Business Entity Law

This section examines the law related to business entities. It begins with the basic rules of agency relationships and then provides a discussion of the basic forms of business organizations (sole proprietorships, general partnerships, limited partnerships, and corporations). Finally, it ends with a more in-depth treatment of corporate law, including corporate governance.

Agency Relationships

What is Agency?

Most people are familiar with the use of the word “agent” from interactions in their daily lives. Common examples of agency relationships are real estate agents, who buy or sell a house on your behalf, or stockbrokers, who buy and sell shares on your behalf. More formally, agency “is a relationship that exists when one party represents another party in the formation of legal relations.” The agent is the “person who is authorized to act on behalf of another” and the principal is the “person who has permitted another to act on his behalf.” Agents are often given authority to bind principals in contractual relationships.

Creation of an Agency Relationship

Agency relationships arise in one of three ways:

1. Express authority (agency by express agreement) – An oral or written contract appoints the agent and gives her specific authority to act on behalf of the principal.

2. Apparent authority (agency by conduct; agency by estoppel) – No agreement exists, but the actions or statements of the principal give a third party a reasonable impression that the agent has authority to act on behalf of principal.

3. Ratification – There is no express or apparent authority, but a principal accepts a contract that was negotiated on his behalf without his authority. Figure 4-29 sets out the requirements for ratification.

Figure : Ratification of an Agency Relationship

The Scope of an Agent’s Authority

Actual Authority

A principal is bound by any actions that are within the agent’s actual authority. In this context, actual authority refers to authority that was:

1. Expressly given (orally or in writing); or

2. Could be implied by the principal’s conduct (e.g., principal pays for the goods); or

3. Could be implied based on the usual authority given to a person appointed to that position (e.g., corporate secretary) (also referred to as commercial usage).

The principal is bound whether or not the third party is aware of the exact scope of the agent’s actual authority.

Apparent Authority

Apparent authority is authority that a third party is entitled to assume the agent possesses, based on either usual authority or the conduct of the principal. The term holding out is used to refer to conduct where a principal represents someone to be its agent. A principal is bound by contracts within the agent’s apparent authority only if the third party relied on the appearance of that authority. A third party will not be able to enforce a contract if it knew, or should have known, that the agent did not have authority to bind the principal.

Ratification

Finally, a principal will be held liable if it ratifies (subsequently adopts, based on words or actions) a contract that was made by an agent without authority. In effect, the principal establishes the contract retroactively, thus placing the principal, agent, and third party in the same position as they would have been in if the agency relationship had existed at the time of the contract.

When is the Agent Liable?

An agent can be held liable when she is acting on behalf of an undisclosed principal. As long as the agent had authority to act on behalf of the principal, the third party can hold either the agent or the principal liable if the third party later discovers the person it dealt with was only an agent.

As well, an agent can be held liable when he indicates that he is authorized to act for a principal but is in fact not authorized—regardless of whether or not the agent is honestly mistaken. This would be considered a breach of warranty of authority.

Responsibilities of Agent to Principal

Figure identifies the four main duties an agent owes to his or her principal.

Figure: Responsibilities of Agent to Principal

Responsibilities of Principal to Agent

The principal is required to:

1. Pay reasonable remuneration (unless the parties expressly agreed otherwise).

2. Indemnify the agent from expenses reasonably incurred in connection with relationship.

Termination of Agency Relationship

Termination of an agency relationship may occur in a number of ways:

1. At the end of a time, event, or project specified in the agency agreement;

2. On notice by either party; or

3. By circumstances; for example, it becomes impossible for the agent to perform tasks, the principal or the agent dies or becomes insane, or the principal becomes bankrupt.