2.4: The Principal-Agent Model

Types of Principals

There are three types of principals, which are described from the perspective of a third party: disclosed, partially disclosed, and undisclosed.

• The most common form is that of a disclosed principal — a principal whose identity is revealed by the agent to a third party. For example, agents work for a disclosed principal when they are on the employer’s premises, wear a name badge or uniform identifying the employer, or answer the phone by identifying the employer’s name.
• A partially disclosed principal is a principal whose existence, but not actual identity, is revealed by the agent to a third party. In other words, a third party knows that the agent represents a principal but does not know the identity of the principal. For example, a realtor may represent an owner who does not want their name disclosed publicly.
• An undisclosed principal is a principal whose identity is kept secret by the agent. Often, third parties do not realize that an agency relationship exists and believe that the agent is working on his or her own behalf. Undisclosed principals are typically arranged when the identity of the principal can lead to increased purchase prices, unwanted publicity, and security concerns.

Types of Agents

An agent is someone who is authorized to act on behalf of a principal. Because there are a variety of authorizations that a principal can grant an agent, there are many different types of agents. Broadly speaking, agents are described as either general or special. General agents have the authority to transact all the principal’s business of a particular kind or in a particular place. General agents often include partners, managers, factors, and brokers.

Special agents, in contrast, only have the authority to conduct a particular transaction or to perform a specific act. Special agents often include realtors, athlete’s agents, and employment recruiters.

Some of the most common business agents include:

• Broker — Receives a commission to make contracts with third parties on behalf of a principal.
• Business Agent — Has general power involving the exercise of judgment and discretion, such as a manager or officer.
• Factor — Receives and sells goods or property for a commission.
• Forwarding Agent — Receives and ships goods for a principal.

Types of Authority

Authority is the right or permission to act legally on another’s behalf. In general, authority can be either actual or apparent. Authority is critical in agency as it is the key element that gives an agent the authority to act on behalf of a principal. Agency cannot occur unless authority is given. Authority matters to principals because the moment an agent has the authority to act, the principal becomes liable for the actions of the agent. Therefore, principals should always take care to ensure that the authority is granted clearly.

Actual authority, sometimes called real authority, is established when a principal intentionally confers authority on an agent. Actual authority can be either express or implied.

• Express authority is authority given by an express agreement, either verbally or in writing. For example, a principal clearly states to an agent, “I am granting you the authority to sell my house.”
• Implied authority is authority granted to the agent as a result of the principal’s conduct. Imagine a principal invites a real estate agent to their property and describes the features of the house, when they want it to go on the market, at what price, and other conditions that a principal would typically share with an agent, but without clearly stating, “you will be the agent to sell my house.” In this situation, the principal is acting as if the agent is in fact an agent but has not expressly stated that fact. However, the agent could interpret that they are in fact the agent to sell the house based on the principal’s actions, which imply the agent has been given the authority to sell the house.

Apparent authority is authority that a third party reasonably believes an agent has based on the third party’s dealings with the principal. If a principal’s words or actions lead others to believe that authority was given to someone else, then the principal is held accountable for the perceived transfer of authority. For example, if a principal fails to give notice that an agent is no longer working for the principal, the agent may still bind the principal through apparent authority when dealing with third parties. This is important because the agent’s actions could bind the principal to accept a deal when the principal did not necessarily want that deal. It can also open the principal up to third-party liability if a third party was damaged during or by the outcome of the transaction.

Ratification and Authority

Ratification occurs when a disclosed principal adopts or confirms a contract entered into on his or her behalf by an agent. Ratification can be automatic if the agent has been granted signing authority.

The authority to act is critical to a principal and an agent. The agent wants authority so that they can broker a deal in good faith with a third party. A principal wants to grant authority only to those agents who will achieve their desired results and not increase their liability risk.

Retroactive Ratification and Authority

If an agent does not have the authority to act on behalf of the principal but presents an opportunity for the principal to benefit from the third-party transaction, then the principal has the right to retroactively grant the authority to the agent in order to take advantage of the opportunity.

Imagine you have a friend who wants to sell their car. You have another friend, who does not know the seller of the car but knows he wants to buy the exact type of the car the first friend is selling. You could approach the potential buyer and say, ‘I might know someone who has the car you want; what price are you willing to pay?’ Once known, you could then go to the seller and say, ‘I have a deal for your car at this price, do you want it? If yes, then I want to be the agent to broker the sale.’ The seller (or principal) could then agree to effectively make you the agent, retroactively, to a time before you asked the buyer so that you can effectively broker the deal acting as an agent with authority.

Duties of Agents

Agents are fiduciaries of principals and so they are required to act with the highest duty of care. Fundamentally, agency is a fiduciary relationship created by express contract or implied actions in which the agent has the authority to act on behalf of the principal and legally bind the principal to third parties.

A fiduciary relationship is a relationship in which one person is under a duty to act for the benefit of another on matters within the scope of the relationship. Fiduciary relationships require trust, good faith, and acting in the best interest of the other. In fiduciary relationships, the law requires the fiduciary to act with the highest duty of care. This means that the fiduciary must put the interests of the other party before their own. Examples of fiduciary relationships include doctor-patient, attorney-client, accountant-client, trustee beneficiary, and guardian-child. An agent is also a fiduciary of a principal.

Beyond a fiduciary duty, an agent is required to provide:

• Duty Description Account: An agent must keep proper records to account for all the principal’s money and property given to the agent. An agent must act reasonably, in good faith, and always avoid negligence.
• Disclosure: An agent must inform the principal of all material facts that affect the principal’s interests.
• Loyalty: An agent cannot engage in any dealings that compete or interfere with the principal’s business or interests.
• Obedience: An agent must obey all the principal’s instructions within the scope of agency unless they are illegal or unethical.
• Protect Confidential Information: An agent cannot use or disclose a principal’s confidential information.

An agent cannot normally delegate their authority to a “sub-agent.”

Duties of Principals

Principals also owe duties to agents as part of the fiduciary relationship. These duties include:

• Compensation: A principal must pay an agent for work performed.
• Honesty: Principals cannot deceive agents about the nature and scope of the work they are to perform.
• Indemnification: A principal must hold an agent harmless and free from legal liability for actions properly taken on the principal’s behalf.
• Loyalty: A principal cannot engage in any dealings that prevent an agent from performing agency tasks
• Reimbursement: A principal must reimburse an agent for money reasonably expended on behalf of the principal

An agency relationship affects liability to third parties. The scope of liability depends on the type of principal involved, the type of authority involved, and the nature of the dispute.

Contractual Liability

A principal is always liable on a contract if the agent has authority. However, the agent’s liability on a contract depends on how much the third party knows about the principal. Disclosure, when allowed by the principal, is the agent’s best protection against legal liability.

An agent is not liable for any contracts made with authority on behalf of a fully disclosed principal. Therefore, if a third party knows the existence and identity of the principal, then all legal liability rests with the principal. The only exception to this is when an agent exceeds his or her authority. In that case, the agent has not acted with authority and becomes personally responsible to the third party. If the agent did not have authority, but the principal later ratified the contract, then the principal would be liable for the contract.

If a principal is partially disclosed, then the third party may recover from either the principal or agent. In this situation, the principal and agent are jointly and severally liable, and the third party may sue either or both to recover the full amount of damages owed. However, the third party cannot seek “double damages” and recover more than the total amount owed for the contractual breach.

In the event of an undisclosed principal, a third party may recover from either the agent or the principal. The fact that a principal’s existence or identity is hidden from third parties does not change the nature of the agent-principal relationship. Therefore, an undisclosed principal may become liable for contracts entered into by an agent acting with actual authority. An undisclosed principal has no liability to an agent or third party when the agent exceeds the actual authority granted by the principal. In addition, the type of contract must be the type that can be assigned to the undisclosed principal. If the contract is for personal services, then liability cannot be assigned to the principal in case of a breach.

Termination of Agency Relationship

Agents and principals may end their agency relationship in various ways, but the most common way is through mutual agreement. Additionally, there are some events that will terminate an agency relationship as a matter of law. The death of a principal or agent automatically terminates the agency agreement, even if the other party is unaware of the death. Once the time of death is established, any transactions afterward are deemed void.

The mental incapacity of a principal or agent also terminates an agency relationship. It is often hard to determine the precise time someone loses mental capacity. Therefore, courts often hold that an agent’s contract with a third party is binding on the principal unless the third party is aware of the principal’s incapacity.

Bankruptcy terminates an agency relationship when the bankruptcy affects the subject matter of the agency agreement. For example, if a principal declares bankruptcy and the real property that an agent is authorized to sell is part of the bankruptcy estate, then the bankruptcy will automatically terminate the agency relationship.

Finally, the destruction or illegality of the subject matter will terminate the agency relationship. For example, if Parliament passes a law making it illegal for private parties to sell specific types of polluting vehicles, then the agency relationship between a principal / car manufacturer and the agent / dealer selling those types of cars will automatically end.

Legal Principles of Competitive Bidding and Procurement

Two Contracts in Tendering

The concept of legal contractual obligations and the law of tendering begins with the court’s decision in the Ron Engineering & Construction case (1981). The decision of the Supreme Court of Canada in R. v. Ron Engineering is considered a landmark development in the law of tendering.

In the Ron Engineering & Construction case, there was a tendering package that called for bids within a specific period of time. Any contractor submitting a bid was required to pay a deposit. After the time for submitting bids had closed, bids could no longer be withdrawn or amended. If a bid was selected, the offeror was to be called upon to enter into Contract B in accordance with the submitted bid. Failure to do so would result in forfeiture of the deposit. If a bid was not selected, the deposit would be returned.

Ron Engineering made a mistake in their bid and attempted to withdraw it, but the Supreme Court of Canada ruled that the bid could not be withdrawn and the bid deposit was forfeited. The case established that two separate contracts were formed during the tendering process:

• Contract A (which is a unilateral contract created upon a contractor submitting a bid to do certain work in response to a formal tender package), and
• Contract B (which is the contract formed between the parties when a bid is accepted).

Both these contracts bind the bidder and the owner (agency). In the invitation to tender, the expectation is that the contract will be awarded upon completion of the tender using the evaluation criteria set out in the tender documentation. The tendering process is governed in Canada by Contract “A” and Contract “B”.

Binding and Non-Binding Processes

Case law has clearly drawn a distinction between the competitive procurement processes that are binding (where Contract “A” is created) and those that are not intended to be binding (where no Contract “A” is created). Courts have emphasized that the procuring agency must be clear in its competitive procurement documents regarding its intention to create Contract “A.”

Contract “A” is the contract that comes into existence between a bidder and an agency upon the submission of a compliant bid in a tender call. Contract “B” is the goods and service contract itself, which comes into existence upon the acceptance by an agency of the submitted bid made by the contractor.

Contract “A” governs how the tendering process will occur, including but not limited to how a bidder can expect their tender response to be evaluated. If the owner fails to comply with the terms and conditions set out in the original invitation to tender (i.e., the owner deviates from the originally described evaluation criteria), the bidder can argue that Contract “A” was breached.

Fairness in Tendering

Bids must be compliant to take effect. In M.J.B. Enterprises Ltd. v. Defence Construction (1951) Ltd., the court established that Contract “A” only comes into effect the moment a compliant tender is submitted.

The court went on further to observe that the ruling in the Ron Engineering case does not imply that Contract “A” will always be formed. Whether the tendering process creates a preliminary contract depends upon the terms and conditions of the tender call. Also, there can be no breach of duty of fairness in procurement law when no Contract “A” is formed.

What is important is that the submission of a tender in response to an invitation to tender may give rise to contractual obligations, quite apart from the obligations associated with the contract to be entered into upon the acceptance of a tender, depending upon whether the parties intend to initiate contractual relations by the submission of a bid. If such a contract arises, its terms are governed by the terms and conditions of the tender call.

The duty of fairness in procurement contract law is that all bidders must be treated fairly and equally unless otherwise expressly agreed upon in tender terms. In Martel Building v. Canada, the courts held that implying an obligation to treat all bidders fairly and equally is consistent with the goal of protecting and promoting the integrity of the bidding process and benefits all participants involved. Without this implied term, tenderers could incur significant expenses in preparing futile bids or ultimately avoid participating in the tender process.

Exclusion Clauses and Liability

No matter how clear or broadly interpreted, exclusion clauses cannot exclude an agency from liability in the event of modifications to the tendering process. In the Tercon Contractors Ltd. v. British Columbia (Transportation and Highways) case, Tercon filed a suit for breach of contract and damages against the Ministry of Transportation. Tercon was one of the bidders, along with Brentwood Enterprises Ltd. Brentwood recognized that it lacked the depth of expertise to complete the project on its own and entered into a joint venture with another contractor named Emil Anderson Construction (EAC). This arrangement would have been compliant had Emil Anderson been a sub-contractor and not a joint-bidder. However, since the arrangement (EAC and Brentwood) was a joint venture, it did not comply with the terms and conditions of the RFP. The British Columbia Supreme Court found that the Ministry of Transportation and Highways had breached its contractual duty of fairness and equity by awarding the contract to a non-compliant bidder. In quantifying the damages, the court established that when a bidder under a tendering agreement sues for breach of Contract “A,” the appropriate measure of damages is the “expectation principle” (i.e., what would the bidder’s financial position have been had they performed the contract). Whether a Contract” A” has arisen and what terms, if any, should be implied are case-specific determinations.

Public procurement law in Canada has evolved, but only by a combination of good documents and good practices can the agency truly reduce and manage the legal risk created by the laws of competitive bidding.

Attributions

“2.4: The Principal-Agent Model” is remixed and adapted from the following sources:

“Chapter 8: Labour Law—Agency” from Business Law and Ethics, Canadian Edition by Craig Ervine, licensed under a Creative Commons Attribution-NonCommercial-ShareAlike 4.0 International License, except where otherwise noted.

Contracts – Tender (Bidding) from Simon’s Megalomaniacal Legal Resources www.isthatlegal.ca licensed under a CC0 1.0 Universal – Creative Commons License.

The multiple choice questions in the Checkpoint boxes were created using the output from the Arizona State University Question Generator tool and are shared under the Creative Commons – CC0 1.0 Universal License.