112/4212 STUDY GUIDE AUTHORITY OF AGENTS AND PRINCIPALS

Question 1

4211.01

Answer 1

An agency is a fiduciary relationship between two persons when one person (the agent) acts for the benefit and under the control of the other person (the principal) and has the power to affect the legal relationships of the principal.

Question 2

4211.02

Answer 2

The word “person” is used in the legal sense. A corporation, a partnership, or an individual can be a person and can therefore act in the capacity of either a principal or agent.

Question 3

4211.06

Answer 3

If a principal/agent relationship exists, the agent will also be viewed as either an employee or an independent contractor.

Question 4

4212.08

Answer 4

Apparent authority. Apparent authority, or appearance of authority, comes from the words or actions of the principal that lead a third party to reasonably believe and act upon the belief that actual authority exists in the purported agent. Belief and reliance are shown when the third party makes a contract with the purported agent. Apparent authority is determined from the view of the third party dealing with the purported agent. The words or actions must come from the principal, not the purported agent, in order to create apparent authority.

Example: Andrea, an outside salesperson for Mamou Corporation, called on customers, sold merchandise, delivered merchandise, and collected receivables. After being fired, Andrea collected some of the receivables from existing customers and disappeared. The existing customers will not have to pay Mamou again. The principal, Mamou, created the situation by allowing Andrea to collect the receivables previously. From the customers’ point of view, Andrea had apparent authority to collect the balances due. The firing terminated actual authority, but the principal, Mamou, had led the customers to believe and act upon the belief that Andrea had actual authority. These existing customers should be informed of the firing in order to terminate the apparent authority.
The following factors are sometimes considered in determining whether apparent authority exists:
The third party’s knowledge of the agent’s actual authority and limitations
The customs in that type of business
The principal’s prior approval of similar activities by the agent

Question 5

4211.09

Answer 5

The agency relationship can be used in either business or personal situations.

Question 6

4211.11

Answer 6

Principal and agent.

The agent works for the benefit and under the control of the principal and has the right to represent the principal and make contracts with third parties on behalf of the principal.

The agent must be either an employee or an independent contractor (but not all employees or independent contractors are agents).
The principal is liable on contracts made by an agent if the agent has authority to act on behalf of the principal.
The principal is not liable on contracts made by an employee or independent contractor unless that person is also an agent.
The principal may be held liable for torts against third parties committed by agents who are employees of the principal, but not for torts committed by independent contractors.
Example: SAS Corporation hires Gerry to sell its products as an outside salesman. Gerry calls on customers and makes sales contracts with them. SAS Corporation would be the principal, Gerry would be an agent, and the customers would be third parties. Contracts entered between Gerry and the customers would generally be binding on SAS Corporation.

Question 7

4211.13

Answer 7

Principal and independent contractor. The independent contractor acts for the benefit of the principal but not under the principal’s control. The principal who deals with an independent contractor is sometimes called a proprietor. The principal contracts for the end result, but the principal has no right of direction or control while the activity is being performed. The principal is not usually liable for the torts of an independent contractor even though the independent contractor is acting for the principal at the time the tort occurred.

• Example: In conducting an audit for a client, the CPA acts as an independent contractor. The client seeks an opinion, but the CPA determines what is audited and how it is audited. If the client controlled the audit, the CPA would not have professional independence.
• Example: SAS Corporation hires Williams to repave its parking lot. Williams completes the work over the weekend with no involvement by SAS Corporation. Williams would be an independent contractor as to SAS Corporation because the principal exercised no control over the physical details of the work.
• Example: Williams (in the prior example) hires individuals to work for him in his repaving business. Williams tells them what to do in repaving the SAS Corporation parking lot. These individuals would be employees of Williams since he has control over the physical details of the work they perform.

It is a question of fact as to what type of relationship exists between two persons. The question arises when there is a tort while the other person is acting for the benefit of the principal. Liability of the principal is determined by the control factor.

Question 8

4211.17

Answer 8

Ratification. Ratification occurs when the principal gives approval of an act previously done by the purported agent for the principal without authority. When the act happens, it must have been done for the purported principal, not for the purported agent. The ratification must also occur within a reasonable time.

The principal can expressly ratify the unauthorized act by indicating the intent to be bound. Oral or written statements to either the third party or the agent can result in an express ratification.
An implied ratification can result if the principal retains the benefits and advantages of the contract with the third party.
Ratification retroactively acts as an acceptance by the principal of the unauthorized contract from the date the contract was made.
Ratification cannot generally be retracted once done.
The third party can withdraw from the contract before ratification by the principal, but not after.
The entire contract must be ratified by the principal. Partial ratification of the favorable parts and rejection of the unfavorable parts of the contract are not permitted.
Ratification is possible only when the principal knows all the important terms of the contract.

Question 9

4211.21

Answer 9

Question 10

4211.23

Answer 10

Gratuitous agent. Person who agrees to act as an agent without expectation of compensation. The relationship is generally the same as in the case of a compensated agent, except that a gratuitous agent has no obligation to act for the principal unless the gratuitous agent has caused the principal to reasonably rely on the agent to perform the act.

Example: Dave wants to place a bid on property being sold at auction but is unsure that he will be able to be there in time. A friend, Bill, offers to go and place the bid on Dave’s behalf. If Bill fails to go and make the bid, he may be liable to Dave because Dave reasonably relied on Bill placing the bid at the auction.

Question 11

4212.18

Answer 11

Operation of law.

Operation of law means automatically without any action needed by the parties. All authority of the agent is terminated, even apparent authority, when the termination is by operation of law. An agency relationship is terminated by operation of law without notice being required in the following circumstances:

• Death of the principal or agent. It is not necessary that the other party have knowledge of the death.
• Insanity of the principal or agent. It is not necessary that the other party have knowledge of the insanity.
• Bankruptcy of the principal. It is not necessary that the other party have knowledge of the bankruptcy. The agency relationship is not terminated if the agent becomes bankrupt.
• Impossibility of performance. If the purpose of the agency becomes objectively impossible to perform, the agency terminates by operation of law.
  Example: Caitlin is acting as agent to sell Erin’s office building. If the building is destroyed by fire, the purpose of the agency becomes objectively impossible to perform. The agency therefore terminates by operation of law.
• The performance of the agency becomes illegal.
  Example: Brian employs Kevin as his agent to sell fireworks to third parties. If the state subsequently passes a statute making the sale of fireworks illegal, the agency would terminate by operation of law.

(If the principal is declared incompetent the agency terminates by operation of law).

Question 12

4212.19

Answer 12

Notice to third parties

Generally, the principal should give personal notice of termination of the agency to any third party who has dealt with the agent. This would eliminate any problems with the principal being bound to contracts entered by the former agent under the doctrine of apparent authority.
Published notice of termination of the agency is generally sufficient notice to any third parties who have not dealt with the agent previously.
Acts of the agent after a termination by operation of law cannot bind the principal or the principal’s estate based on a theory of apparent authority

Question 13

4211.26

Answer 13

Disclosed principal. A disclosed principal is a person whose existence and identity are known to the third party at the time of making the contract with the agent.

Question 14

4211.27

Answer 14

Partially disclosed principal.
A partially disclosed principal is a principal whose existence is known to the third party at the time of contracting with the agent. The specific identity of the principal, though, is unknown to the third party.

Question 15

4211.28

Answer 15

Undisclosed principal. An undisclosed principal is a principal whose existence and identity are not known to the third party at the time of contracting. From the third party’s point of view, the agent appears to be acting on their own behalf.

Question 16

4212.01

Answer 16

The authority, or power, of an agent is the capacity to change the legal status of the principal by dealing with third parties.

(The power to change the legal status of the principal with certain persons)

Question 17

4212.02

Answer 17

The authority of the agent is determined by the principal and can come only from the principal. Authority comes from the consent of the principal.

The burden of proving the agent’s authority rests with the third party who deals with the agent. If authority cannot be proved, the purported principal is not liable on the contract.
The agent cannot create their own authority.
A third party who deals with an agent, knowing the agent exceeds their authority, does so at their own peril and will not generally be able to hold the principal liable for the agent’s unauthorized act.

Question 18

**

4212.03

Answer 18

Express authority.

Authority that is stated in spoken or written words by the principal.

Example: David owns a fruit and vegetable market. He tells Jennifer to enter a contract with Acme Produce Wholesalers to purchase 10 cases of apples. Jennifer, as agent, has express authority to make this purchase.

Question 19

4212.04

Answer 19

Implied authority.

1. Implied authority is that authority that is commonly and customarily needed to conduct the purpose of the agency.
2. Implied authority is needed to fill in the gaps to carry out the agent’s express authority.
3. Implied authority cannot come from words or conduct of the agent.
4. Implied authority can vary business to business and from location to location.

Example: Brian owns a clothing store. He hires Erin and gives her the authority to manage the store. Erin enters a contract with ABC Clothing Corporation in order to obtain clothing to sell in the store. Even though Erin did not have express authority to enter the contract with ABC, she would have implied authority to enter this contract since it is necessary to fulfill the purpose of the agency.

Reference: 4212.04
Implied authority. The authority that is commonly and customarily needed to conduct the purpose of the agency. Implied authority is needed to fill in the gaps to carry out the agent’s express authority. It cannot come from words or conduct of the agent. It can vary from one location to another. It can vary among different types of businesses.

Example: Brian owns a clothing store. He hires Erin and gives her the authority to manage the store. Erin enters a contract with ABC Clothing Corporation in order to obtain clothing to sell in the store. Even though Erin did not have express authority to enter the contract with ABC, she would have implied authority to enter this contract since it is necessary to fulfill the purpose of the agency.

Question 20

4212.06

Answer 20

Actual authority. The combination of express and implied authority.

Question 21

4212.08

Answer 21

Apparent authority.

Apparent authority, or appearance of authority, comes from the words or actions of the principal that lead a third party to reasonably believe and act upon the belief that actual authority exists in the purported agent. Belief and reliance are shown when the third party makes a contract with the purported agent. Apparent authority is determined from the view of the third party dealing with the purported agent. The words or actions must come from the principal, not the purported agent, in order to create apparent authority.

• Example: Andrea, an outside salesperson for Mamou Corporation, called on customers, sold merchandise, delivered merchandise, and collected receivables. After being fired, Andrea collected some of the receivables from existing customers and disappeared. The existing customers will not have to pay Mamou again. The principal, Mamou, created the situation by allowing Andrea to collect the receivables previously. From the customers’ point of view, Andrea had apparent authority to collect the balances due. The firing terminated actual authority, but the principal, Mamou, had led the customers to believe and act upon the belief that Andrea had actual authority. These existing customers should be informed of the firing in order to terminate the apparent authority.
• The following factors are sometimes considered in determining whether apparent authority exists:
  1. The third party’s knowledge of the agent’s actual authority and limitations
  1. The customs in that type of business
  1. The principal’s prior approval of similar activities by the agent

Question 22

4211.09

Answer 22

The agency relationship can be used in either business or personal situations.

Question 23

4211.10

Answer 23

Formalities. No particular formalities are required to form the agency relationship. The formation can be oral, written, or the agency can be created by some conduct of the principal that may be interpreted by a third party as an intention to appoint an agent. If formed by contract, it must satisfy the requirements of a contract. The statute of frauds requires an agency contract to be in writing to be enforceable if the contract cannot be performed within one year from the time of making the contract.

Power of attorney. A power of attorney is a formal instrument, usually acknowledged by a notary public, to confer authority on an agent. The agent is referred to as an attorney-in-fact, to distinguish them from a lawyer who is an attorney-at-law.

Question 24

4212.12

Answer 24

Termination. The agent’s actual authority ceases when the agency is terminated; however, the agent still has apparent authority from the viewpoint of third parties with whom the agent has dealt. These third parties must be given actual notice of the termination to end the apparent authority. For those third parties who have not dealt with the agent, constructive notice is adequate to end the apparent authority. Publishing the termination in a newspaper having general circulation is adequate constructive notification as to those third parties.

Question 25

4212.13

Answer 25

Revocation by the principal. The principal acting alone can revoke the authority of the agent. This is because an agency is a consensual relationship requiring the consent of both parties.

If the relationship is an agency coupled with an interest, the principal cannot revoke the agency.
The principal can still be liable on the agency relationship because the agent may still have apparent authority from the view of third parties with whom the agent has previously dealt. These third parties should be given actual notice of the dismissal of the agent. This notice would eliminate the lingering apparent authority. The notice can be given in person, by letter, or by phone.
If the revocation is contrary to the agency contract, the principal could be liable for breach of contract if the breach is not justified. This is true because, while principals have the power to terminate the agency, they may not have the legal right to do so.

Question 26

4222.16

Answer 26

The court will not enforce an illegal bargain, generally leaving the parties where the court finds them. This means the court will not adjust the equities between the parties. The courts will sometimes grant relief to the following persons even though they are involved in an illegal bargain:

A party that the violated law intended to protect. States have laws that require all physicians to be licensed by the state. An unlicensed physician who contracts with a patient has violated the licensing statute making the agreement an illegal bargain. The courts will help the patient, but not the physician. The licensing statute was enacted to protect patients from unlicensed physicians.
A party that is not in a good bargaining position when making the agreement. This party is said to be not equally at fault (not in pari delecto). Courts will sometimes grant relief to this type of party.
A party who seeks to back out of an illegal bargain before execution
A party to an agreement when part is legal and part is illegal. Sometimes the courts will grant relief if the obligations are severable. This means the courts will separate the agreement to make an enforceable portion and an unenforceable illegal bargain.

Question 27

4212.18

Answer 27

Operation of law. Operation of law means automatically without any action needed by the parties. All authority of the agent is terminated, even apparent authority, when the termination is by operation of law. An agency relationship is terminated by operation of law without notice being required in the following circumstances:

Death of the principal or agent. It is not necessary that the other party have knowledge of the death.

Insanity of the principal or agent. It is not necessary that the other party have knowledge of the insanity.

Bankruptcy of the principal. It is not necessary that the other party have knowledge of the bankruptcy. The agency relationship is not terminated if the agent becomes bankrupt.

Impossibility of performance. If the purpose of the agency becomes objectively impossible to perform, the agency terminates by operation of law.

Example: Caitlin is acting as agent to sell Erin’s office building. If the building is destroyed by fire, the purpose of the agency becomes objectively impossible to perform. The agency therefore terminates by operation of law.
The performance of the agency becomes illegal.
Example: Brian employs Kevin as his agent to sell fireworks to third parties. If the state subsequently passes a statute making the sale of fireworks illegal, the agency would terminate by operation of law.

Question 28

4212.19

Answer 28

Notice to third parties

Generally, the principal should give personal notice of termination of the agency to any third party who has dealt with the agent. This would eliminate any problems with the principal being bound to contracts entered by the former agent under the doctrine of apparent authority.
Published notice of termination of the agency is generally sufficient notice to any third parties who have not dealt with the agent previously.
Acts of the agent after a termination by operation of law cannot bind the principal or the principal’s estate based on a theory of apparent authority.

Question 29

4222.15

Answer 29

An agreement whose formation or performance is a tort, a crime, or is opposed to public policy constitutes an illegal bargain.

Question 30

4222.16

Answer 30

The court will not enforce an illegal bargain, generally leaving the parties where the court finds them. This means the court will not adjust the equities between the parties. The courts will sometimes grant relief to the following persons even though they are involved in an illegal bargain:

A party that the violated law intended to protect. States have laws that require all physicians to be licensed by the state. An unlicensed physician who contracts with a patient has violated the licensing statute making the agreement an illegal bargain. The courts will help the patient, but not the physician. The licensing statute was enacted to protect patients from unlicensed physicians.
A party that is not in a good bargaining position when making the agreement. This party is said to be not equally at fault (not in pari delecto). Courts will sometimes grant relief to this type of party.
A party who seeks to back out of an illegal bargain before execution
A party to an agreement when part is legal and part is illegal. Sometimes the courts will grant relief if the obligations are severable. This means the courts will separate the agreement to make an enforceable portion and an unenforceable illegal bargain.

Question 31

4223.15

Answer 31

Impossibility of performance

• Subjective impossibility—it is inconvenient or too expensive to carry out the contract—does not discharge the contract.
• Objective impossibility—discharges the contractual obligation
  1. Nobody could carry out the contract. This is real impossibility.
  2. Either of the following would be objective impossibility:
  i. The subject matter of the contract is destroyed after making the contract but before performance is due.
  ii. The person who is to perform a personal services contract dies after making the contract but before the performance is due.
  3. Doctrine of commercial frustration—excuses contractual performance if both parties contemplated the happening of some event that does not occur
  Example: Coronation case in England. People rented apartments to see the parade, but the king got sick and the parade was canceled.

Question 32

4231.54

Answer 32

Defenses available to the principal debtor:

• Discharge in bankruptcy. This is a personal defense available only to the principal debtor. This defense may not be used by the guarantor or surety to avoid paying the creditor.
• Minority of the principal debtor. This is a personal defense available only to the principal debtor. (Minority generally refers to being under the age of 18.) This defense may not be used by the guarantor or surety to avoid paying the creditor.
• Performance of the obligation. If the principal debtor has done what was promised, the creditor or the surety cannot insist that the debtor do it again.
• Breach of contract by the creditor. Like any other contract, the wrongdoer cannot insist on performance if the wrongdoer has not done what they promised to do.

Question 33

4231.55

Answer 33

Defenses available to the guarantor or surety to avoid liability to the creditor:

• All nonpersonal defenses of the principal debtor are available. Remember that bankruptcy and minority of the debtor are personal defenses not available to the guarantor or surety.
• Minority or bankruptcy of the guarantor or surety is a defense. Minors can avoid liability on all contracts, even guarantor or suretyship contracts.
• Creditor’s fraud or nondisclosure of something important. For example, the creditor does not tell the surety that one of the principal debtor’s employees was embezzling money.
• Creditor modifying principal debtor’s contract. For example, the creditor extends the time for the principal debtor to repay.
• Creditor’s release of security or co-guarantors or co-sureties
• Creditor’s release of the principal debtor
• Anything the creditor does that will hurt the guarantor’s or surety’s chance of coming out whole will discharge the surety from the obligation to the creditor.
  1. Courts tend to release the noncompensated guarantor or surety for any change in the contract.
  2. For a compensated guarantor or surety, only the amount lost due to the change will be excused.