5.1 Authority of Agents and Principals

5.1 Authority of Agents and Principals

The AICPA REG blueprint (Area II, Group A, Topic 1) tests agency as state common-law doctrine — Restatement-style, not a Code section. An agency arises when a principal manifests assent that an agent will act on the principal's behalf and subject to the principal's control, and the agent consents so to act. REG items then ask a practical question: who is bound on the contract, and on what theory of authority?

Formation: agreement or operation of law

Most agencies are formed by agreement. The agreement may be oral, written, or inferred from conduct. Consideration is not required to create the relationship — a gratuitous agent is still an agent — although consideration matters later for the agent's claim to pay. Capacity tracks the underlying act: the principal must have capacity to do the thing authorized; a minor principal can often disaffirm the transaction. The agent need not have full contractual capacity. A sixteen-year-old can bind a competent adult principal to a supply order.

A spouse, roommate, co-shareholder, or co-employee is not an agent by status alone. Partnership-partner and corporate-officer authority is a related, distinct topic in entity formation and management.

Agencies also arise by operation of law:

• Estoppel / apparent authority. If the principal's manifestations cause a third party reasonably to believe that a person is an agent, the principal may be bound even though no actual-agency agreement exists.
• Necessity / emergency. When an unforeseen emergency threatens the principal's property and the agent cannot reach the principal, the agent may have emergency authority to take reasonably necessary protective steps that would otherwise exceed the grant.

Actual authority: express versus implied

Actual authority is power created by the principal's manifestations to the agent. It is a principal–agent conversation, not a conversation with the market.

• Express actual authority is stated in words — a board resolution, an engagement letter, an email, or an oral instruction: "Order toner from our usual vendor up to $2,000."
• Implied actual authority is authority the agent reasonably believes is necessary or incidental to carry out the express grant, or that is customary for the position and locale. An office manager hired to "run the office" reasonably believes she may buy paper, pay the copier lease, and hire a weekend cleaner within a customary budget. She does not reasonably believe she may mortgage the building, confess a judgment, or sell the business.

Implied authority includes incidental authority (steps reasonably necessary to the assigned task) and customary authority (what agents in that trade ordinarily do). A secret limitation the principal communicates only to the agent cuts actual authority as between them. It does not, by itself, cut apparent authority as to a third party who never hears the limitation.

Apparent authority: manifestations to the third party

Apparent authority is created by the principal's manifestations to the third party, not by the agent's self-description. The third party must reasonably believe the actor is authorized, and that belief must be traceable to the principal. Titles, desks, business cards, letterhead, website listings, and continued portal access after a firing are classic manifestations. An agent's boast — "I can bind the firm to anything" — is not a principal manifestation.

Apparent authority can exist without actual authority, and actual authority can exist without apparent authority. A purchasing agent told privately never to exceed $500 still binds the principal to a $4,000 order from a regular vendor who has always dealt with that agent at higher amounts, if the principal never notified the vendor of the cap.

Apparent authority is a disclosed or unidentified-principal doctrine: the third party must think it is dealing with a principal through an agent. A purely undisclosed principal is bound, if at all, through actual authority or ratification, not through the third party's belief that the actor is someone else's representative.

Ratification

Ratification is the principal's after-the-fact adoption of an unauthorized act. The transaction is then treated as authorized from the outset (relation back). REG-tested requirements:

1. The actor purported to act for the principal (or, for an undisclosed principal, the principal later elects to take the transaction).
2. The principal existed and had capacity at the time of the act and at ratification.
3. The principal knew all material facts, or ratified with awareness that it lacked those facts.
4. The principal ratifies the entire transaction. The principal cannot ratify in part to the third party's detriment — keep the profitable equipment and reject the related service covenant.
5. The third party has not already withdrawn.

Silence, acceptance of benefits, or suing to enforce the deal can be ratification by conduct. Once the principal ratifies, the principal cannot un-ratify because the market moved.

Emergency authority

When an unexpected threat to the principal's property or interests arises and communication with the principal is impracticable, an agent may take reasonably necessary protective action even beyond the ordinary grant. Selling perishable inventory after a freezer failure, or hiring a night watchman after a break-in, fits. Luxury upgrades and speculative new product lines do not.

Termination of authority — and the notice problem

Actual authority ends by:

Apparent authority can survive as to third parties who lack notice. REG's favorite trap: the principal fires a salesperson but leaves cards, a public title, and an active email. Until the principal notifies customers — actual notice to those who have dealt with the agent; constructive notice, such as a public announcement, to others — the fired salesperson can still bind the firm on customary orders. Treat notice as the exam pivot, including when a living principal revokes and when death or incapacity is unknown to the third party.

A power coupled with an interest (the agent holds a proprietary interest in the subject matter, not merely a right to be paid) is irrevocable and is the classic exception to at-will revocation.

Disclosed, unidentified, and undisclosed principals

Who is liable on an authorized contract depends on what the third party knows at the time of contracting:

If the agent has no authority and the principal does not ratify, the principal is not bound. The agent is then liable to the third party for breach of the implied warranty of authority, developed with duties in 5.2.

Equal dignity rule

If the underlying contract must be in writing under the statute of frauds (land, a contract not performable within one year, and similar categories), the authorization to make that contract must also be in writing. That is the equal dignity rule. An oral appointment can still create an agency for acts that themselves need no writing. Land-sale authority is the classic REG application; a routine supply order is not. The writing rules for contracts themselves are in contract formation.

Authority types at a glance

Worked scenario: office manager orders supplies

Facts. Westbrook LLC hires Dana as office manager "to keep the office running." Custom in the trade is that office managers order supplies from a handful of vendors, typically under $3,000 per purchase. Westbrook's owner privately tells Dana never to exceed $400 without a countersignature. Dana orders $2,200 of paper and toner from Pacific Office, a vendor that has filled similar Dana-signed orders for a year. Pacific has never been told of the $400 cap.

Analysis. The private $400 cap cuts actual authority at $400. Pacific, however, may rely on apparent authority: Westbrook put Dana in the role, allowed a course of dealing above $400, and never notified Pacific of the cap. Westbrook is bound to Pacific on the $2,200 order. Westbrook's remedy, if any, is against Dana for exceeding instructions, not a defense against Pacific.

Worked scenario: terminated salesperson still has business cards

Facts. Meridian fires Pat on Monday and confiscates the laptop, but does not retrieve business cards and sends no notice to the customer list. On Wednesday Pat, still carrying a Meridian card, writes a routine reorder for Coastal, a customer that has bought from Pat for three years. Coastal has no reason to know of the firing.

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