Considerations in Drafting Board Advisor Arrangements

This article and the companion article on board advisors both address a corporate governance arrangement under which the skill set of the formal board of directors is supplemented by individuals who are appointed to serve in an observational or advisory capacity. These individuals do not have the fiduciary duties of elected board members. Board observers are typically a phenomenon of venture capital backed companies and represent the interests of such investors. In contrast, the use of board advisors is increasingly becoming a feature of board of directors meetings across the spectrum, including closely-held family-controlled businesses, venture capital or private equity-backed companies, and public companies.

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Companies increasingly are including board advisors or corporate advisory boards in their corporate governance arrangements. This trend is not limited to any particular segment, but spans across companies large and small, public and private, and corporations and alternative entities (such as limited liability companies).

Board advisors are individuals with business experience or other relevant expertise who advise a company's directors and management, most frequently on management and strategy issues. Board advisors are voluntarily appointed and serve at the pleasure of the board or company management. Board advisors attend board meetings and may advise the company’s directors and management, but have no actual authority to make business decisions.

Since advisors are not elected and have no authority to make business decisions, they do not owe fiduciary duties to the shareholders of the company by virtue of their advisory role. This is a key difference from the company’s directors, who do owe fiduciary duties, and are subject to liability arising from any breach of those duties. This distinction may be a contributing factor to the increasing use of advisory boards, which allows advisors to contribute to the company’s management and strategic planning without the duties (and liability exposure) accompanying service as a director of the company.

There is little case law or other legal authority addressing the rights, duties and potential liabilities of board advisors. Reference to basic principles of corporate law and corporate authority, however, should provide corporations sufficient guidance in structuring advisory board arrangements. This article is intended to provide insights and tools that practitioners can use to advise their clients who may currently use advisors or may be considering using them.

While much of the discussion applies to businesses using other entity forms, this article assumes that the company is organized as a corporation.

Role of the Advisory Board

Unlike the members of a company's board of directors, shareholders do not elect board advisors. The advisors instead are appointed by, and generally serve at the pleasure of, the board or company management. Before a company begins a relationship with a board advisor or establishes an advisory board, the company and its counsel should have a clear idea of the benefits the company expects from the relationship and how the relationship will function in practice. A company and its counsel should also be prepared to address common board advisor concerns and protect key company interests throughout the relationship.

A board advisor’s precise duties and responsibilities depend on the company's particular needs and objectives. Board advisors generally provide the company with knowledge, expertise, and connections that expand those of the company's management and directors. For example, an entrepreneurial company may engage board advisors who have started their own businesses to help identify common pitfalls or be a sounding board for product or business plan ideas. A mature, public company may organize an advisory board because, unburdened by regulatory and oversight responsibilities, the advisors will be free to focus exclusively on strategic issues, such as technology improvements, product marketing and development, and the like.

Advisors Distinguished from Board Observers

In many cases, investors in companies financed by venture capital or private equity firms have a contractual right to appoint board observers to attend meetings and receive information available to the directors. A board observer represents the interests of the investor that appointed the observer, and therefore, from the company's perspective, the board observer is a mandatory requirement driven by the investors' rights and needs. For this reason, while observers may provide valuable advice and perspective to the board and company management similar to advisors, they may face greater skepticism or hostility from directors or management because they primarily protect the investor group they represent.

Like board advisors, board observers attend and participate in meetings of a company's board of directors and are typically entitled to receive all information provided to board members. Also like board advisors, board observers have no voting rights.

Fiduciary Duties

Similar to a board observer, a board advisor should not be considered a fiduciary of the corporation solely by virtue of his or her role as an advisor. The imposition of fiduciary duties on board advisors would be largely inconsistent with the corporate law underpinnings of fiduciary duties. Corporate law fiduciary duties arise from trust law concepts – a party who manages an asset for the benefit of another party is held to standards of care and loyalty in managing the asset for the beneficiary. Thus in a corporation, as its business and affairs are managed by or under the direction of the board of directors, the directors owe fiduciary duties to the stockholders.

Members of a company's board of directors have fiduciary duties to shareholders and can be liable for breach of those duties. Board advisors, on the other hand, are not elected by shareholders and have no authority to make business decisions for the company. Accordingly, under corporate law, they do not owe fiduciary duties to company shareholders solely because of the advisor role.

Nonetheless, board advisors may be concerned about potential liability to the company's shareholders and other parties arising out of their role. Therefore, the company should reduce the risk of liability by (1) creating documents that clearly identify advisors and distinguish their duties from those of the members of the board of directors; (2) ensuring that board advisors do not, in practice, perform duties traditionally reserved to a director (such as participating in board or committee voting); and (3) ensuring that advisors do not exert (or appear to exert) control over members of the board of directors when they meet in their capacity as directors.

Advisory Board Agreements

For practical and legal reasons, a company should define its relationship with its advisory board members in a written agreement or policy. While there is no legal requirement to have any particular documents, clearly drafted agreements and other documents can help avoid misunderstandings and confusion about the advisors’ roles, limit their liability exposure, and protect the company’s interests, including confidentiality and intellectual property rights.

Board advisor relationships are typically documented by using an advisory board or consulting agreement. Some companies also adopt by-law provisions and separate advisory board charters. To the extent an advisor’s role is not detailed in the agreement, it may be helpful to prepare an onboarding memo outlining the role of the advisory board and the particular advisor. In any case, the company's board should formally approve the creation of the advisor relationship or advisory board with resolutions or a written consent, including adoption of the advisory board agreement.

Advisory Board Agreements – Key Provisions

Duties

The agreement should specify that the advisor’s role is to provide consulting services, either to the board of directors or to management, as an independent contractor. It should make clear that the advisor has no power to act for, represent, or bind the company and cannot take action that implies it has this type of authority. The agreement also should specify the duties the company expects the advisor to perform, which may include: (1) the number of meetings, conference calls, or other events the advisor must attend; (2) any preparation the advisor should complete in advance of these meetings or events, including reviewing materials such as business plans or budgets; and (3) any other duties the company and advisor have agreed upon, such as identifying business opportunities or assisting the board with management communications.

Term of Service

Advisors generally serve at the will of the board or company management. However, providing for a term encourages advanced planning and helps ensure the company and advisor are on the same page about the minimum commitment expected. It also provides the company a graceful way to exit the relationship if the advisor does not add value. Even if the agreement specifies a term, it should also clearly state that the advisor serves at the will of the board or management and that the agreement may be terminated at any time by either party, with or without reason.

Compensation

Companies take different approaches to compensating their board advisors. Whether or not the advisor is compensated, the agreement should address which party is responsible for expenses and how expenses must be reported. If the advisor will be compensated, the amounts and timing of payments should be specified. If the compensation involves an equity component, then there will be many more issues for consideration and much more documentation involved, all of which is beyond the scope of this article.

Information and Participation Rights

Unlike directors, board advisors have no statutory or common law right to receive notice of meetings of the board, to receive any materials or other information provided to directors, or to inspect the corporation’s books and records. Any rights extended to the advisors, therefore, are provided voluntarily by the directors or company management. Also, unlike board observer arrangements, the right to access company information is, in most cases, expressly reserved to the company in its sole discretion.

In order to ensure that the advisors can assist the board or management effectively, however, the company should provide copies of all notices, minutes, reports, and other materials that the corporation provides to members of the board (or committee) at such time as those documents and materials are provided to members or the board or committee. That said, the agreement should be clear that the company, in its sole discretion, may or may not provide information as it deems necessary or appropriate.

Confidentiality and Privilege

Given that board advisors will have access to board meetings and sensitive corporate materials, all confidential and proprietary materials and information furnished to the advisor must remain the property of the corporation, and the use and disclosure of such materials and information should be restricted. The agreement should contain a detailed definition of what constitutes “confidential information” and should require the advisor to keep those materials confidential, subject to customary exceptions (e.g., where the disclosure is required by law).

The advisor will want to ensure, however, that the confidentiality restrictions are not drafted so broadly as to encroach upon his or her other business activities. For this reason, the company should carefully consider any conflicts of interest that might develop in light of its business and an advisor’s other activities and commitments.

If the agreement permits the advisor to share confidential information and materials with his or her representatives, it should obligate the advisor to inform such representatives of the restrictions on the disclosure and use of such information and materials and instruct them to comply with those provisions. The agreement also should provide that the advisor is responsible for any breach of the agreement by his or her representatives.

A corollary to confidentiality is attorney-client privilege. A recent Illinois decision confirms that, generally speaking, the privilege does not extend to advisors. (See BSP Software, LLC v. Motio, Inc. (N.D. Ill., June 12, 2013).) This includes discussions during board of directors' meetings with counsel regarding privileged matters. As a practical matter, this means that advisors should be asked to step out of any meeting when privileged matters are being discussed, and privileged documents should not be shared with advisors.

Protecting Intellectual Property, Disclosing Conflicts of Interest

The company also should take steps to protect any intellectual property its advisors may create while performing their roles. Developments or other works created by advisors generally would not be deemed work-for-hire owned by the company. As a result, any intellectual property rights would generally be retained by the advisor. Therefore, the agreement should contain an express assignment to the company of any developments or works created by the advisor within the scope of his or her engagement, or that otherwise arise from the use of the company's confidential or proprietary information.

More broadly, the company again should consider potential conflicts of interest of its advisors or prospective advisors. Generally speaking, a company may not want to engage an advisor that is also serving on the board of, or consulting with, a competitor or company in a related industry. Those circumstances create conditions for potential cross-over discussions of proprietary information or trade secrets, which may lead to disputes over IP rights. For this reason, the agreement should clarify whether the advisor’s role with the company is exclusive, and the advisor should represent and warrant that his or her duties under the advisory board agreement do not conflict with any arrangement with another company or venture.

Indemnification and Advancement

Due to his or her participation in board meetings and access to materials, a board advisor runs the risk of being named as a defendant in shareholder lawsuits or other actions involving the corporation. This is particularly true for start-up companies, when an advisor often has a net worth greater than the corporation itself (and therefore may be viewed as a “deep pocket” by potential litigants).

The company typically will indemnify the advisor and advance expenses in connection with any suits or proceedings brought against the advisor, or to which the advisor is otherwise made a party or witness, by reason of his or her role with the company. Assuming such rights are extended, the agreement should specify that the corporation is providing third-party indemnification rights, and is not providing rights to indemnification or advancement of expenses to the advisor in his or her capacity as a director or officer of the corporation.

Governing Law and Consent to Jurisdiction or Arbitration

The agreement should specify the law by which it is governed. In general, the parties should provide that the agreement will be governed by the law of the jurisdiction in which the corporation is incorporated or in which its principal place of business is located. The agreement should also require that disputes be resolved in a specified jurisdiction and venue. Given that any disputes are likely to be business disputes among sophisticated parties, the parties should waive the right to a jury trial.

Alternatively, the parties may wish to provide that disputes arising under the agreement be submitted to binding arbitration. In that case, the agreement should set forth with specificity the provisions that would govern the arbitration proceedings. Any such provisions should have a carve-out for the enforcement of any restrictive covenants (such as confidentiality restrictions).

Conclusion

Board advisors can provide tremendous value to a company’s board and management. Like board observers, however, this arrangement is defined almost entirely by contract, with few statutory or common law rights or obligations granted to or imposed upon the corporation or the advisor. For that reason, directors and management should ensure that the agreement governing the arrangement covers the key issues that are important to the parties and is drafted with precision.