There are occasional situations on a board of directors where more standard board roles may not suffice, for instance when an advisory board is needed to consult with on a particular issue. Two of these alternative roles are that of observers and ex-officio board members, both of which entail their own unique functions.
Board observers are persons who the board has authorised to attend a board meeting and, as the name suggests, observe the proceedings and participate where permitted. Observers are typically investors in a company who want access to, and some say in the direction of a company.
They have no fiduciary duties or voting rights, invited only to comment at a board meeting and can be excluded, if necessary, from portions of the meeting. Like in the case of an advisory board, it is often prudent to have the observer sign an intellectual property assignment agreement given that they will be privy to proprietary information.
Beyond this, whatever rights they have are at the discretion of the board directors, typically outlined in an “observer agreement”. An “observer agreement” contains terms relating to the observers’ participatory rights, confidentiality and indemnification. More specifically, it should outline:
- Provisions specifying whether the observer is entitled to compensation.
- What materials the observer board member is allowed to access throughout the course of a board meeting.
- The enforceability of any obligations that may arise between the board and the observer.
Ex-Officio Board Members
An ex-officio board member is a person who holds a seat on the board by virtue of their position, usually because they need to have input into company decision making. Typically, they are senior level executives such as the Chief Executive Officer, Chief Financial Officer and Chief Operating Officer. They may either be an observer or director depending on what the company constitution stipulates. Unlike observers, ex-officio board members generally have voting rights and are eligible to be counted in the quorum unless otherwise constrained by the company’s by-laws. Due to this, they are also subject to the same obligations and duties as a regular director.
The Dilemma of Board Observer Rights
Questions such as what investment threshold an investor has to meet to be appointed an observer, what rights they should be entitled to and their legal obligations are all relevant.
Practically, too many people participating in a board meeting could reduce the productivity of the discussion. It may also adversely affect the development of close working relationships that come with a manageable and tight-knit board. However, this could be overcome by limiting an observers’ right to speak or having them attend on a rotational basis if such an arrangement is agreeable. The chair should also reserve the right to exclude them from meetings.
On the other hand, investors often have a large equity stake in a business, and may require some form of strategic control in return for their capital. Observers also bring extensive professional experience and mentorship to the board table, something invaluable for a newly established company.
It is this balancing act companies have to carry out when deciding whether the advantages of appointing a board observer outweigh the downsides listed. This is something that varies with the individual needs of a company, and should ultimately be a choice made in consultation with the full board and external advisors.
Observer and ex-officio board members form part of a number of alternative board roles that a company may consider better suits the structure of their particular business and board. However, in creating these roles, company’s should be aware of how their rights and obligations differ from a traditional board member and ensure a business solicitor briefs them on what exactly they entail. Questions? Get in touch with our commercial lawyers on 1300 544 755.