One of the first premises of the law of agency is that the agent is engaged in the business of the principal. Therefore the agent has a duty to act solely for the benefit of and in accord with the principal�s directions. Under the rules of agency law, an agent is a fiduciary of the principal. Thus an agent occupies a special position of trust that imposes on the agent a duty of loyalty to the principal.

The comprehensive and legalistic definition above can be stated less precisely, but more simply, by breaking it down into its several parts as follows:

There are many different kinds of principal and agent relationships. One type is referred to as master and servant. This term, once in common use, is now largely limited to defining relationships for purposes of determining personal injury liability. It is applicable, for example, when a person is injured or his or her property damaged by another person�s employee.

For employment purposes, the more common terms are employer and employee or employer and independent contractor. However, the latter relationship is not really an agency relationship; it is actually a contractual arrangement between two independent contractors.

There are only a few limitations on the principal�s liability for the acts of his or her agent. For liability to attach to the principal, the agent�s action must meet one of the following three criteria:

Capacity is a term with a specific definition in the law. If a person or entity has legal capacity, then he, she, or it is eligible to accept authority or responsibility to act for another.

Capacity is not the same as authority or permission. For example, a 21-year-old American citizen residing in Philadelphia has the capacity to vote in municipal elections. Until that person registers to vote, however, he or she does not have the right, permission, or authority to vote.

Legal capacity is required for persons or entities to act as principals or as agents. The capacity required to perform either role is different. Lesser capacity is required to be an agent than to be a principal.

Not every person or entity may be a principal. To be a principal one must have the capacity to execute a contract. Minors, incompetents, and other natural persons with limited contractual capacity may be restricted in their ability to be a principal or even prohibited entirely from becoming a principal. Adult persons of limited mental capacities or adults who are temporarily incapacitated (for example, while intoxicated) are not permitted to appoint agents freely. Under modern legal theory, minors have contractual capacity for necessities and thus may be principals and appoint agents for any item deemed to be necessary (food, shelter, and so on). This is complicated by the fact that there is no uniform definition of what falls within the term "necessary." Consequently the practical result is that very few people are willing to contract with minors for anything, and even fewer people will deal with the agent of a minor.

A corporation has contractual capacity and can be a principal. The corporation�s ability to appoint an agent is limited to the scope of activities authorized in its articles of incorporation. This caused some problems in the past because lawyers used to draft the articles of incorporation to encompass only those activities contemplated by the incorporators (for example, to operate a railroad). However, since modern legal practice is to create a corporation with the ability to conduct any business the law allows, there are few limitations on a corporation�s capacity to act as a principal.

Partnerships can usually act as principals, although there are two legal theories to explain how. Where state law does not treat a partnership as a legal entity, the partnership itself is not technically capable of being a principal. In these states, because the partnership lacks contractual capacity, the individual partners are deemed to be the principal and the partnership�s agent is really the agent of the partners. In states where a partnership is a legal entity, this fiction need not be observed, and the partnership can act directly as a principal through its agents.

When an agent creates a contract on behalf of the agent�s principal, the agent is not a party to that contract. A contract signed by an agent is the contract of the principal, not the agent. Thus the agent need not have contractual capacity in order to create binding contracts for his or her principal.

Since it is not necessary that an agent have contractual capacity, there are fewer limitations on who can serve as an agent. Minors and incompetent persons who do not have the capacity to act as principals and appoint agents still have the capacity to act as the agent for another as long as they are capable of understanding the assignments given to them and can transmit information.

Regardless of whether the agent has contractual capacity, it is also the general rule that an agent will not be personally liable to a third party on a contract entered into by him or her on behalf of a principal if the identity of the principal and the fact of the agency relationship are disclosed to the third party. In the context of an insurance agent�s relationships with his or her clients this means that for an insured to recover against the insurance agent, the basis of the agent�s liability must arise from something other than the terms of the insurance policy and the agency or brokerage contract. A producer is not likely to incur personal liability to an insured (under the law of agency) as long as the producer is clearly understood to be the agent of the insurer and stays within that role. However, the law of agency may operate to impose unexpected duties and liabilities on producers who are also found to be agents of the insured. (This will be more fully discussed below.)

Many businesses are regulated by government at various levels because of the impact they have on the general public. Agents may not be appointed to act in these businesses-examples are law, real estate, public accounting, and insurance�unless they meet the state licensing requirements. Insurance is a business that so manifestly affects the public welfare that it is subject to considerable governmental regulation�primarily at the state level. Thus the capacity to be an insurance agent and the capacity to appoint insurance agents are closely regulated. Only persons licensed by the state may act as insurance agents. Only those insurers approved by the state may act as principals and employ agents to offer their products for sale in the state. A person who wants to become an insurance agent must meet the state requirements to obtain and maintain the license to sell insurance. An insurance company that wants to appoint agents must meet the state requirements for being admitted to business in that state.