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Business Law Chapter 32 Homework Coming With Ideas For New Products Was

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Book Title
Business Law: Text and Cases 14th Edition
Frank B. Cross, Kenneth W. Clarkson, Roger LeRoy Miller
Chapter 32
Agency Formation and Duties
Up to this point, most of the material has considered when a person may be liable for something that he or she
did. With this chapter, the text goes a step further to ask when and under what circumstances a person may make
another person liable. That is, when can the actions of an agent bind a principal? As importantly, when does the law
consider a person an agent?
One of the most common, important, and pervasive legal relationships is that of agency. In an agency
relationship between two parties, one party (the agent) agrees to represent or act for the other (the principal). A
principal has the right to control an agent’s conduct in matters entrusted to the agent. Generally, the law of agency is
based on the maxim that “one acting by another is acting for himself?”
I. Agency Relationships
An employee or an independent contractor may act in the capacity of an agent.
An employee is one whose physical conduct is controlled, or subject to control, by an employer.
The key feature is the employer’s right to control the employee in the performance of tasks involved
in the employment.
An employee can be an agent if the employee has an appointment or contract for hire with authority
to represent the employer.
Agency Relationships
An employee can be an agent if the employee has an appointment or contact for hire with authority to
represent the employer. According to the Restatement (Second) of Agency employees are always agents.
The following is the text of the Restatement (Second) of Agency, Sections 2, 14N, and 25 with selected
§ 2. Master; Servant; Independent Contractor
(1) A master is a principal who employs an agent to perform service in his affairs and who controls or has the
right to control the physical conduct of the other in the performance of the service.
(3) An independent contractor is a person who contracts with another to do something for him but who is not
controlled by the other nor subject to the other’s right to control with respect to his physical conduct in the
performance of the undertaking. He may or may not be an agent.
a. Servants and non-servant agents. A master is a species of principal and a servant is a species of agent.
§ 14 N. Agent and Independent Contractor
One who contracts to act on behalf of another and subject to the other’s control except with respect to his
physical conduct is an agent and also an independent contractor.
§ 25. Applicability of General Agency Rules
The rules applicable generally to principal and agent as to the creation of the relation, delegability and
capacity of the parties apply to master and servant.
a. As stated in Section 2, a servant is an agent of a special kind, over whose physical acts the principal has
control or the right to control. Consequently, the master has special liabilities both to the servant * * * and to
third persons * * * with reference to physical harm caused to or by a servant. But, aside from these features,
the relation between master and servant is the same as between a principal and a non-servant agent and is
created in accordance with the same rules, and the rules * * * applicable to principals and agents are
applicable to masters and servants.
Independent contractors are not employees, because the person for whom they have agreed to
perform has no control over the physical conduct of their performance. Generally, the less control
an employer has over the work, the more likely that the worker is an independent contractor.
An independent contractor may or may not be an agent.
 
As an employer, you may at some time consider hiring an independent contractor. Hiring workers as
independent contractors instead of as employees may help you reduce both your potential tort liability and
your tax liability.
One reason for using an independent contractor is that doing so may reduce your susceptibility to tort
liability. If, however, an independent contractor’s words or conduct leads another party to believe that the
independent contractor is your employee, you may not escape liability for the contractor’s tort.
To minimize the possibility of being legally liable for negligence on the part of an independent contractor,
you should inquire about the contractor’s qualifications before hiring him or her. The degree to which you
should investigate depends, of course, on the nature of the work. A more thorough investigation is necessary
when the contractor’s activities present a potential danger to the public (as in delivering explosives).
Generally, it is a good idea to have the independent contractor assume, in a written contract, liability for
harms caused to third parties by the contractor’s negligence. You should also require the independent
contractor to purchase liability insurance to cover the costs of potential lawsuits for harms caused to third
persons by the independent contractor’s hazardous activities or negligence.
Another reason for hiring independent contractors is that you need not pay or deduct Social Security and
unemployment taxes on their behalf. The independent contractor is the party responsible for paying these
taxes. Additionally, the independent contractor is not eligible for any retirement or medical plans or other
fringe benefits that you provide for yourself and your employees, and this is a cost saving to you.
A word of caution, though: simply designating a person as an independent contractor does not make her
or him one. Under Internal Revenue Service (IRS) rules, individuals will be treated as employees if they are
“in fact” employees, regardless of how you have classified them. For example, the IRS will not treat an office
assistant as an independent contractor simply because you designate him or her as such. If the IRS
determines that you exercise significant control over the assistant, the IRS may decide that the assistant is, in
fact, an employee.
If you improperly designate an employee as an independent contractor, the penalty may be high.
Usually, you will be liable for back Social Security and unemployment taxes, plus interest and penalties.
When in doubt, seek professional assistance in such matters.
1. Check the qualifications of any independent contractor you plan to use to reduce the possibility that you
might be legally liable for the contractor’s negligence.
3. Require that independent contractors working for you carry liability insurance. Examine the policy to make
4. Make sure that independent contractors do not represent themselves as your employees to the rest of the
5. Regularly inspect the work of the independent contractor to make sure that it is being performed in
accordance with contract specifications. Such supervision on your part will not change the worker’s status as
an independent contractor.
Certain factors can determine whether a person is an employee or an independent contractor.
1. Criteria Used by the Courts
To decide whether an individual is an employee or independent contractor, courts consider
How much control does the employer have over details of the work (most important factor)?
How distinct are the occupations of the individual and employer?
Does the employer supervise the work?
Does the employer supply the tools at the place of work?
What is the length of the employment?
How is the individual paid (periodically or by project)?
What skill does the work require?
2. Criteria Used by the IRS
The IRS considers chiefly the degree of control that an employer exercises over the work.
3. Employee Status and “Works for Hire”
An employee’s work of intellectual property belongs to the employer, but an independent
contractor’s similar effort is the employer’s only if the parties agreed to exchange the rights.
Case 32.1: Coker v. Pershad
Terence Pershad, the driver of a tow truck for Five Star Auto Service, responded to a call to AAA North
Jersey, Inc. for road assistance by the driver of a car involved in an accident. Pershad got into a fight with
Nicholas Coker, a passenger in the car. Coker filed a suit in a New Jersey state court against Pershad, Five
Star, and AAA. The court ruled that Pershad was an employee of Five Star, not AAA, and that Five Star was
Notes and Questions
Why would AAA want to avoid liability for Coker’s injuries? AAA would want to avoid liability for the
injuries because of the cost. It is likely, of course, that AAA has insurance that would cover the expense
directly but its premiums could be increased or its coverage might be canceled in the wake of too many
claims. It may be that this concern is a significant reason for the employer-independent contractor relationship
in the facts of this case in the first place.
Employer-Independent Contractor Relationships
Recent cases in which the status of a worker as an employee or an independent contractor affected
the employer’s liability for the worker’s actions include the following.
Guillaume v. Hall Farms, Inc. 914 N.E.2d 784 (Ind.App. 2009) (a harvesting contractor who supplied a
crew of farm laborers to a produce distributor was an “independent contractor” of the distributor, who did not
control the contractor or its crew, for purposes of determining (whether the distributor was liable for the
injuries of one of the laborers).
liability for a vehicle passenger's personal injury).
II. Formation of the Agency Relationship
An agency relationship must be based on an affirmative indication that the agent agrees to act for the
principal and the principal agrees to have the agent so act. It may be created for any legal purpose. In
most states, the principalbut not the agentmust have contractual capacity.
An agency agreement need not be in writing.
Generally, no formalities are required to create an agency relationship. Agency can be implied from
conduct, or can be created by written contract or oral agreement.
Agency is created by ratification when a principal affirms a contract made by a person who is not an
agent, or a person who is an agent acting outside the scope of his or her authority.
Agency is created by estoppel when a principal causes a third person to believe that another is the
principal’s agent, and the third person deals with the other.
1. The Third Party’s Reliance Must Be Reasonable
2. Created by the Principal’s Conduct
The deeds or statements of the principal create an agency by estoppel.
Agency may be created by operation of law. The text points out that courts have granted agents
emergency power under unusual circumstances and have held agency to arise in family relationships.
Agency by Operation of Law
For businesses, some state statutes make state officials (a state’s secretary of state) the businesses’
agents for service of process. This is an agency created by operation of law. Most states require a corporation
to designate a registered agent for service of process on the corporation. In some states, designation of
the registered agent is by a separate instrument filed with the articles of incorporation. New York requires
designation of the state’s secretary of state as agent of the corporation for service of process. This
designation must be in the articles of incorporation. In addition to this requirement, however, New York
permits the articles of incorporation to designate a resident agent. The following is the text of the New York
statutes spelling out this addition (New York Business Corporation Law Sections 304, 305, 402).
§ 304. Statutory designation of secretary of state as agent for service of process
(a) The secretary of state shall be the agent of every domestic corporation and every authorized foreign
corporation upon whom process against the corporation may be served.
(b) No domestic or foreign corporation may be formed or authorized to do business in this state under this
chapter unless in its certificate of incorporation or application for authority it designates the secretary of state
as such agent.
(c) Any designation by a domestic or a foreign corporation of the secretary of state as such agent, which
designation is in effect on the effective date of this chapter, shall continue. Every domestic or foreign
corporation, existing or authorized on the effective date of this chapter, which has not designated the
secretary of state as such agent, shall be deemed to have done so. Any designation prior to the effective
date of this chapter by a foreign corporation of an agent other than the secretary of state shall terminate on
the effective date of this chapter.
(d) Any designated post-office address to which the secretary of state shall mail a copy of process served
upon him as agent of a domestic corporation or a foreign corporation, shall continue until the filing of a
certificate under this chapter directing the mailing to a different post-office address.
§ 305. Registered agent for service of process
(a) In addition to such designation of the secretary of state, every domestic corporation or authorized foreign
corporation may designate a registered agent in this state upon whom process against such corporation may
be served. The agent shall be a natural person who is a resident of or has a business address in this state or
(b) Any such designation of a registered agent may be made, revoked or changed as provided in this chapter.
(c) A registered agent may resign as such agent. A certificate, entitled “Certificate of resignation of registered
agent of ................. (name of designating corporation) under section 305 of the Business Corporation Law”,
shall be signed, verified by him and delivered to the department of state. It shall set forth:
(2) The date the certificate of incorporation or the application for authority of the designating corporation was
(3) That he has sent a copy of the certificate of resignation by registered mail to the designating corporation at
the post office address on file in the department of state specified for the mailing of process or if such address
§ 402. Certificate of incorporation; contents
(a) A certificate, entitled “Certificate of incorporation of ............ (name of corporation) under section 402 of
the Business Corporation Law”, shall be signed by each incorporator, with his name and address stated
beneath or opposite his signature, acknowledged and delivered to the department of state. It shall set forth:
* * * *
(8) If the corporation is to have a registered agent, his name and address within this state and a statement
that the registered agent is to be the agent of the corporation upon whom process against it may be served.
III. Duties of Agents and Principals
An agency relationship is fiduciary.
An agent’s duties are implied from the agency relationship whether or not the identity of the principal is
disclosed to a third party.
1. Performance
a. Standard of Care
The degree of skill or care required of an agent is that expected of a reasonable person under
similar circumstances (unless the agent has presented himself or herself as possessing
b. Gratuitous Agents
An agent who does not act for money may be subject to the same standards of care, but
cannot be liable for breach of contract because there is no contract.
2. Notification
3. Loyalty
An agent cannot represent two principals in the same transaction unless both know of the dual
capacity and consent.
a. Maintain Confidentiality
Knowledge acquired through an agency relationship is confidential.
b. Actions Benefit the Principal
An agent must act solely for the benefit of the principal.
Case 32.2: Taser International, Inc. v. Ward
Taser International, Inc., develops and makes electronic control devices and accessories, including video
and audio recording devices. Steve Ward was Taser’s vice president of marketing when he began to explore
the possibility of developing and marketing devices of his own design, including a clip-on camera. He talked to
patent attorneys and a product development company and completed most of a business plan before he
resigned from Taser. Ward then formed Vievu LLC to market a clip-on camera. Taser filed a suit in an Arizona
state court against Ward, alleging a breach of the duty of loyalty. The court issued a summary judgment in
Taser’s favor. Ward appealed.
A state intermediate appellate court reversed and remanded. “An agent is under the duty to act with entire
good faith and loyalty for the furtherance of the interests of his principal in all matters concerning or affecting
the subject of his agency.” Under this principle, “an employee is precluded from actively competing with his or
her employer during the period of employment.” In this case, substantial design and development efforts by
Ward during his employment would constitute direct competition with the business activities of Taser and
would violate his duty of loyalty.” But summary judgment was inappropriate because a genuine issue of
material fact exists as to the extent of Ward's pre-termination design and development efforts.”
Notes and Questions
Short of resigning his employment based on no more than a desire to work for himself, could
Ward have taken any steps towards starting his own firm without breaching his duty of loyalty? Yes.
Taking steps that any businessperson might make before initiating a business could be permissible—Taser’s
counsel shrugs off “investigating computer software, acquiring a line of credit, securing office space, or getting
prices on telephones.” And any steps taken in furtherance of an enterprise that in no way would have
competed with Taser would also likely have been acceptable.
Why was it unclear whether Ward’s pretermination actions constituted direct competition with his
employer or were mere planning activities? The court found it difficult to draw the line between “mere
preparation” and “active competition” in this case because of the nature of Taser’s business. Taser was not
just in the business of selling electronic devices, including audio/video devices, but also in researching and
developing such products. Coming up with ideas for new products was thus part of Ward’s job at Taser. As
Taser argued, Ward had been “developing a rival design during employment, knowing full well Taser has sold
such a device and continues to develop a second generation product.” Thus, the question was not clear-cut.
In the eyes of the court, there were several questions of fact that precluded summary judgment. For
example, to what extent, if any, did Ward use Taser’s time, facilities, or resources in his pre-termination
efforts? Although an employee may, in the absence of a noncompete covenant, prepare to compete with a
current employer, the tactics that an agent may use are subject to limits. According to Section 8.04, comment
b, of the Restatement (Third) of Agency, “an agent has a duty (1) not to use property of the principal for the
agent’s own purposes” and “(2) not to use or communicate confidential information of the principal for the
agent’s own purposes or those of a third party.” Because questions of fact remained to be decided, the court
held that summary judgment was improper and remanded the case for trial.
If the judgment in the case of remand is again in Taser’s favor, what might be an appropriate
remedy? A principal has contract remedies for an agent’s breach of fiduciary duties. The principal also has
4. Obedience
5. Accounting
An agent must account for all property and money received and paid out on behalf of the principal.
The agent should keep personal funds separate.
A principal’s duties may be express or may be implied by law.
1. Compensation
2. Reimbursement and Indemnification
A principal must reimburse an agent for sums disbursed at the principal’s request or for necessary
expenses in the agent’s performance of his or her duties. A principal also must indemnify an agent
for liability incurred in accord with the agency. A subagent can recover from the principal or the
agent who hired him or her.
Case 32.3: NRT New England, LLC v. Jones
Christopher Jones and Katherine Wiltshire were engaged to be married and seeking a new home. Jones
signed an agreement designating Andrea Woolston, a realtor working for NRT New England, LLC, as his
exclusive agent for finding and buying property. The agreement stipulated a commission “if the [buyer] * * *
purchases * * * any property.” Woolston spent hundreds of hours, alone and with Jones, searching for and
visiting properties. Despite this effort, Jones later e-mailed Woolston that he had bought a home through Mary
Jane Burt, a realtor with H. Pearce Real Estate. Jones then revealed to Woolston that before his agreement
Notes and Questions
Could Burt successfully claim that Jones was in violation of the exclusive agency agreement he
had executed with her? Yes, Burt could successfully claim that Jones was in violation of the exclusive
agency agreement that he had executed with her. But because she had also closed the deal with Jones and
been paid her commission, per their agency agreement, there would be no damages to recover.
The agreement with Woolston stipulated a commission of 2.5 percent “if the [buyer] * * * purchases * * *
any property.” Woolston expended considerable effort on behalf of Jones, as presumably did Burt. Later,
however, Jones e-mailed Woolston that he had bought a home for $1,375,000 through Burt, and still later
revealed the existence of his exclusive agency agreement with Burt.
In NRT’s suit in a Connecticut state court against Jones for breach of contract, the court issued a
judgment in the plaintiff’s favor and awarded $34,375 in damages (2.5 percent of the price for the Guilford
property). A state intermediate appellate court affirmed and would likely have affirmed a similar judgment in
Burt’s favor, without the award of damages.
Suppose that instead of Jones and Wiltshire buying the Guilford property, Burt had closed on the
deal on their behalf. Would the result have been different? No. If, instead of Jones and Wiltshire buying
the Guilford property, Burt had closed on the deal on their behalf, the result would not have been different. In
involves trust and confidence.
Under those principles and the facts stated in this question, the use of Burt as an agent to close on the
house in Guilford would not have absolved Jones and Wiltshire (the principals) of their liability to Woolston for
breaching their exclusive agency contract with her.
3. Cooperation
A principal must cooperate with and assist an agent in performing his or her duties.
4. Safe Working Conditions
A principal must provide safe premises, equipment, and conditions (and warn about unsafe areas).
IV. Rights and Remedies of Agents and Principals
For every duty of a principal, an agent has a corresponding right.
2. Demand for an Accounting
An agent can withhold further performance and demand that a principal give an accounting.
Remedies follow normal contract and tort remedies. Actions available include constructive trust,
avoidance, and indemnification.
1. Constructive Trust
2. Avoidance
3. Indemnification
A third party can sue a principal for an agent’s negligent conduct, and sometimes an agent must
1. When an independent contractor is injured on the job, he or she is responsible for the loss. When an in-
dependent contractor is out of work, can he or she collect unemployment compensation? Call your
2. When considering an agency problem, students may find it helpful to determine first whether the parties
are in an employer-employee relationship. To categorize the relationship, they should pay careful attention to
3. It should be made clear, if it is not apparent from a reading of this chapter, that the legal term “agent”
4. You might explain that no area of the law is more pervasive than the law of agency, which affects virtually
everyone everyday. When confronted with legal problems to analyze your students may find it helpful to
Cyberlaw Link
Does the speed of communication via the Internet play have any effect on the duties of principals
and agents?
1. Why is agency law essential to the existence and operation of a corporation? An agent acts for a prin-
2. What is a principalagent relationship? In a principalagent relationship, the parties have agreed that the
3. Define an employeremployee relationship. The details of an employee’s conduct in employment are
4. What are some of the factors that can determine whether an individual is considered an employee or
an independent contractor? The factors include: (1) the amount of control an employer exercises over the details of
5. How is an agency relationship created? An agency relationship can be created by oral agreement or by
written contract, or can be implied from conduct (a hotel’s permitting an individual to park its guests’ cars manifests
willingness that the individual do so, and the individual can infer authority to act as a valet, and as an agent for that
principal’s agent, and the third person deals with the other.
6. What are the policy reasons for holding a principal liable on a theory of agency by estoppel? Equity is
7. What are the general duties that agents and principals owe each other? An agency relationship is fidu-
8. What are an agent’s rights and remedies against a principal? For every duty of a principal, an agent has
a corresponding right (a right to be compensated, reimbursed, and indemnified and to work in a safe environment).
9. What are a principal’s rights and remedies against an agent? A principal has general contract remedies
(and may terminate an agency relationship) for an agent’s breach of fiduciary duties. A principal has tort remedies for
10. Are there situations in which the duty of loyalty to one’s employer could come into conflict with other
duties? The duty of loyalty is a fundamental duty in an agency relationship (like the duty to act in good faith), and it is
11. What are some advantages to being an independent contractor? What might be some disadvantages?
The principal advantage of being an independent contractor is probably the degree to which the independent
Divide students into groups (four to five students per group) and have them compile lists of the jobs held by
members of the group. Ask them to discuss with each other the rights and responsibilities of each job to determine
whether the student is an agent and an employee or an independent contractor, or only an agent, an employee, or an
independent contractor. Have each group share its conclusions with the class. Discuss with the class the difference
between employees and independent contractors. Are there students with jobs in which they are referred to as
“independent contractors,” when in fact they are employees?
Footnote 4: Gilbert Bishop was admitted to Laurel Creek Health Care Center. He indicated to Laurel Creek
that he was physically incapable of signing admission documents but was of sound mental capacity and wanted his
wife to sign the documents on his behalf. When he told this to his sister, she brought Anna in to sign the documents,
In Laurel Creek Health Care Center v. Bishop, a state intermediate appellate court reversed and remanded.
There are three steps to the creation of an agency relationship. First, “the principal manifests assent to be affected by
the agent's action. In the instant case, Gilbert asked that Anna come to the hospital to sign the papers for him.
Second, the agent's actions establish the agent's consent to act on the principal's behalf. Here, Anna signed all the
contractual capacity to be a principal. Those who cannot legally enter into contracts directly cannot do so through an
agent. A lack of sound mental capacity is a lack of mental capacity. In that circumstance, Gilbert could not have
authorized his spouse to sign admission papers on his behalf. Thus there would have been no principal-agent
relationship. The hospital’s policy was to have a person’s spouse sign the papers if the person could not, however, so
that the lack of capacity might not have affected the ultimate result in this case. Only the legal arguments would have
been different.
Which party benefited from the court’s ruling? Why? At the heart of this case was Laurel Creek’s desire to
arbitrate the negligence claim instead of having to defend against negligence in a lawsuit. Economically, this makes
sense from Laurel Creek’s perspective. After all, defending against a lawsuit is a costly undertaking for a party, even
if the party wins the suit. In contrast, arbitration is (usually) a less expensive and less time-consuming process.
Laurel Creek argued that even if there was no actual agency relationship, an implied agency relationship
existed. Is this argument valid? Why or why not? One could argue that the statements made by Gilbert and
Rachel on Gilbert’s admission to the hospital and the subsequent events evidenced the creation of an implied agency.
Rachel had offered to sign the admission paperwork, but the hospital staff told her that it was the hospital’s policy to

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