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Contractual Liability & Authority of a Principal

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  • 0:05 Agency
  • 0:46 Contractual Liability
  • 1:42 Actual Authority
  • 3:04 Apparent Authority
  • 4:48 Lesson Summary
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Lesson Transcript
Instructor: Ashley Dugger

Ashley is an attorney. She has taught and written various introductory law courses.

Many business transactions are conducted through the use of agency relationships. This means an agent conducts business on behalf of a principal. This lesson discusses the liability of a principal for contracts made by an agent.

Agency

Many business transactions are conducted through the use of an agency relationship. This means two parties have a business relationship where one party acts on behalf of the other party. An agency relationship requires a principal. This is the party who gives legal authority to another to act on his or her behalf in a business transaction.

An agency relationship also requires an agent. This is the party who is legally authorized to act on behalf of the principal when dealing with a third party. All agency relationships involve these two parties.

Contractual Liability

An agent works as an extension of the principal. As long as the agent acts within the scope of authority granted by the principal, the agent's actions obligate the principal as if the principal was present and acted alone. So if the agent makes business contracts with a third party, then the principal will usually be obligated to fulfill those contracts.

The principal will be obligated, or bound, if the agent acts with authority to make the contract. This means that the agent must generally act with the approval of the principal. Acts committed with the approval of the principal are known as 'authorized acts.' The principal will be bound to the contract if the agent acts with either actual authority or apparent authority. Let's take a look at each of these types of authority.

Actual Authority

If an agent acts with actual authority, then that agent acts with the principal's definite permission. However, note that actual authority can be either express or implied.

Express authority is actual authority based on the principal's oral or written statement to the agent. Let's say Penny owns Penny's Pretty Papers, a stationery store. Penny hires Albert to manage the store. Penny specifically tells Albert that it's his job to negotiate and make purchases with the store's paper suppliers. Albert is Penny's agent, and therefore has express authority to make contracts on behalf of Penny, the principal.

Actual authority can also be implied authority. This is actual authority based on the agent's common sense fulfillment of the principal's business. For example, let's say Penny hires Albert to manage Penny's Pretty Papers. As part of Albert's duties, Penny tells him to keep the store well stocked. Ordering paper from the store's suppliers is reasonably necessary to fulfill this duty. Therefore, Albert has implied authority to make contracts with the store's suppliers.

Apparent Authority

The principal will also be bound to the contract if the agent acts with apparent authority. Apparent authority is when a third party reasonably assumes that the principal granted contractual authority to the agent. An agent has apparent authority when a third party reasonably assumes that the principal authorized the agent to make contracts on the principal's behalf, based on the principal's conduct.

Note that apparent authority can exist even when the principal expressly directs the agent not to make contracts on his or her behalf. In this sense, apparent authority can defeat the unauthorized acts of the agent.

For example, let's say Penny hires Albert to work at Penny's Pretty Papers. Albert is the only employee of the store and is left alone to manage the store each day. Penny gives Albert an office in the store and a nametag that says 'Manager.' However, Penny considers herself to be the real manager of the store and told Albert he's not to make any major decisions on behalf of the store.

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