10.3 Contracts, Agency, and Business Entities

Business Law on REG

The 2026 AICPA REG blueprint assigns Business Law (Area II) a 15-25% weighting. These are short fact patterns: Was a contract formed? Did the agent bind the principal? Is an owner personally liable? Who has a remedy after breach? Identify the relationship first, then apply the rule.

Agency

An agency relationship exists when a principal authorizes an agent to act on the principal's behalf and subject to the principal's control, and the agent consents. No consideration is required. Authority comes in three forms:

• Actual express authority — the principal's spoken or written instructions.
• Actual implied authority — power reasonably necessary to carry out the express authority (e.g., a store manager hired to "run the store" can buy inventory).
• Apparent authority — arises from the principal's manifestations to a third party, never from the agent's own claims. A secret limitation unknown to the third party does not defeat it.
• Ratification — a principal later adopts an unauthorized act with full knowledge of the material facts; the whole act must be ratified, not just the favorable parts.

Agents owe duties of loyalty, obedience, care, accounting, and notification. Principals owe compensation, reimbursement, and indemnification per the agreement. A principal is vicariously liable for an employee's torts within the scope of employment (respondeat superior) but generally not for an independent contractor's torts.

Worked example. A company tells its sales clerk privately, "Do not sign contracts over $10,000," but gives the clerk the title and forms normally used for large deals. A customer reasonably relying on that appearance binds the company through apparent authority; the private cap is irrelevant to the third party.

Contracts

A valid contract requires offer, acceptance, consideration, capacity, and legality. Common-law rules govern services and real estate; UCC Article 2 governs sales of goods and is more flexible.

Formation. Under common law, an acceptance that changes material terms is a counteroffer (the mirror-image rule). Under the UCC Sec. 2-207 "battle of the forms," additional terms between merchants can become part of the contract unless they materially alter it, the offer limits acceptance to its terms, or it is objected to. Consideration requires a bargained-for exchange; the pre-existing duty rule means doing what you already owe is not new consideration — but UCC sales-contract modifications need no new consideration if made in good faith.

Statute of Frauds. A signed writing is required for:

Performance and discharge. Duties end through complete performance, accord and satisfaction, novation (substituting a new party), mutual rescission, impossibility, commercial impracticability, frustration of purpose, or operation of law (bankruptcy discharge, statute of limitations).

Breach and remedies. A material breach excuses the non-breaching party and allows suit; a minor breach allows suit only for actual damages. Remedies aim to give the injured party the benefit of the bargain (expectation damages). Specific performance is available when the subject is unique (real estate, rare goods) and money damages are inadequate; it is never ordered for personal-service contracts. Liquidated damages are enforceable only if a reasonable forecast of harm and not a penalty.

Business Entities

Entity choice fixes authority and liability:

• Sole proprietorship — no separate entity; owner has unlimited personal liability.
• General partnership — arises automatically when two or more persons carry on a business for profit as co-owners, even without filings; partners are mutual agents and jointly and severally liable.
• Limited partnership (LP) — at least one general partner (full liability) and limited partners (liability capped at investment if they avoid management control).
• LLP — partners shielded from other partners' malpractice; common for professional firms.
• LLC — members enjoy limited liability with pass-through taxation; may be member-managed or manager-managed.
• Corporation — shareholders are not personally liable (absent piercing the corporate veil). Directors owe fiduciary duties and rely on the business judgment rule when acting in good faith, on reasonable information, without self-interest.

Exam Pattern

Label each person first: principal, agent, buyer, seller, partner, member, manager, shareholder, director, officer, surety, or creditor. The legal consequence usually follows the relationship and the authority or formation facts.