What Is a Principal-Agent Relationship in Business?

Types of Agency Relationships in Business

Business Owners Agreement
••• Hero Images/Getty Images

Every business hires professionals for a variety of short-term and long-term purposes. These people become agents, acting for the business, benefitting the business and potentially causing harm to the business. In this article, we’ll look at how this principal/agent relationship works.

What Is a Principal and Agent Relationship? 

The relationship between two people in business or legal matters where one (the principal) has power over the other (the agent). The agent is acting in the place of the principal for specific or general purposes.

The principal is the party who authorizes the other to act in his or her place, and the agent is the person who has the authority to act on behalf of the principal. It’s incredibly important to hire agents who are trustworthy and who can do the job your business has hired them to do.

Why Hire an Agent? 

All agency relationships have a common factor: the principal is hiring the agent to do something that the principal can’t do or doesn’t have time to do. Your corporation’s shareholders appoint the members of the board of directors to take advantage of their expertise in running a business. You hire a real estate agent to find business property for you. You hire employees to make business deals with customers. Sure, you could do that yourself, but that would take time away from your business. 

How Is a Principal and Agent Relationship Started? 

Often, the relationship starts with a contract that sets out the duties of both parties. For example, if an employee is a project manager, they might be acting on your company's behalf in that capacity, based on their job description, but if you ask them to act in a different capacity, that might create an unintentional agency relationship.

Some common examples of an agency contract are a power of attorney form or a contract with a realtor to sell a building your business owns. 

Who Can be a Principal or an Agent? 

Anyone can be a principal or an agent. A court decides if the principal-agent relationship exists, based on the behavior of the two parties. Someone can assume you have made someone your agent even if there is no contract. Be careful not to allow the appearance of agency in your business dealings. For example, if your employee buys something for your business after the employee was fired, your business may still be charged for the purchase. 

What Tasks Can an Agent NOT Do? 

Your agent can’t vote for you, sign your will, or make a statement for you under oath. Also, a contract for personal services can’t be delegated if the person performing the service is essential (for a performance by a singer or famous author, for example).

What are the Types of Agents in Business? 

Principal-agent relationships in a business can be internal (your employees) or external, like a literary agent or your real estate agent. For example:

  • Employees. Hiring an employee doesn’t necessarily mean you are hiring an agent, but if the employee is a corporate officer who signs contracts or writes checks, that person is your agent.
  • Outside contractors. In the same way, hiring an outside contractor doesn’t necessarily mean that a person is an agent. But if the contractor signs documents for you or makes financial decisions, that person is your agent.  

What Are the Duties of the Agent and Principal? 

The agent's duties include:

  • Duty of loyalty. The agent must act according to the principal’s wishes, put the principal’s interest first, and not benefit from the relationship at the principal’s expense. 
  • Duey to obey instructions, including the duty to clarify instructions. 
  • Duty to act with skill and care. An agent is hired because of their specific professional expertise. More expertise means the agent is held to a higher standard. 
  • Duty to notify the principal of important matters that come up in the course of the agent’s service. 
  • Duty to account for time and money spent and property used in the course of the agency relationship.

The principal’s duties include: 

  • Duty to compensate. The principal must pay the agreed-upon fee for the agent's services. This is often done by contract. If there is no written contract, the agent may not be liable for acts not requested or consented to. 
  • Duty to reimburse the agent for expenses incurred as a result of the agency relationship. 
  • Duty to indemnify. The principal gives an implied promise to indemnify (hold harmless) an agent for losses during the time of the relationship

What Happens if a Principal or Agent Doesn’t Do Their Duty? 

If there is a written contract, the agent or principal can sue the other party for breach of contract. Even if there isn’t a written contract, a court can make the principal liable for the actions of an agent. 

How Do I Protect My Business from Bad Agents? 

You can’t protect your business from all misdoings by agents, but you can prevent some bad agent relationships by taking preventive measures, including: 

  • Creating specific job descriptions for agents, 
  • Carefully checking out all agents (including background checks) before you hire them,
  • Making sure contracts are specific and binding, and
  • Monitoring the actions of your agents to make sure they are doing their duties.

Disclaimer: Every business situation is different and agency laws are complex. This article is intended to be a general overview. Get help from your attorney for specific questions.

Article Sources

  1. Legal Information Institute. "Agent," Accessed Nov. 5, 2019.

  2. Legal Information Institute. "Principal," Accessed Nov. 5, 2019. 

  3. Stedman, Barry N. Chapter 16. "Agency," Accessed Nov. 5, 2019.

  4. Stedman, Barry N. Chapter 16. "The Formation of the Agency Relationship," Page 1. Accessed Nov. 5, 2019.

  5. The Legal Environment and Business Law: Master of Accountancy Edition (v. 1.0). Chapter 25.1: Introduction to Agency and the Types of Agents. "Apparent Agency," Accessed Nov. 5, 2019. 

  6. Stedman, Barry N. Chapter 16: Agency. "The Formation of the Agency Relationship," Page 1. Accessed Nov. 5, 2019.

  7. The Legal Environment and Business Law: Master of Accountancy Edition (v. 1.0). Chapter 25.1: Introduction to Agency and the Types of Agents. "Creation of the Agency Relationship," Accessed Nov. 5, 2019.

  8. Harvard Law School Forum on Corporate Governance and Financial Regulation. "Corporate Officers as Agents," Accessed Nov. 5, 2019.

  9. The Legal Environment and Business Law: Master of Accountancy Edition (v. 1.0). Chapter 25.1: Introduction to Agency and the Types of Agents. "Capacity," Accessed Nov. 5, 2019.