CPA REG: Agency Law and Relationships
Guide to agency law for the CPA REG exam covering formation, authority types, principal and agent duties, liability rules, and termination of agency relationships.
Agency Law for the CPA REG Exam
Agency law governs the relationship in which one party (the agent) acts on behalf of another (the principal) with the authority to bind the principal in dealings with third parties. Agency relationships are fundamental to business operations and are tested on the REG exam in the context of business law and professional responsibilities.
Formation of Agency
An agency relationship can be formed by agreement, ratification, estoppel, or operation of law. No consideration is required to form an agency, and a writing is generally not necessary unless the agent will execute contracts that fall within the Statute of Frauds (the equal dignities rule). The three essential elements are consent by the principal, agreement by the agent to act, and the principal's right to control the agent's conduct.
The distinction between an agent and an independent contractor is important. A principal controls the manner and method of an agent's work but controls only the result of an independent contractor's work. This distinction affects liability for torts and the withholding of employment taxes.
Types of Authority
Actual authority is authority that the agent reasonably believes they possess based on the principal's communications. It includes express authority (specifically granted by the principal) and implied authority (reasonably necessary to carry out the express authority, including authority arising from custom, necessity, or prior dealings).
Apparent authority exists when the principal's conduct causes a third party to reasonably believe the agent has authority. It arises from the principal's representations to third parties, not from the agent's claims. Even after actual authority is revoked, apparent authority may continue until third parties are notified of the termination.
Authority by ratification occurs when a principal affirms an unauthorized act after the fact. To be effective, the principal must ratify the entire transaction, must have knowledge of material facts, and must be legally competent. Ratification relates back to the time of the original act.
Duties of Agent to Principal
An agent owes fiduciary duties to the principal, including the duty of loyalty (avoiding conflicts of interest, not making secret profits, not competing with the principal), the duty of obedience (following reasonable instructions), the duty of care (acting with reasonable skill and diligence), the duty to account (maintaining and reporting financial information), and the duty of notification (informing the principal of material facts relevant to the agency).
Duties of Principal to Agent
The principal must compensate the agent as agreed (or for reasonable value if no agreement), reimburse the agent for authorized expenses incurred in carrying out the agency, indemnify the agent against losses suffered without fault in performing authorized acts, and cooperate with the agent by not unreasonably interfering with the agent's performance.
Liability in Agency Relationships
The principal's liability for the agent's contracts depends on whether the principal is disclosed, partially disclosed, or undisclosed. A disclosed principal (whose identity is known to the third party) is liable on contracts made by the agent within the scope of authority. A partially disclosed principal (whose existence but not identity is known) is liable along with the agent. An undisclosed principal (whose existence is unknown) is liable once discovered, and the third party may elect to hold either the principal or the agent liable.
For tort liability, a principal is vicariously liable for torts committed by an agent within the scope of employment under the doctrine of respondeat superior. This applies to employees but generally not to independent contractors. Exceptions where the principal may be liable for an independent contractor's torts include inherently dangerous activities, nondelegable duties, and negligent hiring or supervision.
Termination of Agency
An agency may be terminated by the acts of the parties (mutual agreement, revocation by the principal, renunciation by the agent, or fulfillment of purpose) or by operation of law (death or incapacity of either party, bankruptcy of the principal, impossibility, or change of law). An agency coupled with an interest is irrevocable and is not terminated by the death, incapacity, or bankruptcy of the principal.
Upon termination, the principal must give actual notice to third parties who have previously dealt with the agent and constructive notice (such as publication) to others. Failure to provide notice may result in continued apparent authority.
Exam Tips
- Distinguish between actual authority (express and implied) and apparent authority
- An agent's fiduciary duties include loyalty, obedience, care, accounting, and notification
- A principal's liability on contracts depends on disclosure status (disclosed, partially disclosed, undisclosed)
- Respondeat superior applies to employees acting within the scope of employment
- An agency coupled with an interest is irrevocable
- The equal dignities rule requires written authority when the agent will execute Statute of Frauds contracts
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