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Why this topic matters
Taxation and Regulation (REG) Business Law covers how agents bind principals, and the legal features of sole proprietorships, partnerships, limited liability companies (LLCs), and corporations — formation, liability, management, and dissolution. The tax side of each entity is covered in the entity taxation topics; here the focus is legal rights and liability.
Agency
Creating an agency
- An agency is a consensual fiduciary relationship: the agent acts on the principal's behalf and subject to its control. It needs no consideration and usually no writing — but if the agent will sign a contract that must be in writing (for example, a sale of land), the authority must also be in writing (the equal dignity rule). A power of attorney is a written authorization.
- Agencies arise by agreement, by ratification, or by estoppel.
- Principals must have capacity; agents need not (a minor can be an agent).
Types of authority
| Authority | Source | Principal bound? |
|---|---|---|
| Express actual | Principal's words to the agent | Yes |
| Implied actual | Reasonably necessary to carry out express authority, or from the agent's position | Yes |
| Apparent | The principal's conduct toward the third party makes it reasonable for the third party to believe the agent has authority | Yes — even if the agent had no actual authority |
| Ratification | After the fact, the principal (with knowledge of all material facts) accepts the entire unauthorized contract | Yes, retroactively |
EXAMPLE: A principal fires a purchasing agent but does not notify a supplier the agent had dealt with for years. The agent later places an order with that supplier. The principal is bound by apparent authority until the supplier receives notice of the termination.
Liability on contracts
| Principal status | Principal liable? | Agent liable? |
|---|---|---|
| Disclosed (third party knows the principal's identity) | Yes | No (if authorized) |
| Partially disclosed (third party knows there is a principal but not who) | Yes | Yes |
| Undisclosed (third party thinks the agent acts for itself) | Yes, once discovered — the third party may elect to hold the principal or the agent | Yes |
An agent who acts without authority is personally liable for breach of the implied warranty of authority.
Liability for torts
- Respondeat superior: an employer is vicariously liable for torts an employee commits within the scope of employment, even without employer fault. Minor detours are within scope; a frolic for purely personal reasons is not.
- Generally no liability for an independent contractor's torts, except for inherently dangerous activities or non-delegable duties.
- Intentional torts are within scope only if they serve the employer's purpose.
- The agent is always personally liable for their own torts; the principal may seek indemnification.
Duties
- Agent to principal: loyalty (no self-dealing, no competing, no secret profits), obedience, reasonable care, accounting, and notification.
- Principal to agent: compensation, reimbursement of expenses, indemnification for losses in authorized acts, and cooperation.
Termination
- By act of the parties: agreement, fulfillment of purpose, lapse of time, revocation by the principal, or renunciation by the agent. Third parties who dealt with the agent must receive actual notice; others need constructive notice (publication) — otherwise apparent authority continues.
- By operation of law: death or incapacity of either party, bankruptcy, destruction of the subject matter, or illegality — no notice required.
- An agency coupled with an interest (the agent holds an interest in the subject matter, such as a lender's power to sell collateral) is not terminated by the principal's death or revocation.
Business structures
| Structure | Formation | Owner liability | Management |
|---|---|---|---|
| Sole proprietorship | No formalities | Unlimited personal liability | The owner |
| General partnership | Agreement (may be oral, even implied from sharing profits) | Joint and several unlimited liability for partnership obligations | Equal rights for each partner unless agreed otherwise; each partner is an agent of the partnership |
| Limited partnership (LP) | Certificate filed with the state; at least one general partner | General partners unlimited; limited partners liable up to their investment | General partners; limited partners may lose protection if they participate in control (under older rules) |
| Limited liability partnership (LLP) | State filing | Partners generally not liable for other partners' malpractice; liable for their own | All partners |
| Limited liability company (LLC) | Articles of organization filed with the state | Limited to investment | Member-managed or manager-managed; operating agreement governs |
| Corporation | Articles of incorporation filed with the state | Shareholders limited to investment | Board of directors; officers manage day to day |
General partnerships
- Profits are shared equally unless otherwise agreed (not in proportion to capital); losses follow profit shares.
- Ordinary matters: majority vote. Extraordinary matters (admitting a partner, amending the agreement): unanimous.
- A partner's transferable interest (the right to distributions) can be assigned; the assignee does not become a partner or gain management rights.
- New partners are liable for pre-existing debts only up to their capital contribution; a withdrawing partner remains liable for existing debts unless released (novation), and for new debts to creditors lacking notice.
- Creditors of the partnership are paid first from partnership assets; personal creditors first from personal assets (the marshaling of assets rule).
Corporations
- Promoters are personally liable on pre-incorporation contracts until the corporation adopts them and the other party agrees to a novation.
- Directors owe duties of care and loyalty and are protected by the business judgment rule when acting in good faith, on an informed basis, and without conflicts.
- Shareholders elect directors, approve fundamental changes (mergers, dissolution, amending articles), and have rights to inspect books for a proper purpose and to bring derivative suits.
- Piercing the corporate veil removes limited liability when the corporation is a sham — commingling funds, inadequate capitalization, or ignoring corporate formalities to commit fraud.
- Dividends may be paid only if the corporation remains solvent; directors who approve illegal dividends can be personally liable.
How it is tested
- Identify the type of authority that binds a principal.
- Allocate contract and tort liability between principal and agent.
- Compare liability and management across entity types.
- Apply partnership rules on profit sharing, new partners, and withdrawal.
EXAM TIP: Apparent authority is created by the principal's words or conduct toward the third party — never by what the agent says about their own authority.