The Importance of Agency Law to a Corporation

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A corporation comes into existence when the incorporators file state-required documentation with the secretary of state. The state’s business laws explain what information must be in the documentation but in general, forming a corporation is relatively easy. Running a corporation is very complex and includes issues of agency law.

Corporate Structure

Agency law principles allow corporations to act. In an agency relationship, there is a principal and an agent. The corporate business entity is a legal “thing.” Once properly set up, the corporation can act like an individual in a business setting: it can operate a company, enter into contracts, conduct business transactions, sue and be sued.

It is the principal in the agency relationship. A corporation can only act through a board of directors; the board is, in essence, the brains of the operation. The board can delegate duties to officers or committees. In general, the board of directors and the officers of the corporation are agents of the corporation.

Accountability

In certain cases, people use the corporate structure to break the rules and the laws so that a benefit is somehow derived. Agency principles make corporations accountable for their actions — whether or not the actions are law abiding. In an agency relationship, the principal is accountable for the actions of his agents if the agents are acting within the scope of the authority bestowed by the agency relationship. If a director or officer of the corporation acts within his scope of employment, the entire corporation is on the hook for those actions, unless an exception applies.

Board Protection

Agents have certain duties to the principal. In a corporate setting, the board members owe both a duty of care and loyalty to the organization. The board members must act based on reliable information and any actions taken must generally be in the best interests of the corporation. Under the “business judgment rule,” the law favors a strong presumption that the directors are acting reasonably and in the best interests of the corporation as the corporation’s agents.

The business judgment rule helps protect the directors from being sued for reasonable, but ultimately poor, decisions unless it can be shown that the director was motivated by self-dealing or was acting on bad information.

Shareholder Protection

Agency principles also help protect the shareholders of the corporation. The shareholders are the actual owners of a corporation who may not necessarily be directors. Because agency principles define how a corporation may conduct business through a board of directors, non-director shareholders are not at risk for the actions of the agents. Non-director shareholders cannot generally be personally liable for the actions of the board, unless an exception applies. Instead, the shareholders generally are at risk to lose any investment into the corporation.

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