Note that agency is defined in terms of the agent�s authority to act for the principal. In the law there is a difference between power and authority, although the terms are not always used by lay persons or lawyers with a clear understanding of the difference. For our purposes, power is the ability to affect the rights and duties of another. Power can be exercised with or without that other person�s authority and consent.

Authority is the ability to affect another person�s rights and duties with that person�s actual or apparent consent. Authority can be exercised only when granted by that person, although in some cases authority to act may be presumed by a third party when the principal has permitted circumstances to exist that justify that assumption.

While agency is not necessarily a contractual relationship, in some cases a contract between the principal and the agent is executed to formalize the nature and scope of the agency being created or granted. This is, of course, the case for life insurance agency relationships. But a contract is not required to create agency, and as mentioned above, a person can create an agency with someone who does not have contractual capacity.

Since a contract is not required to create an agency, the formalities of contract law are also not required. For example, one essential element of the creation of a contract is the exchange of consideration between the parties. This is not true of agency; no consideration is required to appoint an agent. It follows then that absent an agreement to the contrary, compensation to the agent is also not necessary to create an agency relationship. The fact that a contract is not required to create an agency is recognized by our use of the term "appoint an agent," rather than "contract an agent."

An agency relationship is created only after some affirmative act by the principal. No one can make himself or herself the agent of another person without that person�s actual or apparent consent. Consequently there are two basic types of agency authority: actual authority and apparent authority (see table 16-1 for a comparison of agency authority).

Actual authority is further distinguished based on how that actual authority is granted to the agent. Actual authority is either express or implied. Actual express authority is created when the principal either orally or in writing affirmatively "expresses" his or her intent to appoint another party as an agent and that other party consents to the appointment. A principal may limit the scope of an agent�s actual express authority, but if such limitations are to be binding on third parties, they must be clearly communicated to the agent and publicly made known. This is especially so if the limitations take away powers that the public or the agent would reasonably expect the agent to have.

If there is a dispute over the extent of the authority actually granted to the agent, the determination will be based on what the agent (not the principal) reasonably believed his or her scope of authority to be. Since a court cannot read minds, it is not important what the principal believed or intended to grant. The actions of the parties (primarily those of the principal) that manifested their intent will control. Since the principal (and not the agent or the third party) has the ability to expand or limit the scope of the agency granted, he or she bears the burden if any ambiguity arises over the scope of the agent�s authority.

Actual implied authority is sometimes also called incidental authority. By whatever name it is called, actual implied authority is a derivative of actual express authority, and it does not exist in an agent unless there has been an express grant of authority to the agent by the principal. Implied authority is the authority to do all the actions that are necessary to carry out the grant of express authority.

The important distinction between apparent and actual authority is that apparent authority is determined by the reasonable perceptions of the third party. It is the agent�s power as it is reasonably perceived by a person observing the agent. The key to apparent authority is the inducement to a third party to act derived from the acts of the principal that give the agent the appearance of authority to act.

Apparent authority is created when the principal allows conditions to exist that lead a third party (not the purported principal or agent) to reasonably believe that actual authority exists. Apparent authority may exist in addition to a grant of actual express authority, or it may exist when there has been no express grant of actual authority at all. Apparent authority is created when the principal permits its actual agent or an unauthorized person to have the indicia of authority that would lead a third person to believe that agency authority exists.

No one can unilaterally make himself or herself the agent of another person. Consequently those who deal with an agent have an obligation to exercise reasonable diligence and to act in good faith to discover whether the agency actually exists. Agency may not be presumed. However, the third party is not required to establish proof that the principal has conferred actual express authority. If actual authority exists, the principal will be bound by the agent�s actions consistent with that authority. If the agent�s actions are beyond the scope of the actual express grant of authority, the principal will be bound if there were actions by the principal to establish a reasonable belief by the agent that he or she had sufficient implied authority to act.

If no actual express or implied authority to do the act in question exists, apparent authority can be established to bind the principal. The third party needs to establish that the putative agent possessed sufficient indicia of authority that it was reasonable for the third party to believe that the agent had authority to bind the principal. Absent the ability to show that agency exists, everyone deals with an agent at his or her peril. It is the conduct of the principal, not the agent, that must be the basis for establishing the reasonable belief that the agency existed.

Note that the law presumes that the principal has control over its agents. Thus two important rules emerge: (1) The principal is liable if the agent�s wrongful acts within the scope of the agency injure a third party, and (2) the knowledge of the agent is imputed to the principal. These are rules of law that the principal and agent cannot alter by contract. Therefore if an agent acts wrongfully to the detriment of either the principal or a third party and neither of them is at fault, the courts will normally assign the responsibility for that loss to the principal.

A person�s unauthorized actions on behalf of a purported principal may be acts beyond the scope of an actual grant of express or implied authority to an agent, acts done with or beyond the scope of apparent authority, or acts done with no authority whatever but in the name of the purported principal. In any of these circumstances, the principal may wish to accept the benefit of these acts and retroactively claim that person as his or her agent. To do so a ratification must occur.

Ratification is relevant only to unauthorized acts. If an agent�s act is within the scope of the agent�s authority, there is no need for the principal to ratify it.

Ratification requires the following steps:

If the original transaction must be in writing to be effective, then the ratification must also meet the same formalities. Absent a requirement for some formality, any act manifesting the principal�s approval of the act is sufficient for the ratification. Thus in the same way that agency authority may be actual or apparent, so may the ratification.

Ratification may occur if the principal accepts the benefit (such as profits, services, publicity, and so forth) of the agent�s unauthorized activities. Acceptance of the benefits will override the principal�s claimed lack of intent to ratify the act. In addition, ratification may occur if the principal has full knowledge of the facts of the agent�s unauthorized action and fails to repudiate it within a reasonable time.

Ratification has the following results:

An agent has these three basic duties to his or her principal:

As a result of these duties, the agent may not divert the principal�s business to benefit the agent or another party. Similarly, an agent must disclose to the principal any interests that the agent may have that are adverse to the principal�s interests. Except in the rare case of dual agency, which is discussed below, an agent may not serve two principals whose interests are adverse unless both consent.

If the agent violates his or her duties to the principal, the law will hold the agent liable for damages caused by that breach of duty. The remedies available to a principal vary depending on the duty violated.

The wrongful acts of an agent toward a third party may result in a third-party lawsuit against the principal. Such an action could be based on a breach of contract by the agent or by an act of the agent that resulted in a personal injury to another party. If the principal is required by the court to pay damages to the third party, the principal may then recover the amount of the damages from the agent.

The principal may also have a direct action against the agent if the agent breaches the terms of the agency contract or violates a duty owed to the principal. If the agent has failed to perform his or her duties, the principal may terminate the agent�s contract and refuse to pay the agent.

The agency relationship imposes some duties on the principal, and the principal can be held liable to the agent if these duties are not performed. Note that the contract defining the agency relationship may specify otherwise. If there is a contract defining the agency relationship, the principal will be required to abide by the terms of that agreement.

A principal has a general obligation not to interfere with the agent�s opportunity to conduct his or her duties. Unless their contract provides differently, a principal has a general obligation to compensate the agent reasonably and to reimburse the agent for expenses reasonably incurred on the principal�s behalf. Both the principal and the agent have an obligation to keep accurate accounts of the money or other property that is the subject of the agency.

The principal�s duties can be summarized as follows:

If the principal breaches the agency agreement, the agent is entitled to sue the principal for damages incurred as a result of that breach. The agent may also retain any of the principal�s property that is lawfully in the agent�s possession as security for any money that the principal owes to the agent.

Normally, neither the agent nor the principal will be able to sue the other party for specific performance of the agency agreement. This is because an agency agreement is a contract for the performance of personal services, and the law of this country will not require a person to perform personal services against his or her will. If someone refuses to perform personal services as required by a valid contract, the proper remedy is not specific performance but a lawsuit for damages incurred by the failure to perform.

The agent�s knowledge is imputed to the principal. It is a rule of agency law that any material knowledge the agent acquires about a transaction within the scope of the agency will be imputed to the principal. It does not matter if the agent does not, in fact, communicate his or her knowledge to the principal. (This rule does not apply if there has been collusion between the third party and the agent to perpetrate a fraud upon the principal.)

In the majority of states, if an insurance agent knowingly provides false information on an application for life insurance, the insurance company will not be charged with knowing that the information is false. Upon discovery of the material misstatement, the insurer can sue to rescind the policy. This reflects an exception to the general rule of agency law that the knowledge of the agent is the knowledge of the principal.

This exception to the general rule exists despite the fact that in a minority of jurisdictions, the insurer is charged with the agent�s knowledge even in the case of the agent�s participation in a fraud upon the insurer. In these few states, the general rule is strictly applied, and the insurer is bound by the contract even if it is issued in reliance on the false information and would not have been issued if the truth had been known.

There is an additional rule of agency law, however, that works to the benefit of insurers who are defrauded by their agents. This rule states that people who sign a contract are presumed to know the terms of the contract. A majority of jurisdictions have applied this rule to require applicants to read their policies upon receipt and to inform the insurer if there are any material misstatements. Consequently in the majority of jurisdictions, if an agent knowingly falsifies an application that induces an insurer to issue a policy and the applicant does not report the material misstatement to the insurer upon delivery, the insurer will be permitted to sue for rescission of the contract.