The legal environment in business law: Part 2

UNIT

Agency and

Employment

Law 6

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Lauren Brenner had a great idea for a new kind of fitness studio in New York.

Called Pure Power Boot Camp, Brenner’s gym was modeled on a U.S.

Marine training facility, with an indoor obstacle course, camouflage colors,

and a rubber floor designed to look like dirt. Brenner’s special insight was

that people would be more likely to stick to an exercise regime if they

worked out together in a small group. So she limited classes to 16 people

(called “recruits”) who went through the training program together (a “tour

of duty”). Brenner also hired retired Marines as “drill instructors.”

Ruben Belliard, a retired Marine, was Pure

Power’s head drill instructor. On his recommendation, Brenner also hired Alexander Fell. But, as

Brenner began plans to franchise her concept, the

two men went to war against her. They decided to start their own copycat

gym, which was to be called Warrior Fitness Boot Camp.

While still employed by Brenner, Belliard and Fell rented a gym space

nearby. Belliard stole copies of Pure Power’s confidential customer list,

business plan, and operations manuals. The two men sent marketing emails

about Warrior to Pure Power’s clients and even invited them to a cocktail

party to announce Warrior Fitness’s launch.

Then one day at Pure Power, Fell openly defied Brenner’s instructions, screaming at her that he dared her to fire him. She had little choice

but to do so. Belliard then convinced her to fire another drill inspector.

Two weeks later, Belliard quit without giving notice, intentionally leaving

Brenner with only one drill instructor. Two months later, Fell and Belliard

opened Warrior Fitness.

The two men went to war

against her.

Agency Law

CHAPTER

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Chapter 28 Agency Law

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Thus far, this book has primarily dealt with issues of individual responsibility: What happens

if you knock someone down or you sign an agreement? But most businesses need more than

one worker. Certainly Lauren Brenner could not operate her business by herself.

That is where agency law comes in. It is concerned with your responsibility for the

actions of others and their obligations to you. What happens if your agent assaults someone

or signs a contract in your name? Or tries to leave with all of your clients?

Hiring other people presents a significant trade-off: If you do everything yourself, you

have control over the result. But the size and scope of your business (and your life) will

be severely limited. Once you bring in other people, both your risks and your rewards can

increase immensely.

The Pure Power case highlights a common agency issue: If your employees decide to

leave, what obligation do they owe you in that period before they actually walk out the door?

The court’s opinion is later in the chapter.

28-1 THE AGENCY RELATIONSHIP

Principals have substantial liability for the actions of their agents.1

Therefore, disputes about

whether an agency relationship exists are not mere legal quibbles but important issues with

potentially profound financial consequences.

28-1a Creating an Agency Relationship

Let’s begin with two important definitions:

• Principal: A person who has someone else acting for him

• Agent: A person who acts for someone else

In an agency relationship, someone (the agent) agrees to perform a task for, and under

the control of, someone else (the principal). To create an agency relationship, there must be:

• A principal and

• An agent,

• Who mutually consent that the agent will act on behalf of the principal and

• Be subject to the principal’s control

• Thereby creating a fiduciary relationship.

Consent

To establish consent, the principal must ask the agent to do something, and the agent must

agree. In the most straightforward example, you ask a neighbor to walk your dog, and

she agrees. Matters were more complicated one night when Steven James sped down a

highway and crashed into a car that had stalled on the roadway, thereby killing the driver.

In a misguided attempt to help his client, James’s lawyer took him to the local hospital for a

blood test. Unfortunately, the test confirmed that James had indeed been drunk at the time

of the accident.

1The word principal is always used when referring to a person. It is not to be confused with the word

principle, which refers to a fundamental idea.

Principal

In an agency relationship, the

person for whom an agent is

acting

Agent

In an agency relationship, the

person who is acting on behalf

of a principal

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The attorney knew that if this evidence was admitted at trial, his client would soon be

receiving free room and board from the Massachusetts Department of Corrections. So at

trial, the lawyer argued that the blood test was protected by the client-attorney privilege

because the hospital had been his agent and therefore a member of the defense team. The

court disagreed, however, holding that the hospital employees were not agents for the lawyer

because they had not consented to act in that role.

The court upheld James’s conviction of murder in the first degree by reason of extreme

atrocity or cruelty.2

Control

Principals are liable for an agent’s acts because they exercise control over that person. If principals direct their agents to commit an act, it seems fair to hold the principal liable when that

act causes harm. How would you apply that rule to the following situation?

William Stanford was an employee of the Agency for International Development. While

on his way home to Pakistan to spend the holidays with his family, his plane was hijacked

and taken to Iran, where he was killed. Stanford had originally purchased a ticket on Northwest Airlines but had traded it for a seat on Kuwait Airways (KA). The airlines had an agreement permitting passengers to exchange tickets from one to the other. Stanford’s widow sued

Northwest on the theory that KA was Northwest’s agent. The court found, however, that no

agency relationship existed because Northwest had no control over KA.3

Northwest did not

tell KA how to fly planes or handle terrorists; therefore, it should not be liable when KA made

fatal errors. Not only must an agent and principal consent to an agency relationship, but the

principal also must have control over the agent.

Fiduciary Relationship

A fiduciary relationship is one of trust: The beneficiary places special confidence in the

fiduciary who, in turn, is obligated to act in good faith and candor, doing what is best for the

beneficiary, rather than acting in his own best interest. Agents have a fiduciary duty to their

principals.

All three elements—consent, control, and a fiduciary duty—are necessary to create an

agency relationship. In some relationships, for example, there might be a fiduciary duty but

no control. A trustee of a trust must act for the benefit of the beneficiaries, but the beneficiaries have no right to control the trustee. Therefore, that trustee is not an agent of the

beneficiaries. Consent is present in every contractual relationship, but that does not necessarily

mean that the two parties are agent and principal. If Horace sells his car to Lily, they both

expect to benefit under the contract, but neither has a fiduciary duty to the other and neither

controls the other, so there is no agency relationship.

Elements Not Required for an Agency Relationship

Consent, control, and a fiduciary relationship are necessary to establish an agency relationship. The following elements are not required for an agency relationship:

• Written agreement. In most cases, an agency agreement does not have to be in writing. An oral understanding is valid, except in one circumstance—the equal dignities

rule. According to this rule, if an agent is empowered to enter into a contract that

must be in writing, then the appointment of the agent must also be written. For

example, under the Statute of Frauds, a contract for the sale of land is unenforceable

unless in writing, so the agency agreement to sell land must also be in writing.

2Commonwealth v. James, 427 Mass. 312 (S.J.C. MA 1998).

3Stanford v. Kuwait Airways Corp., 648 F. Supp. 1158 (S.D.N.Y. 1986).

Fiduciary relationship

The trustee must act in the best

interests of the beneficiary.

Equal dignities rule

If an agent is empowered to

enter into a contract that must

be in writing, then the appointment of the agent must also be

written.

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Chapter 28 Agency Law

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• Formal agreement. The principal and agent need not agree formally that they have

an agency relationship. They do not even have to utter the word agent. So long as

they act like an agent and a principal, the law will treat them as such.

• Compensation. An agency relationship need not meet all the standards of contract

law. For example, a contract is not valid without consideration, but an agency agreement is valid even if the agent is not paid.

28-1b Duties of Agents to Principals

As we have seen, agents owe a fiduciary duty to their principals. There are four elements to

this duty.

Duty of Loyalty

An agent has a fiduciary duty to act loyally for the principal’s benefit in all matters connected

with the agency relationship.4

The agent has an obligation to put the principal first, to strive

to accomplish the principal’s goals.

The following case reveals the outcome of the opening scenario.

4Restatement (Third) of Agency §8.01.

Facts: Based on the facts in the opening scenario, Brenner

filed suit against Belliard and Fell, alleging that they had

violated their duty of loyalty to her company.

Issue: Did Belliard and Fell violate their duty of loyalty

to Pure Power?

Excerpts from Judge Katz’s Decision: An agent is obligated under New York law to be loyal to his employer and

is prohibited from acting in any manner inconsistent with

his agency or trust and is at all times bound to exercise the

utmost good faith and loyalty in the performance of his

duties. This duty is not dependent upon an express contractual relationship, but exists even where the employment relationship is at-will.

When an employee uses an employer’s proprietary or

confidential information when establishing a competing

business, the employee breaches his or her fiduciary duty to

the employer. Although an employee may, of course, make

preparations to compete with his employer while still working

for the employer, he or she may not do so at the employer’s

expense, and may not use the employer’s resources, time,

facilities, or confidential information; specifically, whether or

not the employee has signed an agreement not-to-compete,

the employee, while still employed by the employer, may not

solicit clients of his employer, may not copy his employer’s

business records for his own use, may not charge expenses to

his employer, which were incurred while acting on behalf of his

own interest, and may not actively divert the employer’s business for his own personal benefit or the benefit of others.

In addition, even in the absence of trade secret protection,

employees are not permitted to copy their employer’s client

list, and such acts have been deemed to be an egregious breach

of trust and confidence.

This ongoing and deliberate conduct, transpiring

over the course of several months, constitutes a clear

breach of the duty of loyalty owed by employees, Belliard

and Fell, to their employer, Pure Power. [Belliard and

Fell must pay Brenner $245,000.]

Pure Power Boot Camp, Inc. v.

Warrior Fitness Boot Camp, LLC

813 F. Supp. 2d 489

United States District Court for the Southern District of New York, 2011

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The various components of the duty of loyalty follow.

Outside Benefits. An agent may not receive profits unless the principal knows and

approves. Suppose that Emma is an employee of the agency Big Egos and Talents, Inc.

(BEAT). She has been representing Zac Efron in his latest movie negotiations.5

Efron often

drives her to meetings in his new Aston Martin. He is so thrilled that she has arranged for

him to star in the movie Little Men that he buys her an Aston Martin. Can Emma keep this

generous gift? Only with BEAT’s permission. She must tell BEAT about the gift; the company may then take the vehicle itself or allow her to keep it.

Confidential Information. The ability to keep secrets is important in any relationship, but

especially a fiduciary relationship. Agents can neither disclose nor use for their own benefit

any confidential information they acquire during their agency. As the following case shows,

this duty continues even after the agency relationship ends.

5Do not be confused by the fact that Emma works as an agent for movie stars. As an employee of BEAT,

her duty is to the company. She is an agent of BEAT, and BEAT works for the celebrities.

Facts: Bright Tunes Music Corp. (Bright Tunes) owned

the copyright to the song “He’s So Fine,” a hit for the Chiffons. The company sued Beatle George Harrison alleging

that his composition “My Sweet Lord” copied “He’s So

Fine.” At the time the suit was filed, Allen B. Klein handled the business affairs of the Beatles.

Klein (representing Harrison) met with the president of Bright Tunes to discuss possible settlement of the

interested in purchasing the copyright to “He’s So Fine.”

Shortly thereafter, Klein’s management contract with the

Beatles expired. Without telling Harrison, Klein began

negotiating with Bright Tunes to purchase the copyright

to “He’s So Fine” for himself. To advance these negotiations, Klein gave Bright Tunes information about royalty

income for “My Sweet Lord”—information that he had

gained as Harrison’s agent.

The trial judge in the copyright case ultimately found

that Harrison had infringed the copyright on “He’s So

Fine” and assessed damages of $1.6 million. After the trial,

Klein purchased the “He’s So Fine” copyright from Bright

Tunes and with it, the right to recover from Harrison for his

breach of copyright.

Issue: Did Klein violate his f iduciary duty to Harrison

by using conf idential information after the agency relationship terminated?

Excerpts from Judge Pierce’s Decision: There is no

doubt that the relationship between Harrison and [Klein]

prior to the termination of the management agreement was

that of principal and agent, and that the relationship was

fiduciary in nature. [A]n agent has a duty not to use confidential knowledge acquired in his employment in competition with his principal. This duty exists as well after

the employment is terminated as during its continuance.

Abkco Music, Inc. v. Harrisongs Music, Ltd.

722 F2d 988

United States Court of Appeals for the Second Circuit, 1983

George Harrison, a few months after writing “My Sweet Lord”

AP Images

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Competition with the Principal. Agents are not allowed to compete with their principal

in any matter within the scope of the agency business. If Allen Klein had purchased the “He’s

So Fine” copyright while he was George Harrison’s agent, he would have committed an

additional sin against the agency relationship. Owning song rights was clearly part of the

agency business, so Klein could not make any such purchases without Harrison’s consent.

Once the agency relationship ends, however, so does the rule against competition. Klein was

entitled to buy the “He’s So Fine” copyright after the agency relationship ended; he was just

not allowed to use confidential information.

Conflict of Interest between Two Principals. Unless otherwise agreed, an agent

may not act for two principals whose interests conflict. Suppose Travis represents both

director Steven Spielberg and actor Jennifer Lawrence. Spielberg is casting the title role

in his new movie, Nancy Drew: Girl Detective, a role that Lawrence covets. Travis cannot

represent these two clients when they are negotiating with each other unless they both

agree to let her. The following Exam Strategy illustrates the dangers of acting for two

principals at once.

EXAMStrategy

Question: The Sisters of Charity was an order of nuns in New Jersey. Faced with

growing healthcare and retirement costs, they decided to sell off a piece of property.

The nuns soon found, however, that the world is not always a charitable place. They

agreed to sell the land to Linpro for nearly $10 million. But before the deal closed,

Linpro signed a contract to resell the property to Sammis for $34 million. So, you say,

the sisters made a bad deal. There is no law against that. But it turned out that the

nuns’ law firm also represented Linpro. Their lawyer at the firm, Peter Berkley, never

told the sisters about the deal between Linpro and Sammis. Was that the charitable—

or legal—thing to do?

Both this case and Pure Power provide examples of agents who competed against their principal. You may well be in this situation at some point in your own life. As we saw in the Ethics

chapter, rationalization is a common, and dangerous, trap. Imagine how Klein, Belliard, and

Fell might have rationalized their wrong-doing. What steps can you take to ensure that you do

not fall prey to this same ethics trap?

Ethics

On the other hand, use of information based on general business knowledge or gleaned from general business

experience is not covered by the rule, and the former agent

is permitted to compete with his former principal in reliance

on such general publicly available information. The evidence

presented herein is not at all convincing that the information

imparted to Bright Tunes by Klein was publicly available.

While the initial attempt to purchase [the copyright

to “He’s So Fine”] was several years removed from the

eventual purchase on [Klein]’s own account, we are not

of the view that such a fact rendered [Klein] unfettered in

the later negotiations. Taking all of these circumstances

together, we agree that [Klein’s] conduct did not meet the

standard required of him as a former fiduciary.

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Secretly Dealing with the Principal. If a principal hires an agent to arrange a transaction,

the agent may not become a party to the transaction without the principal’s permission.

Suppose Spielberg hires Trang to read new scripts for him. Unbeknownst to Spielberg, Trang

has written her own script, which she thinks would be ideal for him. But she may not sell

it to him without revealing that she wrote it herself. Spielberg may be perfectly happy to

buy Trang’s script, but he has the right, as her principal, to know that she is the person with

whom he is dealing.

Appropriate Behavior. An agent may not engage in inappropriate behavior that reflects

badly on the principal. This rule applies even to off-duty conduct. While off-duty (but still

in uniform), a coed trio of flight attendants went wild at a hotel bar in London. They kissed

and caressed each other, showed off their underwear, and poured alcohol down their trousers.

The airline fired two of the employees and gave a warning letter to the third.

Other Duties of an Agent

Before Taylor left for a five-week trip to Antarctica, he hired Angie to rent out his vacation

house for a year. Angie neither listed his house on the Multiple Listing Service used by all

the area brokers, nor posted it online, but when the Fords contacted her looking for rental

housing, she did show them Taylor’s place. They offered to rent it for $2,000 per month.

Angie emailed Taylor in Antarctica to tell him. He responded that he would not accept

less than $3,000 a month, which Angie thought the Fords would be willing to pay. He told

Angie to email him back if there was any problem. The Fords decided that they would go no

higher than $2,500 a month. Although Taylor had told Angie that he had no cell phone service

in Antarctica, she texted him the Fords’s counteroffer. Taylor never received it, so he failed

to respond. When the Fords pressed Angie for an answer, she said she could not get in touch

with Taylor. Not until Taylor returned home did he learn that the Fords had rented another

house. Did Angie violate any of the duties that agents owe to their principals?

Duty to Obey Instructions. An agent must obey her principal’s instructions unless the

principal directs her to behave illegally or unethically. Taylor instructed Angie to email him

if the Fords rejected the offer. When Angie failed to do so, she violated her duty to obey

instructions. If, however, Taylor had asked her to say that the house’s basement was dry when

in fact a river flowed through it every spring, Angie would be under no obligation to follow

those illegal instructions.

Duty of Care. An agent has a duty to act with reasonable care. In other words, an agent must

act as a reasonable person would, under the circumstances. A reasonable person would not

have texted Taylor while he was in Antarctica.

Under some circumstances, an agent is held to a higher—or lower—standard than usual.

An agent with special skills is held to a higher standard because she is expected to use those

skills. A trained real estate agent should know enough to post all listings online.

Strategy: Always begin by asking if there is an agency relationship. Was there consent,

control, and a fiduciary relationship? Consent: Berkley had agreed to work for the nuns.

Control: they told him what he was to do—sell the land. The purpose of a fiduciary

relationship is for one person to benefit another. The point of the nuns’ relationship

with Berkley was for him to help them. Once you know there is an agency relationship,

then ask if the agent has violated his duty of loyalty.

Result: You know that an agent is not permitted to act for two principals whose

interests conflict. Here, Berkley was working for the nuns, who wanted the highest

possible price for their land, and Linpro, who wanted the lowest price. Berkley has

violated his duty of loyalty.

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But suppose Taylor had asked his neighbor, Jed, to help him sell the house. Jed is not a

trained real estate agent, and he is not being paid, which makes him a gratuitous agent. A

gratuitous agent is held to a lower standard because he is doing his principal a favor and, as

the old saying goes, you get what you pay for—up to a point. Gratuitous agents are liable if

they commit gross negligence, but not ordinary negligence. If Jed, as a gratuitous agent, texted

Taylor an important message because he forgot that Taylor could not receive these messages

in Antarctica, he would not be liable for that ordinary negligence. But if Taylor had, just that

day, sent Jed an email complaining that he could not get any text messages, Jed would be

liable for gross negligence and a violation of his duty.

Duty to Provide Information. An agent has a duty to provide the principal with all information in her possession that she has reason to believe the principal wants to know. She also

has a duty to provide accurate information. Angie knew that the Fords had counteroffered

for $2,500 a month. She had a duty to pass this information on to Taylor.

Principal’s Remedies When the Agent Breaches a Duty

A principal has three potential remedies when an agent breaches her duty:

• Damages. The principal can recover from the agent any damages the breach has

caused. Thus, if Taylor can rent his house for only $2,000 a month instead of the

$2,500 the Fords offered, Angie would be liable for $6,000—$500 a month for one year.

• Profits. If an agent breaches the duty of loyalty, he must turn over to the principal any

profits he has earned as a result of his wrongdoing. Thus, after Klein violated his duty

of loyalty to Harrison, he forfeited profits he would have earned from the copyright of

“He’s So Fine.” Some states also allow punitive damages against disloyal employees.

• Rescission. If the agent has violated her duty of loyalty, the principal may rescind

the transaction. When Trang sold a script to her principal, Spielberg, without telling

him that she was the author, she violated her duty of loyalty. Spielberg could rescind

the contract to buy the script.6

28-1c Duties of Principals to Agents

Because an agent’s job can be so varied, the law needs to define that person’s duties carefully.

The role of the principal, on the other hand, is typically less complicated—often little more

than paying the agent as required by the agreement. Thus, the law enumerates fewer duties

for the principal. Primarily, the principal must indemnify (i.e., reimburse) the agent for reasonable expenses and cooperate with the agent in performing agency tasks. The respective

duties of agents and principals can be summarized as follows:

Duties of Agents to Principals Duty of Principals to Agents

Duty of loyalty Duty to compensate as provided by the agreement

Duty to obey instructions Duty to indemnify for reasonable expenses

Duty of care Duty to cooperate with the agent

Duty to provide information

Gratuitous agent

Someone not paid for performing duties

6A principal can rescind his contract with an agent who has violated her duty but, as we shall see later

in the chapter, the principal might not be able to rescind a contract that the agent has made with a

third party.

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Duty to Indemnify

As a general rule, the principal must indemnify the agent for any expenses she has reasonably

incurred. These reimbursable expenses fall into three categories:

• A principal must indemnify an agent for any expenses or damages reasonably incurred

in carrying out his agency responsibilities. Peace Baptist Church of Birmingham,

Alabama, asked its pastor to buy land for a new church. He paid part of the purchase

price out of his own pocket, but the church refused to reimburse him. Although the

pastor lost in church, he won in court.7

• A principal must indemnify an agent for tort claims brought by a third party if

the principal authorized the agent’s behavior and the agent did not realize he was

committing a tort. Marisa owns all the apartment buildings on Elm Street, except

one. She hires Rajiv to manage the units and tells him that, under the terms of the

leases, she has the right to ask guests to leave if a party becomes too rowdy. But she

forgets to tell Rajiv that she does not own one of the buildings, which happens to

house a college sorority. One night, when the sorority is having a raucous party, Rajiv

hustles over and starts ejecting the noisy guests. The sorority is furious and sues

Rajiv for trespass. If the sorority wins its suit against Rajiv, Marisa would have to pay

the judgment, plus Rajiv’s attorney’s fees, because she had told him to quell noisy

parties and he did not realize he was trespassing.

• The principal must indemnify the agent for any liability to third parties that the agent

incurs as a result of entering into a contract on the principal’s behalf, including

attorney’s fees and reasonable settlements. An agent signed a contract to buy

cucumbers for Vlasic Food Products Co. to use in making pickles. When the first

shipment of cucumbers arrived, Vlasic inspectors found them unsuitable and

directed the agent to refuse the shipment. The agent found himself in a pickle when

the cucumber farmer sued. The agent notified Vlasic, but the company refused to

defend him. He settled the claim himself and, in turn, sued Vlasic. The court

ordered Vlasic to reimburse the agent because he had notified them of the suit and

had acted reasonably and in good faith.8

Duty to Cooperate

Principals have a duty to cooperate with their agent:

• The principal must furnish the agent with the opportunity to work. If Lewis agrees to

serve as Ida’s real estate agent in selling her house, Ida must allow Lewis access

to the house. It is unlikely that Lewis will be able to sell the house without taking

anyone inside.

• The principal cannot unreasonably interfere with the agent’s ability to accomplish his

task. Ida allows Lewis to show the house, but she refuses to clean it and then makes

disparaging comments to prospective purchasers. “I really get tired of living in such

a dark, dreary house,” she says. “And the neighborhood children are vicious thugs.”

This behavior would constitute unreasonable interference with an agent.

• The principal must perform her part of the contract. Once the agent has successfully

completed the task, the principal must pay him, even if the principal has changed her

mind and no longer wants the agent to perform. Ida is a 78-year-old widow who has

lived alone for many years in a house that she loves. Her asking price is outrageously

7Lauderdale v. Peace Baptist Church of Birmingham, 246 Ala. 178 (S. Ct. AL 1944).

8Long v. Vlasic Food Products Co., 439 F2d 229 (4th Cir. 1971).

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high because she does not really want to sell. She put her house on the market so that

she could show it to all the nice young families who move to town. When Lewis actually finds a couple willing to pay Ida’s price, she rejects the offer. But the contract had

provided that Lewis would find a willing buyer at the asking price. Because he has

done so, Ida must pay his real estate commission even if she refuses to sell her house.

28-1d Terminating an Agency Relationship

Either the agent or the principal has the right to terminate the agency relationship at any

time (although there may be financial consequences). In addition, the relationship sometimes

terminates automatically.

Termination by Agent and/or Principal

The two parties—principal and agent—have these choices in terminating their relationship:

• Term agreement. If the principal and agent agree in advance how long their relationship will last, they have a term agreement. For example:

• Time. Alexandra hires Boris to help her add to her collection of guitars previously

owned by rock stars. If they agree that the relationship will last two years, they

have a term agreement.

• Achieving a purpose. The principal and agent can agree that the agency relationship will terminate when the principal’s goals have been achieved. Alexandra and

Boris might agree that their relationship will end when Alexandra has purchased

ten guitars.

• Mutual agreement. No matter what the principal and agent agree at the start, they

can always change their minds later on, so long as the change is mutual. If Boris

and Alexandra originally agree to a two-year term, but Boris decides he wants to

go to business school and Alexandra runs out of money after only one year, they

can decide together to terminate the agency.

• Agency at will. If they make no agreement in advance about the term of the agreement, either principal or agent can terminate at any time.

• Wrongful termination. A principal and agent have a personal relationship. Hiring an

agent is not like buying a book. You might not care which copy of the book you buy,

but you do care which agent you hire. If an agency relationship is not working out,

the courts will not force the agent and principal to stay together.

Either party always has the power to terminate. They may not, however, have the right. If

one party’s departure from the agency relationship violates the agreement and causes harm

to the other party, the wrongful party must pay damages. Nonetheless, he will be permitted

to leave. If Boris has agreed to work for Alexandra for two years but he wants to leave after

one, he can leave, provided he pays Alexandra the cost of hiring and training a replacement.

If the agent is a gratuitous agent (i.e., is not being paid), he has both the power and the

right to quit any time he wants, regardless of the agency agreement. If Boris is doing this job

for Alexandra as a favor, he will not owe her damages when he stops work.

Principal or Agent Can No Longer Perform Required Duties

If the principal or the agent is unable to perform the duties required under the agency agreement, the agreement terminates:

• Either the agent or the principal fails to obtain (or keep) a required license. Caleb

hires Allegra to represent him in a lawsuit. If she is disbarred, their agency agreement terminates because the agent is no longer allowed in court. Alternatively, if

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Emil hires Bess to work in his gun shop, their agency relationship terminates when

he loses his license to sell firearms.

• The bankruptcy of the agent or the principal affects their ability to perform required

duties. Bankruptcy rarely interferes with an agent’s responsibilities. After all,

there is generally no reason why an agent cannot continue to act for the principal whether the agent is rich or poor. If Lewis, the real estate agent, becomes

bankrupt, he can continue to represent Ida or anyone else who wants to sell a

house. The bankruptcy of a principal is different, however, because after filing for

bankruptcy, the principal loses control of his assets. A bankrupt principal may be

unable to pay the agent or honor contracts that the agent enters into on his behalf.

Therefore, the bankruptcy of a principal is more likely to terminate an agency

relationship.

• Either the principal or the agent dies or becomes incapacitated. Agency is a personal

relationship that requires action. If either party is unable to act, whether through

death or incapacity, the relationship ends.9

• The agent violates her duty of loyalty. Agents are appointed to represent the principal’s interest; if they fail to do so, there is no point to the relationship. Thus, in the

Pure Power case, Belliard’s and Fell’s agency relationship with Brenner automatically

ended once they engaged in disloyal activities. She had the right to fire them on the

spot, whether or not they had employment contracts.

Change in Circumstances

After the agency agreement is negotiated, circumstances may change. If these changes are

significant enough to undermine the purpose of the agreement, the relationship ends automatically. For example:

• War. Andrew hired Melissa to open a branch of his clothing store in Syria. But

after civil war broke out, Melissa could no longer reasonably believe that Andrew

wished to have a branch there. Her authority terminated automatically.

• Change of law. Oscar hired Marta to ship him succulent avocados from California’s

Imperial Valley. Before she sent the shipment, Mediterranean fruit flies were

discovered, and all fruits and vegetables in California were quarantined. The

agency agreement terminated because it had become illegal to ship the California

avocados.

• Loss or destruction of subject matter. Sam hired Damian to sell his New Orleans

home, but before Damian could even measure the living room, Hurricane Katrina

destroyed it. The agency agreement automatically terminated.

Effect of Termination

Once an agency relationship ends, the agent no longer has the authority to act for the principal.

If she continues to act, she is liable to the principal for any damages he incurs as a result. The

Mediterranean fruit fly quarantine ended Marta’s agency. If she sends Oscar the avocados

anyway and he is fined for possession of a fruit fly, Marta must pay the fine.

The agent loses her authority to act, but some of the duties of both the principal and agent

continue even after the relationship ends:

9Restatement (Third) of Agency §§3.05, 3.06, 3.07, 3.08.

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• Principal’s duty to indemnify agent. Oscar must reimburse Marta for expenses

she incurred before the agency ended. If Marta accumulated mileage on her car

during her search for the perfect avocado, Oscar must pay her for gasoline and

depreciation. But he owes her nothing for her expenses after the agency relationship ends.

• Confidential information. An agent is not entitled to use confidential information

even after the agency relationship terminates. In the George Harrison case earlier in

the chapter, the former agent was wrong to use confidential information to negotiate

on his own behalf the purchase of the “He’s So Fine” copyright.

28-2 LIABILITY TO THIRD PARTIES

Thus far, this chapter has dealt with the relationship between principals and agents. Although

an agent can dramatically increase his principal’s ability to accomplish her goals, an agency

relationship also dramatically increases the risk of legal liability to third parties. A principal

may be liable in tort for any harm the agent causes and also liable in contract for agreements

that the agent signs. Indeed, once a principal hires an agent, she may be liable to third parties

for the agent’s acts, even if he disobeys instructions. Agents may also find themselves liable

to third parties.

28-2a Principal’s Liability for Contracts

Many agents are hired for the primary purpose of entering into contracts on behalf of their

principals. Salespeople, for example. Most of the time, the principal is pleased to be liable on

these contracts. But even if the principal is unhappy (because, say, the agent has disobeyed

orders), the principal generally cannot rescind contracts entered into by the agent. After all,

if someone is going to suffer, it should be the principal who hired the disobedient agent, not

the innocent third party.

The principal is liable for the acts and statements of his agent if (1) the agent had

authority or (2) the principal ratified the acts of the agent. In other words, the principal

is as responsible as if he had performed those acts himself. Thus, when a lawyer lied on

an application for malpractice insurance, the insurance company was allowed to void the

policy for the entire law firm. It was as if the firm had lied. In addition, the principal is

deemed to know any information that the agent knows or should know.

Authority

A principal is bound by the acts of an agent if the agent had authority. There are three types

of authority: express, implied, and apparent. Express and implied authority are categories

of actual authority because the agent is truly authorized to act for the principal. In apparent authority, the principal is liable for the agent’s actions even though the agent was not

authorized.

Express Authority. The principal grants express authority by words or conduct that, reasonably interpreted, cause the agent to believe the principal desires her to act on the principal’s

account.10 In other words, the principal asks the agent to do something and the agent does

it. Craig calls his stockbroker, Alice, and asks her to buy 100 shares of Banshee Corp. for his

account. She has express authority to carry out this transaction.

10Restatement (Third) of Agency §2.01.

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Unit 6 Agency and Employment Law

Implied Authority. Unless otherwise agreed, authority to conduct a transaction includes

authority to do acts that are reasonably necessary to accomplish it.11 The principal does

not have to micromanage the agent. After David inherits a house from his grandmother,

he hires Nell to auction off its contents. She advertises the event, rents a tent, and generally does everything necessary to conduct a successful auction. After withholding her

expenses, she sends the balance to David. Totally outraged, he calls her phone, “How

dare you buy ads and rent a tent? I never gave you permission! I absolutely refuse to pay

these expenses!”

David is wrong. A principal almost never gives an agent absolutely complete instructions.

Unless some authority is implied, David would have had to say, “Open the car door, get in,

put the key in the ignition, drive to the store, buy stickers, mark an auction number on each

sticker, …” and so forth. To solve this problem, the law assumes that the agent has authority

to do anything that is reasonably necessary to accomplish her task.

Apparent Authority. A principal can be liable for the acts of an agent who is not, in fact,

acting with authority if the principal’s conduct causes a third party reasonably to believe that

the agent is authorized.12 In the case of express and implied authority, the principal has

authorized the agent to act. Apparent authority is different: The principal has not authorized

the agent, but has done something to make an innocent third party believe the agent is

authorized. As a result, the principal is every bit as liable to the third party as if the agent had

had authority.

Zbigniew Lambo and Scott Kennedy were brokers at Paulson Investment Co., a stock

brokerage firm in Oregon. The two men violated securities laws by selling unregistered

stock, which ultimately proved to be worthless. Kennedy and Lambo were liable, but they

were unable to repay the money. Either Paulson or its customers would have to bear the

loss. What is the fair result? The law takes the view that the principal is liable, not the third

party, if the principal, by word or deed, allowed the third party to believe that the agent was

acting on the principal’s behalf. In that case, the principal could have prevented the third

party from losing money.

Although the two brokers did not have express or implied authority to sell the stock (Paulson

had not authorized them to break the law), the company was nonetheless liable on the

grounds that the brokers had apparent authority. Paulson had sent letters to its customers

notifying them when it hired Kennedy. The two brokers made sales presentations at

Paulson’s offices. The company had never told customers that the two men were not authorized

to sell this worthless stock.13 Thus the agents appeared to have authority, even though they

did not. Of course, Paulson had the right to recover from Kennedy and Lambo, if they still

had assets.

Remember that the issue in apparent authority is always what the principal has done

to make the third party believe that the agent has authority. Suppose that Kennedy and

Lambo never worked for Paulson but, on their own, printed up Paulson stationery. The

company would not be liable for the stock the two men sold because it had never done

or said anything that would reasonably make a third party believe that the men were

its agents.

Ratification

If a person accepts the benefit of an unauthorized transaction or fails to repudiate it, then he

is as bound by the act as if he had originally authorized it. He has ratif ied the act.14

11Restatement (Third) of Agency §2.02.

12Restatement (Third) of Agency §2.03.

13Badger v. Paulson Investment Co., 311 Ore. 14 (S. Ct. OR 1991).

14Restatement (Third) of Agency §4.01.

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Chapter 28 Agency Law

707

Many of the cases in agency law involve instances in which one person acts without

authority for another. But sometimes, after the fact, the principal decides that he approves

of what the agent has done even though it was not authorized at the time. The law would

be perverse if it did not permit the principal, under those circumstances, to agree to the deal

the agent has made. The law is not perverse, but it is careful. Even if an agent acts without

authority, the principal can decide later to be bound by her actions as long as these requirements are met:

• The “agent” indicates to the third party that she is acting for a principal.

• The “principal” knows all the material facts of the transaction.

• The “principal” accepts the benefit of the whole transaction, not just part.

• The third party does not withdraw from the contract before ratification.

A night clerk at the St. Regis Hotel in Detroit was brutally murdered in the course of

a robbery. A few days later, the Detroit News reported that the St. Regis management had

offered a $1,000 reward for any information leading to the arrest and conviction of the

killer. Two days after the article appeared, Robert Jackson turned in the man who was subsequently convicted of the crime. But then it was Jackson’s turn to be robbed—the hotel

refused to pay the reward on the grounds that the manager who had made the offer had no

authority.

Jackson still had one weapon left: He convinced the court that the hotel had ratified the

offer. One of the hotel’s owners admitted he read the Detroit News. The court concluded that

if someone reads a newspaper, he is sure to read any articles about a business he owns; therefore, the owner must have been aware of the offer. He accepted the benefit of the offer

by failing to revoke it publicly by, say, announcing to the press that the reward was invalid.

This failure to revoke constituted a ratification, and the hotel was liable.15

Subagents

Many of the examples in this chapter involve a single agent

acting for a principal. Real life is often more complex. Daniel,

the owner of a restaurant, hires Michaela to manage it. She

in turn hires chefs, waiters, and dishwashers. Michaela is

called an intermediary agent—someone who hires subagents

for the principal. Daniel has never even met the restaurant

help, yet they are his subagents.

As a general rule, an agent has no authority to delegate

her tasks to another unless the principal authorizes her to

do so. But when an agent is authorized to hire a subagent,

the principal is as liable for the acts of the subagent as he is

for the acts of a regular agent. After Daniel authorizes

Michaela to hire a restaurant staff, she hires Lydia to serve

as produce buyer. When Lydia buys food for the restaurant,

Daniel must pay the bill.

28-2b Agent’s Liability for Contracts

The agent’s liability on a contract depends upon how much the third party knows about the

principal. Disclosure is the agent’s best protection against liability.

15Jackson v. Goodman, 69 Mich. App. 225 (1976).

Intermediary agent

Someone who hires subagents

for the principal

Subagent

Someone appointed by an agent

to perform the agent’s duties

If these subagents serve rotten tomatoes, the owner

of the restaurant is liable.

FRANCES M. ROBERTS/Newscom

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