill is James’ agent. James terminates the agency relationship. Nonetheless, unbeknownst to James, Bill continues to transact with third parties on James’ behalf. James fails to notify third parties of Bill’s termination. James may be bound to any agreement entered into by Bill.

By Necessity – Agency by necessity arises when one party makes a decision on behalf of another person who is unable to do so. The decision must be essential in nature and it must be in the interest of the principal in making that decision. As such, the law will impute a de facto agency relationship where no actual agency exists.

  • Example: Bill is hired to deliver Tom’s goods. He drops the goods off at the fulfillment center. The center says that there is no contract in place and intends to reject the goods.  Tom is out of country and cannot be reached. The goods will spoil if not accepted. Bill signs the warehousing agreement on Tom’s behalf.

Discussion: How do you feel about the ability to form an agency relationship without a principal expressly authorizing the agent to act on her behalf? What intent should be required before a court can find that an implied agency exists? What constitutes ratification of an agent’s actions by a principal? When is reliance upon an agent’s representations about her authority reasonable? Should a third party be required to verify an agents actual authority? How great must the need be for a court to find an agency by necessity?

Practice Question: Terrence hires Joe as a general manager of his business. Joe routinely purchases supplies for the business, though this authority is not in his job description. Terrence never gave Joe the authority to enter into these purchase agreements, but he routinely acknowledges Joe’s actions and keeps the purchased goods. When Terrence falls sick, Joe handles all store operations, including signing some major purchase orders that Joe generally signs. These purchases were necessary to continue business operations. One of the purchase orders, however, is for the wrong type of goods. The error potentially costs Terrence’s business thousands of dollars. When Terrence recovers and learns of the purchase order, he is furious and refuses to honor the purchase agreement. What are the arguments for and against Terrence’s liability for Joe’s errant purchase order?

Proposed Answer

  • Joe is a general agent for Terrence or his business. Joe has the actual authority for many tasks in that business. Undertaking purchase orders, however, is outside of his actual authority. In this case, however, Joe undertook this activity when Terrence was sick. Making these purchase orders was absolutely necessary for the business. As such, Joe is likely the implied agent (by necessity) for Terrence or his business. There are also arguments for implied and apparent authority for Joe to complete these tasks, based upon past course of conduct and Terrence allowing Joe to undertake similar functions in the past.

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