Undisclosed Agency in the United States

Undisclosed Agency in Contract Law Theory

Introduction

The law of undisclosed agency concerns the following situation: UP’s agent A makes an agreement with T, but UP’s existence and identity are unknown to T. UP is called the ‘undisclosed principal.’ What are the legal relations among these three actors? Do A and T have a valid contract? Can T sue UP for breach? Can T refuse to perform when she discovers the identity of UP? Nearly every legal theorist who has considered the law of undisclosed agency from the point of view of contract theory has concluded that the established rules are anomalous. This has *1970 caused at least one commentator to deprecate the value of legal theory itself. Unfortunately, very few, if any, contemporary contract theorists have considered the issue of undisclosed agency at all.

The Anomaly and Law of Undisclosed Agency

To see why the law of undisclosed agency is thought to be anomalous, consider a series of hypothetical illustrations. First, consider the paradigm case:

A and T manifest to each other assent to a contract for some goods. A bargains for T’s rights to the goods, and T bargains for A’s payment. Unknown to T, A represents UP. If T fails to deliver the goods, can A sue T? Can UP sue T? If UP fails to pay T for the goods, can T sue A? Can T sue UP?

Under conventional contract principles, A is contractually liable to T, and T to A. Each has ‘bargained for’ the assent or promise of the other. Therefore, a failure to pay for or deliver the goods constitutes a breach of contract and provides the nonbreaching party with a good cause of action against the party in breach. The law of undisclosed agency is in accord.

The conceptual problem arises when we consider UP’s liability to T and T’s liability to UP. According to normal contract theory, UP is not a party to the contract between A and T. UP never manifested his assent to T; T never manifested her assent to UP. It was A who promised to pay for the goods and T who promised to buy them. A kept UP’s existence a secret from T. Although the law of contract usually does not permit the secret intentions or knowledge of one party to affect the rights of the other, the normal law of undisclosed agency permits UP to sue T for failure to deliver, [FN9] and permits T to sue UP for failure to pay.

Further problems arise in the ‘hard cases’ where A becomes insolvent. (…)

This was precisely the problem addressed in the early case of Scrimshire v. Alderton. In Scrimshire, the trial judge directed the jury to find that, where T disregarded UP’s instructions and settled with A, UP could recover the purchase price from T, forcing T to pay twice. [FN15] American *1974 courts have accepted this doctrine. (…)

The Anomaly of Undisclosed Agency: Undisclosed Agency and Contract Theory

How well do the traditional theories or principles of contractual obligation explain these doctrinal results? Elsewhere, I have described the five traditional theories of contract as the will, reliance, efficiency, substantive fairness, and bargain theories. Here, I argue that none of these theories adequately explains the law of undisclosed agency.

The will theory looks to see if both parties subjectively assented to a contract. A will theory can explain why T would be bound to A in Illustration 1, but it cannot explain A’s liability T, since A was secretly representing UP and may not have intended to be bound personally. Because subjective assent by T to contract with UP is lacking in all four Illustrations, a will theory does not explain the instances where UP can *1975 sue T. Moreover, in Illustration 4, T may escape liability by objecting to UP as a contracting party, but only if UP or A was aware of T’s unwillingness to contract with UP. This result lends no credence to a subjective will theory.

Even if we limit our inquiry, as most modern analysts would, to the presence of objective or manifested assent, we find no manifestation of assent by T to contract with UP. Nor has UP manifested assent directly to T, except vicariously, and in a disguised manner, through A.

The seeming incongruity between the law of undisclosed agency and theories of contract based on either subjective or objective assent is probably the main reason that the doctrine of undisclosed agency historically has been considered anomalous. This comment from the Restatement (Second) of Agency is representative:

The rules with reference to undisclosed principals appear to violate one of the basic theories of contracts. The relation between the principal and a person with whom the agent has made an authorized contract is spoken of as contractual, although by definition there has been no manifestation of consent by the third person to the principal or by the principal to him. In fact, the contract, in the common law sense, is between the agent and the third person. In spite of this, the law of agency finds it expedient to create rights and liabilities between the other party to the transaction and the principal as if the latter were a contracting party.

The second traditional contract theory, the reliance theory, which looks to the existence of ‘reasonable’ and detrimental reliance, [FN24] fares little better. If T does not know of UP’s existence, she can never rely on UP’s commitment. Therefore, a reliance theory cannot explain why T may hold UP liable as a party to the contract. Frederick Pollock, an early and persistent critic of the doctrine of undisclosed agency, made a similar observation:

A enters into the service of X, he does not know of the existence of Y and Z, X’s dormant partners. It therefore follows that he was induced to enter into the contract by his trust in the promise of X to remunerate him; and if he afterwards discovered that X had no partners, A would have no reason to complain. Why then should be gain by the fact, which never influenced his conduct, that Y and Z were X’s partners when A contracted with X?

Since UP’s liability is a central tenet of undisclosed agency law, a reliance theory has serious explanatory shortcomings. Furthermore, a reliance theory may not explain T’s liability to A in Illustration 1, since it is not clear how A, acting solely on UP’s behalf, would have detrimentally relied on T. The only relations a reliance theory might explain are: (1) T’s liability to UP in Illustration 1, if UP knew of and relied on T’s commitment, and (2) A’s obligation in Illustration 1, if T can be shown to have relied on A’s promise.

Both the efficiency and substantive fairness theories, the third and fourth traditional contract theories we consider, are standards-based. A standards- based theory evaluates the results of the transactions against a predetermined standard regarded as primary. [FN26] There are two immediate problems with such theories. First, they require a mechanism for discovering and justifying the standards they apply. Second, they would not enforce any transaction that failed to meet the proper standard, even one in which the parties are in mutual agreement.

I discuss elsewhere why an efficiency analysis cannot be itself produce a normative assessment of contractual obligation. [FN28] Moreover, if a consent theory of contract is consistent with or even necessary to achieving allocational efficiency, [FN29] then the outcomes it specifies in the area of undisclosed agency are likely to facilitate efficiency without resorting to an explicit efficiency analysis. Still, economic analysis can tell us much of importance about agency relationship. [FN30] Although to may knowledge economists have yet to discuss specifically the problems unique to undisclosed agency, enforcing contracts made on behalf of undisclosed principals provides important economic benefits. Permitting principals to conceal their existence is one way to overcome strategic behavior–or so-called ‘hold-out’ problems– that can impair the formation of mutually beneficial contracts. Many buyers seek to avoid having to pay more for a *1977 particular item solely because the seller knows of the buyer’s deep pocket. [FN31] For example, in Senor v. Bangor Mills, Inc., [FN32] the defendant, a prodigious user of nylon yarn, had to make frequent and substantial purchases in the ‘secondary’ market in order to maintain its production levels. Because its needs and economic position were well known, it was asked to pay prices that were very high even for that market. Accordingly, it sought to buy yarn more cheaply through an intermediary.

In addition to the problems mentioned above, since there is nothing in any of the illustrations to indicate the substantive ‘unfairness’ of the exchange, a substantive fairness theory [FN34] has nothing whatsoever to say about how these cases should be decided.

The final traditional theory, the bargain theory of contract, [FN36] only explains A and T’s liability to each other. Where UP did not himself bargain with T and T certainly did not knowingly bargain with UP, it is unclear under the bargain theory why UP or T would be liable to each other. The inability of the five best known theories of contractual obligation to explain the seemingly anomalous results of the law of undisclosed agency is symptomatic of the general weakness of each of these five approaches standing alone.

Moving beyond the purview of contract theory, a noncontractual, restitution- based ‘unjust enrichment’ analysis is deficient as well. Sometimes UP is enriched at T’s expense, an sometimes (as in Illustration 2) he is not. UP’s liability does not usually turn on this fact. ‘Enrichment’ normally refers to the receipt by a person of benefits not paid for. Therefore, when UP is enriched, A is surely not. Yet A nonetheless remains subject to liability until T elects to pursue UP. Moreover, T’s liability in Illustration 3 cannot be justified in terms of restitution, since T has already paid for the goods once.

Although the law of undisclosed agency has lacked adequate theoretical justification, it makes some sense intuitively. [FN37] If this body of rules *1978 can be theoretically justified, it will reaffirm an important virtue of a common law system: that the process of adjudicating countless cases can lead judges uninformed by the niceties of legal theory (or despite their familiarity with legal theory) to a more just body of rules. [FN38] Legal theory, however, is still necessary to shape the doctrines that result from common law adjudication and to assist judges in deciding hard cases. Legal theory is also needed to justify the spontaneously evolved doctrines. For these reasons, Part II critically applies a consent theory of contract to the law of undisclosed agency.

TRADITION, REASON, AND THE EVOLUTION OF COMMON LAW DOCTRINE

The doctrine of undisclosed agency developed during a period dominated first by will or assent theories and then by reliance and benefit *2001 theories. During this time, it was widely known that none of these theories satisfactorily accounted for this body of law. [FN140] Yet the doctrine developed despite this, and in a remarkably coherent manner. There is a lesson in this for legal theorists.

It is true that we need legal theory to help shapes and rationalize the decisions of courts, and it is true that individual judges are often illequipped to engage in much rigorous theory. But judicial decisions can be the source of important information for legal theorists. The countless judges who developed the law of undisclosed agency never heard of a consent theory of contract. And they might very well have accepted other doctrines that a consent theory would reject. Yet, in spite of their own theoretical knowledge and by the force of their experience and sheet intuition, they produced a body of doctrine that only a consent theory can adequately explain.

Elsewhere, I have argued that judges seek a form of moral knowledge when devising rules that will both resolve present disputes and avoid future ones. [FN141] That is, they seek to determine how a dispute ought to be resolved. Judges have acquired this knowledge in two ways: by tradition and by reason. Two important sources of tradition are precedent and commercial custom. Precedent is derived from the decisions of countless other judges. These decisions consist both of adjudicated outcomes and the judges’ explanations of those outcomes. Commercial custom is derived from the ‘situation sense’ or practical wisdom of countless traders in a particular commercial community coupled with their experience with the strategic behavior of others.

There is a critical evolutionary process at work here, one that is capable of producing what has been called a ‘spontaneous order.’ [FN142] Countless persons must concur before any decision becomes a ‘majority rule’ or a ‘custom’. The resulting consensus is not right solely because it is a consensus; rather, by capturing the ‘local’ wisdom of innumerable persons, it is provides important insights or knowledge about what is right in particular situations.

Pure tradition alone, however, is not enough. Although the insight provided by these processes is the product of the experience and rational faculties of its participants, and as such deserves great respect, even the multitude can be wrong. Instead of rejecting erroneous decisions, traditional processes can sometimes reinforce them. The task of judges and *2002 scholars is to critically evaluate the ‘received wisdom’ or, in the words of Lon Fuller, ‘to separate the tosh from the essential.’ [FN143] Without critical input, tradition would not evolve or progress.

Legal theory applies reason to systematize and reform the rules and practices produced by evolutionary processes. Most legal theorists do not presume that they are capable of creating an entire body of law from whole cloth. Rather, they take the time that most judges cannot afford, often using special techniques to evaluate critically the answers to legal problems that tradition has graciously provided. Sometimes the traditional answers are shown to be either wrong or at least inconsistent with traditional answers to other problems. Theorists then strive to correct perceived error and reconcile perceived inconsistencies. I have called the persons who drive this process of legal evolution ‘the electorate of law.’ [FN144]

If the ‘anomaly’ of undisclosed agency law arises from the conflict between two spontaneously developed doctrines–undisclosed agency law and the modern doctrine of assumpsit–it has persisted because modern contract theories have taken assumpsit as given. Such theories, therefore, uneasily conclude that the doctrines developed to resolve undisclosed agency problems are ‘anomalous.’ It is a sign of the vitality of the ‘electorate of law’ that it has not sacrificed the practical wisdom of this body of rules on the altar of contract theories devised to rationalize a conceptual mistake.

A legal theory needs much more than a correspondence with legal practice to be proved right. The function of legal theory is not simply to predict or explain outcomes of lawsuits, but to justify them. [FN145] Nonetheless, the fact that a consent theory of contract succeeds in explaining the law of undisclosed agency where other theories of contractual obligation have failed is surely a mark in its favor. Moreover, if a consent theory *2003 and its property rights foundations are correct, then the ‘anomalous’ rules devised by judges to regulate the relations of undisclosed principals, their agents, and those with whom they contracted are not only explicable. They are justified.

Author: Randy E. Barnett
Copyright 1987 by the California Law Review, Inc.