What is an agent and how is an agency relationship established?

An agent is a person authorized to act on behalf of another (known as the principal). An agent has the power of one person to bind another. There are two primary steps to determine if an agency relationship has been established:

1. First, have both the principal and agent done something to signify that the agent will be subject to the direction, oversight and control of the principal?
2. Second, have the principal and agent done something to signify that the agent will act on the principal’s behalf?

Answering the first question may seem straightforward, and many times it is, but it isn’t always as easy as looking to see if the “agent” has a signed employment agreement with the company (although that is usually a good indication of an agency relationship).  Agency is not limited to employees, but applies to partners in a partnership, member-managers in an LLC, officers of a corporation, even non-employee independent contractors can become agents of a business. Other factors that can demonstrate the existence of an agency relationship include:

• ownership interest in the business;
• the provision of operating funds to the agent;
• sharing profits between the principal and the agent;
• setting terms and conditions of employment;
• authority to hire and fire;
• payment of salaries; and
• reporting to principal.

While the parties’ characterization of the relationship may be relevant, it is not always conclusive; simply saying that John is not your agent doesn’t make it so if John signs an employment agreement that makes him responsible for signing up new clients for your business. The actions and interaction of the parties is the key.

Once an agency relationship is established, the agent owes certain duties to the principal.  These are legally-imposed duties that may or may not be spelled out in the employment contract or other documents.  These duties, called fiduciary duties, are owed by the agent to the principal, and they include the duty of care and the duty of loyalty.

The duty of care requires that agents exercise good business judgement and use reasonable, ordinary care in carrying out their responsibilities on behalf of the company.

The duty of loyalty is very broad and requires an agent to act loyally for the principal’s benefit in all matters connected with the agency relationship. However, the principal may choose to waive the agent’s duty of loyalty. The agent’s duty of care requires they are careful, competent, and act with diligence. The principal can also waive this duty if they desire to do so.

Now that we know who qualifies as an agent we’ll look at what having an agent means for a business.