Is a person authorized to act or represent another person in dealing with third party?

What Is the Principal-Agent Relationship?

The principal-agent relationship is an arrangement in which one entity legally appoints another to act on its behalf. In a principal-agent relationship, the agent acts on behalf of the principal and should not have a conflict of interest in carrying out the act. The relationship between the principal and the agent is called the "agency," and the law of agency establishes guidelines for such a relationship.

Principal-Agent Relationship

Key Takeaways

• A principal appoints an agent to act on their behalf and in their best interest. Examples include an investor picking a fund manager or someone hiring an attorney for legal work. 
• There should be no conflict of interest between the two, if there is, this creates a principal-agent problem. 
• The principal-agent relationship is expressed clearly through a written contract or is implied through actions.

Understanding a Principal-Agent Relationship

A principal-agent relationship is often defined in formal terms described in a contract. For example, when an investor buys shares of an index fund, he is the principal, and the fund manager becomes his agent. As an agent, the index fund manager must manage the fund, which consists of many principals' assets, in a way that will maximize returns for a given level of risk in accordance with the fund's prospectus.

Agents have an obligation to perform tasks with a certain level of skill and care and may not intentionally or negligently complete the task in an improper manner.

The principal-agent relationship can be entered into by any willing and able parties for the purpose of any legal transaction. In simple cases, the principal within the relationship is a sole individual who assigns an agent to carry out a task; however, other relationships under this guise have a principal that is a corporation, a nonprofit organization, a government agency or a partnership.

The agent is most often an individual capable of understanding and ultimately carrying out the task assigned by the principal. Common examples of the principal-agent relationship include hiring a contractor to complete a repair on a home, retaining an attorney to perform legal work, or asking an investment advisor to diversify a portfolio of stocks. In each scenario, the principal is the individual seeking out the service or advice of a professional, while the agent is the professional performing the work.

Special Considerations

Whether the principal-agent relationship is expressed clearly through a written contract or is implied through actions, the principal-agent relationship creates a fiduciary relationship between the parties involved. This means the agent acting on behalf of the principal must carry out the assigned tasks with the principal's best interest as a priority.

The agent is responsible for completing tasks given by the principal so long as the principal provides reasonable instruction. Additionally, the agent has an obligation to perform tasks that will not intentionally harm the principal. A duty of loyalty is also implied within the principal-agent relationship, which requires the agent to refrain from putting himself in a position that creates or encourages conflict between his interest and the interest of the principal, also known as the principal-agent problem.

Given the nature of companies, it is common for them to enter into contracts with third parties by way of an agent. This article explores some of the legal protections for third parties that enter into a contract with a company through its agent and arguments available to a company seeking to disclaim an agreement in those circumstances. In particular, we examine the concept of ostensible authority and how a company can be bound by the acts of its agent when the scope of the agent’s authority may be questioned.  

Defining the company agency relationship

The case of International Harvester Co of Australia Pty Ltd v Carrigan’s Hazeldene Pastoral Co (1958) stated that the agency relationship in the context of a company is a relationship “involving authority or capacity in one person to create or affect legal relations between another person or company and third parties”.

The company agency relationship may arise by:

• Operation of law.

• Agreement between the company and the agent, either by express agreement or implication (Slater v Strawberry John Pty Ltd [2002] WASC 204).

• The company’s ratification of actions performed by the agent (Australian Blue Metal Ltd v Hughes [1962] NSWR 904). For ratification to be effective the following conditions must be met:

  • the agent must be acting on behalf of the company;

  • the company existed at the time of the unauthorised action;

  • the company had contractual capacity at the date of ratification;

  • the company has full knowledge of the details of the transaction;

  • the company ratifies the entire contract.

• Estoppel under the doctrine of apparent or ostensible authority (Rama Corp Ltd v Proved Tin and General Investments Ltd [1952] 2 QB 147). Specifically, when the company’s conduct encourages others to believe that an agency relationship exists, and the third party relies on that conduct, the company cannot later deny that the agency exists (Tooth v Laws (1988) 9 LR(NSW) 154).

Extent of the agent’s authority

An agent must only act within their authority. In circumstances where an agent acts outside of their authority (ie. entering into an agreement with a third party on behalf of the company which is outside the scope of their authority) the company will not be bound.

There are two types of authority that an agent may hold:

• actual authority; and

• ostensible authority.

Ostensible authority

An agent's ostensible authority is the authority as it appears to others, regardless of any limit to the agent's authority agreed between company and agent. Ostensible authority can arise as a matter of law even where the company did not give consent. This is in contrast to actual authority which does not exist without the company’s consent, either express or by acquiescence.

Requirements for ostensible authority to exist

A company can represent (by words or conduct) to an outsider that another person has a certain extent of authority. If the outsider becomes aware of the representation and, acting reasonably, transacts business with the apparent agent, the company will be estopped from denying the representation. The person held out by the company will be treated as having had ostensible authority.

For a company to be bound by acts of persons having ostensible authority to act on its behalf, several common law requirements must be satisfied.

In Freeman & Lockyer (A Firm) v Buckhurst Park Properties (Mangal) Ltd, Diplock LJ stated four conditions, three of which are relevant to Australian companies:

• Holding out
  There must have been a representation, by words or conduct, to the outside contracting party that the person purporting to act on the company's behalf did have authority to enter a contract of the type in question on behalf of the company. That is, the agent must be "held out". The sort of conduct that can create implied actual authority can also amount to a representation for the purposes of ostensible authority. For example, acquiescence by the board can amount to a representation by the board.

• By someone with actual authority
  The representation or conduct must originate from the company, or someone with actual (as opposed to ostensible) authority to act for the company either generally or in relation to the things to which the contract relates. The actual authority may be found in a company's constitution or some act taken pursuant to the constitution.

• On which the other person relied
  The person making the representation must have intended it to be relied upon and it must be shown that the representation was in fact relied upon.

An outsider cannot claim a contract with any company where the outsider has knowledge that there was no actuality given to the apparent agent. Further, an outsider cannot argue for an ostensible authority if a reasonable person in the outsider’s position would have had doubts as to whether the agent had the authority to enter into the transaction.

Indoor management rule and ostensible authority

At common law, if an outsider entered into a contract with a person who purported to act for the company but who did not have relevant authority, the contract (unless ratified) was voidable at the company’s option. To overcome this problem, the common law developed the indoor management rule (IMR).

The IMR is now included in Part 2B.2 of the Corporations Act 2001 (Cth) (Act). Section 128 of the Act outlines the entitlement to make assumptions and section 129 specifies what assumptions can be made.

Under the IMR, an outsider dealing with a company in good faith and without any notice or reasonable grounds for suspicion of wrongdoing is not affected by any actual misconduct by the company in a matter of internal regulation or management. This means an outsider is not obligated to check whether internal action has been taken and may assume that all the company's internal steps have been fulfilled.

Under section 129(3) a person can make the assumption that anyone who is held out by the company to be an officer or agent of the company:

• has been duly appointed; and

• has authority to exercise the powers and perform the duties customarily exercised or performed by that kind of officer or agent of a similar company.

Where there is a dispute regarding the authority of a company's officer or agent in relation to dealings with a company, the onus of proof is on the outsider to establish:

• a holding out by the company that a person is an officer or agent; and

• that the particular power exercised by the person so held out is within the scope of the powers customarily exercised or performed by an officer or agent of a similar company.

Key takeaways

Over time, and from our examination of the legal measures in place, it is clear that the law has endeavoured to strike a balance between the efficient use of agents by companies in business transactions and the protection of third parties dealing with companies in those transactions.

Whilst there are protections in place, there are still areas of vulnerability for third parties entering into agreements with a company’s agent that every party involved in the agreement should keep in mind. In relevant circumstances, we suggest that parties:

• make relevant enquiries into the scope of a company agent’s authority and their capacity to enter into agreements on the company’s behalf;

• take steps to know the company that that they are intending to do business transactions with. Not all companies that enter into business transactions are doing so genuinely; and

• seek legal advice to ensure that an agent’s authority to enter into transactions on the company’s behalf is both binding and legitimate. 

Should you have any questions in relation to this bulletin, please contact the writers to discuss.

Authors: Gavin Stuart, Emma Boyce & Gabriella Porcu

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