The formation and constitution
of business organizations
CHAPTER 12 AGENCY LAW
INTRODUCTION
In this chapter we examine how an agency relationship arises and how the
agent's authority is acquired and defined. Agency is the foundation of most
business relationships where more than one person engages in commerce
together. Examples include partnerships and companies, which we shall
introduce in the next chapter.
'Agents' are employed by 'principals' to perform tasks which the principals
cannot or do not wish to perform themselves. This is often because the
principal does not have the time or expertise to carry out the task.
If business people did not employ the services of agents, they would be
weighed down by the contractual details, and would probably get little else
done!
When parties enter into an agency arrangement, the principal gives a measure
of authority to the agent to carry out tasks on his behalf. We shall look at the
extent and limits of that authority in Section 3.
The agent contracts and deals with third parties on behalf of the principal. We
shall look at the relationship between agents and the third parties they deal with
in Section 4.
Exam guide
Agency may form a knowledge question requiring you to explain what agents are, how agency
relationships are established and their authority and liability to others.
1 Role of agency and agency relationships
Agency is a relationship which exists between two legal persons (the principal and the agent) in which the
function of the agent is to form a contract between his principal and a third party. Partners, company
directors, factors, brokers and commercial agents are all acting as agents.
Agency is a very important feature of modern commercial life. It can be represented diagrammatically as
follows:
For instance Pendo may ask Alan to take Pendo's shoes to be repaired. Pendo and Alan expressly agree
that Alan is to do this on Pendo's behalf. In other words, Alan becomes her agent in making a contract
between Pendo and Thierry, the shoe repairer, for her shoes to be mended.
1.1 Types of agent
In practice, there are many examples of agency relationships, to which you are probably aware of in
everyday life, although you might not know that they illustrate the law of agency. The most important
agency relationships for the F4 syllabus are those of partners and company directors.
Types of agent
Partners This is a particularly important example of agents in your syllabus as accountants
who own and run an accountancy practice together are partners, and are therefore
agents of each other.
Company directors This is another important example of agency in your syllabus. Company directors
act as agents of their company.
Types of agent
Promoters A promoter is someone (except professionals acting in their professional capacity)
who undertakes to form a company.
Factors A factor, sometimes called a mercantile agent, is a person whose job is to sell or buy
goods on behalf of another person. For example, motor dealers are often factors.
Brokers A broker may operate in many trades. He is essentially an intermediary who
arranges contracts in return for commission. For example, an insurance broker.
Auctioneers Auctioneers are agents authorised to sell property at auction on behalf of the seller.
When an auctioneer accepts a bid from a buyer, he becomes the agent of the buyer
for the purpose of making a record of the sale.
Commercial agents A commercial agent is an independent agent who has continuing authority in connection
with the sale or purchase of goods.
2 Formation of agency 12/07
The relationship of principal and agent is created by mutual consent in the vast majority of cases. This
agreement does not have to be formal or written.
The mutual consent comes about usually by express agreement, even if it is informal. However, it may
also be implied agreement, due to the relationship or conduct of the parties.
2.1 Express agreement
This is where the agent is expressly appointed by the principal. This may be orally, or in writing. In most
commercial situations, the appointment would be made in writing to ensure that everything was clear. An
agent expressly appointed by the principal has actual authority of the principal to act on their behalf.
2.2 Implied agreement
An agency relationship between two people may be implied by their relationship or by their conduct.
For example if an employee's duties include making contracts for his employer, say by ordering goods on
his account, then they are, by implied agreement, the agent of the employer for this purpose. An agent
authorised in this way is said to have implied authority.
2.3 Ratification of an agent's act: retrospective agreement
A principal may subsequently ratify an act of an agent retrospectively.
An agency relationship may be created retrospectively, by the 'principal' ratifying the act of the 'agent'.
Therefore it is created after the 'agent' has formed a contract on behalf of the 'principal'. If the principal
agrees to the acts of the agent after the event, he may approve the acts of the agent and make it as if they
had been principal and agent at the time of the contract.
The conditions for ratification are:
• The principal must have existed at the time of the contract made by the agent
• The principal must have had legal capacity at the time the contract was made
• The ratification must take place within reasonable time
• He ratifies the contract in its entirety
• He communicates his ratification to the third party sufficiently clearly
Once a contract has been ratified by the principal, the effect is that it is as if the agency relationship had
been expressly formed before the contract made by the agent took place.
2.4 Formation of agency agreement without consent
An agency may be created, or an agent's authority may be extended, without express consent. This
happens by estoppel, when the principal 'holds out' a person to be his agent, and when there is an agent
of necessity.
2.4.1 Implied agreement
In some cases, an agency created by implied agreement might result in the agent having more implied
authority than the principal might have consented to.
2.4.2 Agent by estoppel
An agency relationship may be formed by implication when the principal holds out to third parties that a
person is his agent, even if the principal and the 'agent' do not agree to form such a relationship. In such a
case, the principal is estopped from denying the agent's apparent/ostensible authority, hence the name
'agent by estoppel'. An agency relationship is not so formed if it is the 'agent' who creates the impression
that he is in an agency relationship with a 'principal'.
2.4.3 Agent by necessity
In some rare situations, it may be necessary for a person to take action in respect of someone else's
goods in an emergency situation. That person can become an agent of necessity of the owner of the
goods, as he takes steps in respect of the goods.
Illustration
A seller is shipping frozen goods to a buyer in another country. While the ship is docked, the freezers in
the ship break down and the relevant part required to fix them cannot be obtained. If the ship's captain
(acting as the agent of necessity) cannot make contact with the owner of the goods, he might, of
necessity, sell the goods while they are still frozen, rather than allow them to spoil by defrosting.
This is particularly rare, because it would only occur when the 'agent' could not make contact with the
'principal', which in the modern world is extremely unlikely.
This principle is a historic part of English shipping and merchant law and you should be aware that it
might be possible, but do not worry about the other details of the doctrine.
3 Authority of the agent
If an agent acts within the limits of his authority, any contract he makes on the principal's behalf is
binding on both principal and third party. The extent of the agent's authority may be express, implied or
ostensible. Express and implied authority are both forms of actual authority.
A principal does not give the agent unlimited authority to act on his behalf. A contract made by the agent
is binding on the principal and the other party only if the agent was acting within the limits of his
authority from his principal.
In analysing the limits of an agent's authority, three distinct sources of authority can be identified:
• Express authority
• Implied authority
• Ostensible authority
3.1 Express authority 12/07
Express authority is a matter between principal and agent. This is authority explicitly given by the principal
to the agent to perform particular tasks, along with the powers necessary to perform those tasks.
The extent of the agent's express authority will depend on the construction of the words used on his
appointment. If the appointment is in writing, then the document will need to be examined. If it is oral,
then the scope of the agent's authority will be a matter of evidence. If the agent contracts outside the
scope of his express (actual) authority, he may be liable to the principal and the third party for breach of
warrant of authority.
ILLUSTRATION
A board of directors may give an individual direct express authority to enter the company into a specific
contract. The company would be bound to this contract, but not to one made by the individual director
outside the express authority.
3.2 Implied authority 12/07
Where there is no express authority, authority may be implied from the nature of the agent's activities or
from what is usual or customary in the circumstances. Between principal and agent the latter's express
authority is paramount. The agent cannot contravene the principal's express instructions by claiming that
he had implied authority for acting in the way he did. As far as third parties are concerned, they are
entitled to assume that the agent has implied usual authority unless they know to the contrary.
Watteau v Fenwick 1893
The facts: The owner of a hotel (F) employed the previous owner (H) to manage it. F forbade H to buy
cigars on credit but H did buy cigars from W. W sued F for payment but F argued that he was not bound
by the contract, since H had no actual authority to make it, and that W believed that H still owned the
hotel.
Decision: It was within the usual authority of a manager of a hotel to buy cigars on credit and F was bound
by the contract (although W did not even know that H was the agent of F) since his restriction of usual
authority had not been communicated.
Hely-Hutchinson v Brayhead Ltd 1968
The facts: The chairman and chief executive of a company acted as its de facto managing director, but he
had never been formally appointed to that position. Nevertheless, he purported to bind the company to a
particular transaction. When the other party to the agreement sought to enforce it, the company claimed
that the chairman had no authority to bind it.
Decision: Although the director derived no authority from his position as chairman of the board, he did
acquire authority from his position as chief executive. Therefore the company was bound by the contract
as it was within the implied authority of a person holding such a position.
ILLUSTRATION
A principal employs a stockbroker to sell shares. It is an implied term of the arrangement between them
that the broker shall have actual authority to do what is usual in practice for a broker selling shares for a
client. Any person dealing with the broker is entitled to assume (unless informed to the contrary) that the
broker has the usual authority of a broker acting for a client.
3.3 Actual authority
Express and implied authority are sometimes referred to together as actual authority. This distinguishes
them from ostensible or apparent authority.
Actual authority is a legal relationship between principal and agent created by a consensual agreement
between them.
3.4 Apparent/ostensible authority 12/07
An agent's apparent or ostensible authority may be greater than his express or implied authority. This
occurs where a principal holds it out to be so to a third party, who relied on the representation and altered
his position as a result. It may be more extensive than what is usual or incidental.
The ostensible (or apparent) authority of an agent is what a principal represents to other persons that he
has given to the agent (authority by ‘holding out’). As a result, an agent with express or implied authority
which are limited can be held in practice to have a more extensive authority.
Apparent/ostensible authority usually arises either
(a) Where the principal has represented the agent as having authority even though he has not actually
been appointed
(b) Where the principal has revoked the agent's authority but the third party has not had notice of
this: Willis Faber & Co Ltd v Joyce 1911.
3.4.1 The extent of ostensible authority
Ostensible authority is not restricted to what is usual and incidental. The principal may expressly or by
inference from his conduct confer on the agent any amount of ostensible authority.
3.4.2 Example: partnership
A partner has considerable but limited implied authority by virtue of being a partner. If, however, the
other partners allow him to exercise greater authority than is implied, they have represented that he has
wider authority. They will be bound by the contracts which he makes within the limits of this ostensible
authority.
3.4.3 Example: companies
Freeman & Lockyer v Buckhurst Park Properties (Mangal) Ltd 1964
The facts: K and H carried on business as property developers through a company which they owned in
equal shares. Each appointed another director, making four in all. H lived abroad and the business of the
company was left entirely under the control of K. As a director K had no actual or apparent authority to
enter into contracts as agent of the company, but he did make contracts as if he were a managing director
without authority to do so. The other directors were aware of these activities but had not authorised them.
The claimants sued the company for work done on K's instructions.
Decision: There had been a representation by the company through its board of directors that K was the
authorised agent of the company. The board had authority to make such contracts and also had power to
delegate authority to K by appointing him to be Managing Director. Although there had been no actual
delegation to K, the company had by its acquiescence led the claimants to believe that K was an authorised
agent and the claimants had relied on it. The company was bound by the contract made by K under the
principle of 'holding out' (or estoppel). The company was estopped from denying (that is, not permitted to
deny) that K was its agent although K had no actual authority from the company.
It can be seen that it is the conduct of the 'principal' which creates ostensible authority. It does not
matter whether there is a pre-existing agency relationship or not.
This is important – ostensible authority arises in two distinct ways. It may arise where a person makes a
representation to third parties that a particular person has the authority to act as their agent without
actually appointing them as their agent. Alternatively, it may arise where a principal has previously
represented to a third party that an agent has authority to act on their behalf.
3.4.4 Representations creating ostensible authority
The representation must be made by the principal or an agent acting on his behalf. It cannot be made
by the agent who is claiming ostensible authority. Armagas Ltd v Mundogas SA, The Ocean Frost 1986.
It must be a representation of fact, not law, and must be made to the third party. This distinguishes
ostensible authority from actual authority, where the third party need know nothing of the agent's
authority.
3.4.5 Reliance on representations
It must be shown that the third party relied on the representation. If there is no causal link between the
third party's loss and the representation, the third party will not be able to hold the principal as liable.
ILLUSTRATION
If the third party did not believe that the agent had authority, or if they positively knew they did not, then
ostensible authority cannot be claimed. This is true even if the agent appeared to have authority.
3.4.6 Alteration of position following a representation
It is enough that the third party alters his position as a result of reliance on the representation. He does
not have to suffer any detriment as a result, but damages would in such an event be minimal.
QUESTION
Ostensible authority
Give three examples of occasions when ostensible authority may arise.
ANSWER
• Where a person allows another person, who is not his agent, to appear as if he is.
• Where a principal allows his agent to give the impression that he has more extensive authority than
is really the case.
• Where, following termination of the agency relationship, a principal allows his former agent to
continue to appear to be his agent.
3.5 Revocation of authority
Where a principal has represented to a third party that an agent has authority to act, and has subsequently
revoked the agent's authority, this may be insufficient to escape liability. The principal should inform
third parties who have previously dealt with the agent of the change in circumstances. This is particularly
relevant to partnerships and the position when a partner leaves a partnership.
3.6 Termination of agency
Agency is terminated by agreement or by operation of law (death, insanity, insolvency).
Agency is terminated when the parties agree that the relationship should end.
It may also be terminated by operation of law in the following situations:
• Principal or agent dies
• Principal or agent becomes insane
• Principal becomes bankrupt, or agent becomes bankrupt and this interferes with his position as
agent
Termination brings the actual authority of the agent to an end. However, third parties are allowed to
enforce contracts made later by the 'agent' until they are actively or constructively informed of the
termination of the agency relationship.
4 Relations between agents and third parties
An agent usually has no liability for a contract entered into as an agent, nor any right to enforce it.
Exceptions to this: when an agent is intended to have liability; where it is usual business practice to have
liability; when the agent is actually acting on his own behalf; where agent and principal have joint liability.
A third party to a contract entered into with an agent acting outside his ostensible authority can sue for
breach of warranty of authority.
4.1 Liability of the agent for contracts formed
An agent contracting for his principal within his actual and/or apparent authority generally has no liability
on the contract and is not entitled to enforce it. However, there are circumstances when the agent will
be personally liable and can enforce it.
(a) When he intended to undertake personal liability – for example where he signs a contract as
party to it without signifying that he is an agent.
(b) Where it is usual business practice or trade custom for an agent to be liable and entitled.
(c) Where the agent is acting on his own behalf even though he purports to act for a principal.
Where an agent enters into a collateral contract with the third party with whom he has contracted on the
principal's behalf, there is separate liability and entitlement to enforcement on that collateral contract.
It can happen that there is joint liability of agent and principal. This is usually the case where an agent did
not disclose that he acted for a principal.
4.2 Breach of warranty of authority
An agent who exceeds his ostensible authority will generally have no liability to his principal, since the
latter will not be bound by the unauthorised contract made for him. But the agent will be liable in such a
case to the third party for breach of warranty of authority.
CHAPTER ROUNDUPFORWARD
• Agency is a relationship which exists between two legal persons (the principal and the agent) in which the
function of the agent is to form a contract between his principal and a third party. Partners, company
directors, factors, brokers and commercial agents are all acting as agents.
• The relationship of principal and agent is created by mutual consent in the vast majority of cases. This
agreement does not have to be formal or written.
• The mutual consent comes about usually by express agreement, even if it is informal. However, it may
also be implied agreement, due to the relationship or conduct of the parties.
• A principal many later ratify an act of an agent retrospectively.
• An agency may be created, or an agent's authority may be extended, without express consent. This
happens by estoppel, when the principal 'holds out' a person to be his agent, and when there is an agent
of necessity.
• If an agent acts within the limits of his authority, any contract he makes on the principal's behalf is
binding on both principal and third party. The extent of the agent's authority may be express, implied or
ostensible. Express and implied authority are both forms of actual authority.
• An agent's apparent or ostensible authority may be greater than his express or implied authority. This
occurs where a principal holds it out to be so to a third party, who relied on the representation and altered
his position as a result. It may be more extensive than what is usual or incidental.
• Agency is terminated by agreement or by operation of law (death, insanity, insolvency).
• An agent usually has no liability for a contract entered into as an agent, nor any right to enforce it.
Exceptions to this: when an agent is intended to have liability; where it is usual business practice to have
liability; when the agent is actually acting on his own behalf; where agent and principal have joint liability.
• A third party to a contract entered into with an agent acting outside his ostensible authority can sue for
breach of warranty of authority.
QUICK QUIZ
1 Fill in the blanks in the statements, using the words in the boxes below.
Agency is the (1)…………..…...…. which exists between two (2)………...….…… persons. They are the
(3)…………... and the agent, in which the function of the agent is to form a (4)……………. between his
(5)……………. and a (6)……………
• relationship • contract • legal
• third party • principal • principal
2 A principal may, in certain circumstances, ratify the acts of the agent which has retrospective effect.
True
False
3 What is the best definition of ostensible authority?
(a) The authority which the principal represents to other persons that he has given to the agent.
(b) The authority implied to other persons by the agent's actions.
4 What point of law is explained in the case of Freeman & Lockyer v Buckhurst Park Properties (Mangal) Ltd
1964?
5 Which of the following are circumstances where an agent may enforce a contract?
(a) Where the agent is intended to take personal liability
(b) Where it is usual business practice to allow enforcement
(c) Where the agent acts on his own behalf even if he purports to act for a principle
(i) (a), (b)
(ii) (b), (c)
(iii) (a), (c)
(iv) (a), (b) and (c)
ANSWERS TO QUICK QUIZ
1 (1) relationship (2) legal (3) principal
(4) contract (5) principal (6) third party
2 True. Principals may ratify retrospectively.
3 (a). The key word is represents.
4 A director may have ostensible authority to contract if although he does not have their express permission,
the other directors are aware that contracts are being made and do nothing to prevent it.
5 (iv). They are all valid circumstances.
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