This is the first paper in what I plan to be a longer series on the law of the supply chain. The aim of this paper is to give a legal and commercial overview of the use of agents in the supply chain. Topics addressed include: what is an agent? How are they used? What are the advantages and disadvantages of using an agent for sourcing or selling goods? What are some of the common negotiating points between agents and their clients in sourcing transactions?
What is an agent?
Transactions require at least two parties. For example, there may be a buyer and a seller of goods. Or a service provider and their client. Each party to the transaction is called a principal. In a sale of goods contract, the buyer is a principal, and the seller is a principal. In a transaction for services, the service provider is a principal, and their client is a principal. Both principals have rights and obligations that primarily arise under their contract with each other. For example, in a sale of goods transaction, the buyer must pay for the goods, and the seller must deliver the goods, each in accordance with their contract.
Agents represent principals. They help their principals to do business with each other. This is the key to understanding the commercial and legal positions of agents and principals: principals enter into legal relationships with each other; agents facilitate these relationships between principals.
The extent of the agent’s authority usually depends on the scope of the agreement between agent and principal, called an agency agreement. In some cases, regulations may also play a role in determining the scope of an agent’s powers. (There is authority for the creation of agency relationships where there is no agreement between agent and principal, but they are outside the scope of this paper.)
Sometimes, an agent’s authority is limited, such as introducing a seller to a buyer. It is then left to the buyer and seller to negotiate terms. In other circumstances, an agent is given full authority to negotiate and enter contracts on behalf of their principal.
Probably the best-known kind of agent is a real estate agent. Real estate agents act on behalf of buyers and sellers of real estate. The buyer’s agent will help their principal (the buyer) to identify suitable properties, and make offers on properties in accordance with the buyer’s instructions. The seller’s agent will market the property on behalf of their principal, the seller, and collect offers on their behalf. If there is agreement on price and other terms it is then usually left to the buyer and seller, as principals, to enter a sale and purchase agreement directly with each other. (In this sense, real estate agents usually have a form of limited agency, as they typically do not have authority to enter into agreements on behalf of their principals.)
When the property transaction is completed, the buyer pays the seller and the seller transfers title to the buyer. The buyer’s and seller’s agents are compensated in the form of a commission they receive from one or both of the parties (the practice of which principal pays commission to which agent varies from place to place).
Assume the buyer moves in and discovers the property has a leaky roof. Who should be held responsible: the seller’s agent, the seller, or both? Unless the seller’s agent was negligent, committed fraud or breached a regulation, one would expect the seller to be liable. The seller was the owner of the property and sold it to the buyer. The seller’s agent merely represented the seller in the transaction. One would expect that any claim against the seller’s agent would fail unless the buyer is able to identify some defect in the agent’s performance of their duties.
The above summary is highly generalized but hopefully the analysis comes across as common sense. I say this because it is analogous to how buying and selling agents work in the sourcing and supply chain industries.
Agents versus Principals in Sourcing
As the foregoing discussion suggests, there is a fundamental legal difference between agents and principals, namely that agents facilitate transactions between principals, but are not liable to perform the transactions themselves. To understand the difference in a sourcing context, imagine a simple supply relationship between a manufacturer (“Manufacturer A”) that produces goods under its own brand and a customer who is a wholesaler.
Manufacturer A makes the goods, and let’s assume Manufacturer A has title to the goods and possession of them. Manufacturer A has controlled the manufacturing process and knows all the materials that have gone into the goods, along with the fabrication process. Further, in this example, Manufacturer A owns the brand under which the goods are sold.
Conversely, the wholesaler wants to buy the goods, will pay for them and take delivery of them.
In this scenario, the parties’ respective legal obligations are, very generally: Manufacturer A will be responsible for providing title to the goods, for the quality of the goods, and for delivering them on time and to the specified place of delivery. The buyer will be responsible for paying for the goods, and for taking delivery of them.
Let’s say the buyer has hired a buying agent to help them source goods. The buying agent helps the buyer find suitable manufacturers of goods and assists with negotiation of sales terms. In this scenario, the buying agent identifies Manufacturer A as a suitable supplier.
What happens if the buyer pays for the goods and then discovers the goods are defective? Is the buying agent responsible? No, Manufacturer A is responsible for the quality of the goods because they are Manufacturer A’s goods. The buying agent would only be liable to the buyer if the defect is connected in some way to a defect in the way the agent provided their services, for example, if the buying agent failed to perform their services in a manner that complies with the terms of the buying agency agreement. This is analogous to the real estate agent example given above. It is the same analysis.
Buying agents
In the sourcing world, agents can represent the buyer or seller of goods.
Typical services provided by a buying agent include: identifying suitable factories for the goods sought by the buyer, assistance with product development and trends, negotiation and execution of terms with suppliers, payment processing, facilitating factory audits, training factories on the buyer’s compliance standards and assisting with claims against vendors. In return for these services, the buyer’s agent is paid a commission, based on the volume of products ordered.
Usually, the buyer's agent will seek to limit the extent of their liabilities to the buyer, by limiting the scope of services for which it is responsible and negotiating for limitations of liability. The agent will argue they are a mere representative of the buyer and that they have no control over the design and composition of the goods (which are the supplier's responsibility) and that the buyer must look to the seller (not the buying agent) to make good on product claims.
The buyer, on the other hand, may try to negotiate for clauses that make the agent responsible for product-related claims. This makes sense for the buyer: it is to their advantage to make the supplier and the buying agent liable for product-related claims. The buyer may argue that the agent is responsible for identifying good manufacturers, is compensated accordingly and should therefore be responsible for product defects.
Selling agents
Likewise, selling agents will be responsible for representing suppliers who wish to sell their goods. Their responsibilities will chiefly concern identifying, marketing to and negotiating the sale of the supplier’s goods in a certain territory. The selling agent’s authority to market the products may be limited to certain collateral prepared or vetted by the seller. The selling agent may or may not be given authority to conclude sales contracts with buyers.
In return, the seller’s agent is usually compensated with a commission on sales.
Commissionable sales will typically be net of product returns, promotions, rebates and other items such that commissions are only paid on cash received by the seller in connection with the agent’s sales. The seller will usually seek to tie the selling agent’s compensation to the creditworthiness of the buyers; in other words, if a buyer does not pay, no commission is paid to the seller’s agent.
Pros and Cons of Using Agents in Sourcing
The aim of this paper is to give some insight into how agents are used in the sourcing industry, and some of the common commercial and legal points taken into consideration when preparing agency agreements.
Agents provide principals with opportunities to achieve low-cost, less-capital intensive opportunities for business expansion, expertise on foreign markets, and an extensible resource for dealing in markets and products lines where the principal may lack capacity.
On the flipside, principals must be able to trust their agents (particularly where the agents have authority to conclude deals on behalf of the principal). There is always some risk that an agent may exceed their authority, or bring about some reputational damage to the principal. The principal must also be prepared to share margin in the form of agency commissions.
Agents who negotiate good commissions can enjoy healthy remuneration at reduced risk (due to the fact they are not liable as buyer or seller). On the other hand, the agent does not typically enjoy the same margins as their principal, in part due to their reduced risk profile.
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