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An agent with authority normally can’t be held personally liable for a contract made on behalf of a principal. This lesson explains those special circumstances when an agent may be held liable for a contract.

Agency

Business transactions are often conducted through the use of an agency relationship.

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This means two parties have a business relationship where one party acts on behalf of the other party. The first party is a principal and is the party who gives legal authority to another to act on his or her behalf. The second party is an agent and is the party who is legally authorized to act on behalf of the principal when dealing with a third party.The principal will be obligated, or bound, by any contracts the agent makes on his or her behalf as long as the agent acts with the principal’s authority to make the contract. This means that the agent must generally act with the approval of the principal. If the agent makes authorized business contracts with a third party, the principal will be obligated to fulfill those contracts, but the agent won’t be.Generally speaking, the agent’s liability for a contract depends on whether or not the principal’s identity is revealed to the third party.

A principal can be disclosed, partially disclosed or undisclosed. Let’s take a look at how the principal’s status affects an agent’s liability for authorized contracts.

Disclosed Principal

Most contracts made through an agency relationship disclose both the fact of the agency and the identity of the principal.

An agent won’t have personal liability for contracts made on behalf of a disclosed principal. A principal is considered to be disclosed if the third party knows or reasonably should know that the agent acts on behalf of a principal and also knows the identity of that principal.For example, let’s say that Patricia hires Angelo to act as her agent. Angelo negotiates a contract between Patricia and Tyler, a third party.

Patricia will deliver 100 of her special peach pies to Tyler. Angelo executes the contract and signs Patricia’s name with the words ‘by Angelo.’ Patricia is a disclosed principal.

Tyler knows about Angelo’s agency and knows that his contract is with Patricia, the principal.Patricia is a disclosed agent even if Angelo signs the contract with his own name. In this case, Angelo’s signature must be accompanied by sufficient words of agency in order for him to avoid liability. For instance, Angelo can sign his name with the words ‘for Patricia.

‘ Or, he can sign his name with his official title showing agency, such as ‘Angelo, Sales Representative for Patricia’s Peach Pies.’

Partially Disclosed Principal

Sometimes a business contract is made using a partially disclosed principal. This means that the third party knows the agent is acting on behalf of a principal but doesn’t know the identity of the principal. An agent is personally liable for contracts made using a partially disclosed principal.

If the third party can uncover the identity of the principal, then the principal can also be held liable for the contract. Keep in mind that the third party must usually decide which of the two he or she will sue. The third party won’t be permitted to recover damages from both parties.For example, let’s say Patricia is also a well-known real estate investor.

She builds large shopping malls, which sometimes isn’t popular with residential neighbors and smaller businesses. She sends her employee, Angelo, to negotiate the purchase of several homes that have recently been rezoned, so she can acquire a large tract of land for her next mall. Patricia suspects that the neighbors won’t sell to her, so she instructs Angelo not to identify her. Angelo discloses the fact that he’s an agent for a real estate developer but doesn’t say who it is.

Patricia is, therefore, a partially disclosed principal.

Undisclosed Principal

An agent is also personally liable for a contract made using an undisclosed principal. This means that the third party doesn’t know there’s an agency and doesn’t know the principal’s identity. In this case, the third party is led to believe that the agent works alone. Therefore, the third party believes the agent is the only other party to the contract.

If there’s a breach of contract, the third party will seek recovery only from the agent. The agent may then seek recovery from the principal. Or, if the third party later discovers the fact of the agency and the principal’s identity, then the third party can choose to seek recovery directly from the principal.For example, let’s say Patricia is an avid philanthropist.

She makes large donations to several charities a year but prefers to work anonymously. She sends her employee, Angelo, to research and interview several different local charities, so that she can decide who she’d like to donate to next. Angelo meets with the charities and tells them he’s researching a viable candidate for a large donation but never tells them he’s representing someone else or that the gift won’t be from him. Patricia is, therefore, an undisclosed principal.

Lesson Summary

Let’s review. It’s common for business transactions to be conducted through the use of agency relationships. An agency is when two parties have a business relationship where one party acts on behalf of the other party. The first party is a principal and is the party who gives legal authority to another to act on his or her behalf. The second party is an agent and is the party who is legally authorized to act on behalf of the principal when dealing with a third party.As long as the agent acts with the principal’s authority to make the contract, the principal will be bound by that contract. Sometimes the agent is also bound by the contract.

The agent’s liability for a contract depends on whether or not the principal’s identity is revealed to the third party. A principal can be disclosed, partially disclosed or undisclosed. A disclosed principal is one where the third party knows or reasonably should know that the agent acts on behalf of a principal and also knows the identity of that principal.

An agent won’t have personal liability for contracts made on behalf of a disclosed principal.A partially disclosed principal is one where the third party knows the agent is acting on behalf of a principal but doesn’t know the identity of the principal. An agent is personally liable for contracts made using a partially disclosed principal. An undisclosed principal is one where the third party knows neither the fact of the agency nor the identity of the principal.

An agent is personally liable for a contract made using an undisclosed principal since the third party will believe the agent acts alone.

Learning Outcomes

Once you’ve finished with this lesson, you will have the ability to:

  • Define agency relationship, principal and agent
  • Describe the circumstances under which an agent can be bound by a contract
  • Differentiate between disclosed principal, partially disclosed principal and undisclosed principal

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