What is Agency by Necessity?
Agency by necessity is a term used to describe a relationship in which one party makes essential decisions for the other party in the event of an emergency. Such a relationship is recognized by the legal system.
- Agency by necessity describes a relationship during extraordinary or emergency circumstances in which an agent acts on behalf of a principal without receiving authorization from the principal.
- It is done to prevent harm to the principal, and that agent must continue to act in the best interests of the principal.
- Understanding the basic principal-agent relationship itself is key to understanding the agency by necessity relationship.
How Does Agency by Necessity Work?
Agency by necessity enables the agent to act on behalf of the principal without receiving authorization of the principal in order to prevent harm to the principal. It often occurs when an individual, due to health or disability reasons, is unable to make key decisions. In finance, the decisions often relate to critical investment and retirement decisions.
Review of the Principal-Agent Relationship
In order to understand agency by necessity better, we should briefly review the foundational concepts behind the principal-agent relationship. A principal-agent relationship is one in which a party (the agent) acts and makes decisions on behalf of another party (the principal).
The agent is expected to act in the best interests of the principal in the agency relationship. However, it does not always happen and leads to the principal-agent problem, which plagues many business relationships.
The Principal-Agent Problem
In business applications, the principal is often represented by the owners or shareholders of a business or corporation, while the agents are the managers or employees. The problem itself arises when the agents act contradictory to the intentions of the principals due to a number of factors, such as moral hazard and asymmetric information. They often result in agency costs, which are used to better monitor the agents.
Agency by Necessity Example
Agency by necessity becomes particularly important when dealing with important financial decisions, such as investments and/or retirement decisions. For example, if an individual becomes suddenly ill and is incapacitated to the extent of being unable to make decisions, then a family member or lawyer can be appointed to make decisions on behalf of the individual through agency by necessity. Individuals can also be appointed as agents through agency by necessity in the event of the possibility of incapacitation.
In extraordinary circumstances, agency by necessity also enables agents to act in the best interests of the principal, especially when time constraints or pressing demands necessitate an immediate response.
Possible Legal Issues Arising from Agency by Necessity
The agency by necessity relationship can sometimes face challenges from a legal standpoint, especially when the decisions made by the agent concerns large amounts of money. Common examples include cases regarding the distribution and disposition of the assets of wealthy individuals to their descendants. The distribution of inheritances or funds from trusts often causes a great deal of frustration to the families involved.
When an individual acting as an agent by necessity is involved, other family members often take issue with the decisions made by the agent and voice their frustrations. Often, the family arguments are made in the public eye and may cause irrevocable harm to the families – fracturing relationships to the core. The actions of the agent by necessity are often questioned and will likely be subject to lawsuits, particularly when the monetary amounts involved are substantial.
Many of the issues above come into play when a wealthy individual becomes incapacitated, hindering their abilities to make financial, and perhaps more importantly, estate planning decisions. The designated agent by necessity is responsible for making many of the decisions concerning the principal’s estate and assets.
Decisions include the distribution and bequest of assets to the principal’s heirs, writing wills, settling estate taxes, settling off debts, and managing the principal’s financial obligations.
CFI offers the Commercial Banking & Credit Analyst (CBCA)™ certification program for those looking to take their careers to the next level. To keep learning and advancing your career, the following resources will be helpful: