Flyover 1 - Agency Formation

Welcome to the first agency and partnership flyover lesson. We're calling these flyover lessons because we'll be moving quickly and covering essential territory. My goal here is not to teach you every possible thing about agency and partnership law, but to give you core concepts you can apply on the MEE.

Formation

We're going to start with agency relationships. A critical thing to know in this context is how principal-agent relationships form. Although there are significant legal consequences when agency relationships exist, an agency relationship can be created without any paperwork and without the principal understanding all the possible liability. The Restatement gives us a widely accepted definition for agency formation.

Agency is the fiduciary relationship that arises when one person, a principal, manifests assent to another person, an agent, that the agent shall act on the principal's behalf and subject to the principal's control, and the agent manifests assent or otherwise consents so to act.

To put this definition into use, there are three core elements. First, an agent acts on the principal's behalf and for the principal's benefit; second, the agent agrees to act under the principal's control; third, both the agent and the principal manifest assent to this arrangement. You don't need an employment agreement or anything that formal to manifest assent, simply some indication from the principal and the agent that the agent will be acting under some degree of the principal's control and for the principal's benefit.

The control element often generates some confusion. Acting under the principal's control does not mean that the agent has to be closely supervised by the principal or do everything that the principal says. As long as the agent has accepted some guidance or instruction from the principal, that will be enough. If I give someone my credit card and send them to buy me a soda from a particular vendor, that will likely be enough to create an agency relationship.

Types

Agency relationships come in many different varieties. You may encounter both employee agents and non-employee agents on the MEE. Non-employee agents are also often referred to as independent contractors. Now you may be wondering, how do you sort employee agents from non-employee agents? The test here is whether the principal controls the manner and means that agents use to perform their work.

Employee Agents

If the principal controls the manner and means of an agent's work, it's usually an employment relationship. Typically, an employee will work from an employer's facilities and use the employer's tools or other assets to perform the work. Employees are generally integrated into the principal's operations in a meaningful way.

Non-Employee Agents

Non-employee agents are different. They enjoy more freedom. The principal does not control the manner and means of their work. Think about what happens when you call an electrician to your house and ask them to put in a new electrical outlet. You may tell them where you want the outlet, but you don't tell them how to go about wiring it up or what tools to use to accomplish the task. Independent contractors generally have more freedom to apply their expertise to particular projects.

Terminating Agency Relationships

Agency relationships may terminate in a variety of different ways. The simplest is for the principal to manifest to an agent that the principal revokes the agent's ability to act on behalf of the principal. Simply telling an agent that you no longer desire their services suffices to terminate the relationship. Imagine you have painters working on your house and they've done a terrible job, slopping paint all over your floors. You might tell them to stop and that you don't want them to work anymore. If they continue to paint after that, they're not your agents.

Agency relationships also terminate if a key party dies, namely, the agent or the principal. Similarly, if the principal remains alive but has lost the capacity to contract or supervise an agent, the agency relationship will also terminate. Agents can also end agency relationships by simply telling the principal that they no longer wish to serve.

Agency relationships may also terminate if the principal and the agent have agreed that the relationship would terminate if certain events occur. For example, you might hire a laborer to dig until they hit rock or some other mineral. Once the shovel started scraping on rock, the laborer should reasonably know that the agency relationship has terminated.

Fiduciary Duties

We'll be talking about fiduciary duties a good bit in this series, so it's a good time to introduce them. Agents owe fiduciary duties to their principals. Fiduciary duties usually break down into duties of loyalty and duties of care. In the principal-agent context, you may also see a duty of obedience.

Duty of Loyalty

An agent generally has a duty to act loyal for the principal's benefit and all matters connected with the agency relationship. This means that the agent must put the principal's interest first and disclose any conflicts to the principal. This means that an agent should not be taking any undisclosed payments from third parties that the principal does not know about.

It also means that the agent cannot act on behalf of an adverse party when dealing with the principal. An agent must act on the principal's behalf. This also means that an agent cannot compete with a principal while simultaneously working on their behalf.

The duty of loyalty also includes a duty not to misappropriate the principal's property or information. An agent is not allowed to communicate the principal's confidential information for their own purposes while acting as an agent.

Of course, an agent may communicate when acting on a principal's behalf and use the principal's property and information to work for the principal. The duty of loyalty puts up a boundary line here, though. If the agent isn't acting for the principal, the agent cannot use the principal's property or information.

Duty of Care

When an agent acts for a principal, she has a duty to act with the care, competence, and diligence normally exercised by agents in similar circumstances. This is a duty to exercise reasonable care. If an agent claims to have some special skills, the standard rises to how people with those special skills would behave.

Duty of Obedience

An agent also generally has a duty of obedience. This means that the agent must obey all reasonable instructions about the manner of performing a service. An agent is liable to the principal for damages resulting from acting against the principal's instructions.

Summary

Many questions in this space will turn on whether a person acts as an agent for another. Having a good grasp of agency formation will make it much easier to spot agency relationships on the MEE. You always want to look to see if the principal and agent have both somehow manifested an understanding that the agent will work on the principal's terms. After you have an agency relationship, be on the lookout for any violation of the agent's fiduciary duties of loyalty and care.