• What Is a Principal-Agent Relationship?

A principal-agent relationship describes the relationship between an individual and someone hired by that person to act on their behalf. The principal is the business entity (or hiring individual), while the agent is the entity hired to act on behalf of the principal.

The principal-agent relationship is a relationship that arises from situations in which one entity (the principal) has power over another (the agent). The agent is acting in the place of the principal for specific or general purposes. In doing so, the agent is expected to carry out the principal’s wishes.

The principal is the party who authorizes the other to act in their place, and the agent is the person who has the authority to act on behalf of the principal.

  • How Principal-Agent Relationship Works

A principal will hire an agent to do something that the principal either can’t do, doesn’t have time to do, or otherwise doesn’t want to do. There are many examples of how this commonly plays out in business and daily life. Your corporation’s shareholders appoint the members of the board of directors to take advantage of their expertise in running a business. You hire a real estate agent to find business property for you. You hire employees to make business deals with customers. It’s important to vet potential agents. Businesses must only hire agents who are trustworthy and well-qualified to do the job they are hired to do.

You could do all these things on your own. You could spend time searching for building listings and negotiating sale prices. You could spend your time answering phones and taking customer questions. However, there are probably better things you could do with your time, and these tasks might not fit your skill set. By assigning these tasks to others, you’re being efficient with your time.

  • How Is a Principal-Agent Relationship formed?

A principal-agent relationship usually starts with a contract that clearly outlines the duties and responsibilities of both parties. Some common examples of an agency contract are a power of attorney form or a contract with a realtor to sell a building your business owns.

  • The Duties of the Agent and Principal

The agent’s duties include:

  • A duty of loyalty—the agent must act according to the principal’s wishes, put the principal’s interest first, and not benefit from the relationship at the principal’s expense.
  • A duty to obey instructions—this includes a duty to clarify instructions when the agent doesn’t fully understand them.
  • Duty to act with skill and care—an agent is hired because of their specific professional expertise. More expertise means the agent is held to a higher standard.
  • Duty to notify the principal of important matters—if any important information or situations come up in the course of the agent’s service, the agent is expected to notify the principal.
  • Duty to account for time and resources spent—the agent is expected to track their hours worked, money spent, and property used in the course of the agency relationship.

The principal’s duties include:

  • Duty to compensate—the principal must pay the agreed-upon fee for the agent’s services. This is often done by contract. If there is no written contract, the agent may not be liable for acts not requested or consented to.
  • Duty to reimburse the agent—any expenses an agent incurs as a result of the agency relationship should be repaid by the principal.
  • Duty to indemnify—the principal gives an implied promise to indemnify (hold harmless) an agent for losses during the time of the relationship. This is why you can’t sue a financial advisor if they suggest a stock investment that performs poorly (unless you believe they breached their duties in suggesting the investment).

If there is a written contract, the agent or principal can sue the other party for breach of contract. Even if there isn’t a written contract, a court can make the principal liable for the actions of an agent.


Key Takeaways

  • A principal-agent relationship refers to the relationship between an entity (the principal) and the person that entity hires (the agent) to act on their behalf.
  • There are legal expectations for both the principal and the agent in a principal-agent relationship.
  • The details of a principal-agent relationship are ideally outlined in a contract that is signed by both parties before the agent does anything on the principal’s behalf.


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