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Agency Relationships
and Authority

Master the core legal framework of agency law: how principals grant authority, how agents bind third parties, and why it matters on the CPA REG exam.

CPA Regulation (REG)

What Is an Agency Relationship?

An agency relationship exists when one party (the principal) authorizes another party (the agent) to act on the principal's behalf. The agent has the power to create legal obligations that bind the principal to third parties.

The Three Parties in Agency

Principal Agent Third Party Grants Authority Bound by Agent Contracts / Transacts

Why Agency Law Matters

Business Operations
Companies act through agents: employees, officers, and independent contractors sign deals daily.
CPA Liability
Understanding who is bound by a contract determines tax and audit consequences for your clients.
Exam Weight
Agency is tested heavily in REG: expect 3-5 questions covering creation, authority types, and liability.

Types of Authority

Authority Actual Authority Apparent Authority Express Implied Ratification Estoppel

Actual Authority: Express vs. Implied

Express Authority
The principal explicitly communicates the scope of authority to the agent: oral or written instructions, contracts, or board resolutions.
Implied Authority
Authority that is reasonably necessary to carry out express duties: custom, prior dealings, or actions incidental to the agent's role.

Apparent Authority and Estoppel

1
Apparent authority exists when the principal's words or conduct lead a reasonable third party to believe the agent has authority.
2
The third party must reasonably rely on the principal's representations: not the agent's own claims.
3
Agency by estoppel arises when the principal fails to correct a known misrepresentation, and the third party suffers detrimental reliance.

Authority by Ratification

Ratification occurs when a principal approves an unauthorized act after the fact, retroactively granting authority. Once ratified, the act is treated as if it were authorized from the beginning.

1
Agent must have acted on behalf of the principal (not for themselves).
2
Principal must know all material facts at the time of ratification.
3
Principal must accept the entire transaction: no partial ratification.
4
Principal must have had the capacity to authorize the act originally.

Actual vs. Apparent Authority

Actual Authority Apparent Authority
Source Principal \( \rightarrow \) Agent Principal \( \rightarrow \) Third Party
Basis Express or implied consent Principal's conduct or representations
Agent Awareness Agent knows the scope Agent may not know
Third Party Role Irrelevant Must reasonably believe
Exam Tip Look at what the principal told the agent Look at what the third party observed

How to Identify the Authority Type

1
Identify the parties: Who is the principal? Who is the agent? Who is the third party?
2
Check for express authority: Did the principal explicitly grant authority (oral, written, or by resolution)?
3
Check for implied authority: Is the act reasonably necessary or customary to carry out the express duties?
4
Check for apparent authority: Did the principal's conduct lead the third party to reasonably believe the agent had authority?
5
Check for ratification: Did the principal later approve the unauthorized act with full knowledge of the facts?

Example 1: Express Authority

Scenario: GreenCorp's board of directors passes a resolution authorizing CFO Maya to negotiate and sign a lease for new office space up to $500,000 per year.

Board (P) Maya (A) Board Resolution
\( \text{"Sign lease } \le \$500\text{K/yr"} \)

Example 2: Implied Authority

Scenario: Maya, now negotiating the lease, hires a commercial appraiser to evaluate the property. The board resolution did not mention hiring appraisers.

Example 3: Apparent Authority

Scenario: GreenCorp's CEO introduces intern Jake to vendor BlueTech as "our purchasing coordinator." Jake then orders $50,000 of software from BlueTech. The CEO never actually authorized Jake to make purchases.

CEO (P) Jake (A) BlueTech (TP) "Our purchasing coordinator"
\( \text{Orders } \$50\text{K Software} \)

Liability: Disclosed vs. Undisclosed Principals

Disclosed Principal
Third party knows both the existence and identity of the principal. Generally, only the principal is liable on the contract.
Partially Disclosed
Third party knows a principal exists but not their identity. Both principal and agent may be liable.
Undisclosed Principal
Third party doesn't know a principal exists. Both principal and agent are liable. Third party can elect to sue either.

Agent's Fiduciary Duties

1
Duty of Loyalty: Act in the principal's best interest. No self-dealing, no secret profits, no competing interests.
2
Duty of Obedience: Follow the principal's reasonable and lawful instructions within the scope of authority.
3
Duty of Care: Act with the competence and diligence expected of a reasonable agent in the same position.
4
Duty to Notify: Communicate all material information to the principal that could affect the agency relationship.
5
Duty to Account: Keep accurate records and account for all property and funds received on behalf of the principal.

Common Mistakes on the Exam

✕ Confusing Source of Authority
Apparent authority comes from the principal's conduct toward the third party, not from the agent's own claims.
✕ Forgetting Ratification Requirements
Ratification requires full knowledge of material facts and acceptance of the entire transaction: no cherry-picking.
✕ Agent Liability Mix-Up
With a disclosed principal, the agent is generally not liable on the contract. With undisclosed principals, the agent is liable.

Authority Types at a Glance

Type Created By Key Factor Binds Principal?
Express Principal's explicit instructions Oral or written communication Yes
Implied Reasonably necessary actions Custom, prior dealings Yes
Apparent Principal's conduct to third party Third party's reasonable belief Yes
Ratification After-the-fact approval Full knowledge + entire transaction Yes (retroactive)
Estoppel Principal's failure to correct Detrimental reliance by third party Limited

Question 1 of 5

ABC Corp's president introduces contractor Dana to supplier WidgetCo as "our head of procurement." Dana then orders $100,000 in widgets without actual authorization. What type of authority, if any, does Dana have?

Question 2 of 5

Agent Sam, without authorization, signs a contract on behalf of principal Terra Inc. Terra Inc. later learns all the contract details and accepts the benefits. What has occurred?

Question 3 of 5

A store manager is authorized to purchase inventory. Without specific instruction, the manager also arranges shipping for the goods. What type of authority covers the shipping arrangement?

Question 4 of 5

Agent Kim contracts with a vendor on behalf of an undisclosed principal. The vendor later wants to sue for breach. Who can the vendor hold liable?

Question 5 of 5

Which of the following is NOT a fiduciary duty owed by an agent to their principal?