If your company is considering appointing a board observer as part of your corporate governance framework, there are few considerations you should take into account. Both the company and the board observer should understand the board observer’s rights, obligations and liabilities. You can achieve this by putting a comprehensive board observer agreement in place. This article will explain:

  • the role of a board observer;
  • their key rights and obligations; and
  • the common clauses usually included in board observer agreements.

Board Observer

It is becoming increasingly common for companies to include board observers as part of their corporate governance framework. A board observer is a person who has the right to attend the board meetings of a company but has no legal vote on any board matters. Investors of a company with significant equity in the company typically select and appoint board observers. Appointing a board observer allows these investors to obtain access to company decisions and have some say in the direction of the company. This is because investors are usually either not entitled to obtain a seat on the board as a director or chooses not to take up such a position.

Why Appoint a Board Observer?

Investors often prefer to appoint a board observer rather than a director because of the responsibilities and liabilities that come with appointing directors. That is, directors owe significant duties to the company and there are severe consequences if these duties are breached. Appointing a board observer allows investors to keep up with and potentially influence company decisions without these duties.

For your company, a board observer can be beneficial as it allows you to obtain an additional viewpoint from your investors without having to give up any control of the board. However, there is a risk that having an extra person at board meetings may change the focus of the board from growing the business to solely focusing on the interests of investors. As a result, you may decide to only provide investors with access to information and financial reports of the company.

Board Observer Agreement

Unlike the role of company directors, corporations law does not govern the role of board observers. As a result, the rights and obligations of a board observer should be set out under contract. Doing so avoids any misunderstanding about their role and provides legal protection for your company.

You can either have a separate board observer agreement or set out the terms of the board observer’s appointment within the company’s shareholders agreement. Depending on what you choose, the contract between the company and the board observer may also include your company’s shareholders or investors as a party.

Common Board Observer Agreement Clauses

The clauses you should include in your board observer agreement will depend on several factors, including the:

  • type of business;
  • rights the company wishes to give the board observer;
  • investors’ expectations; and
  • plans and goals of the business and investors.

A few of the common clauses included in board observer agreements include provisions about the:

  • right to appointment;
  • scope of the role;
  • procedural matters;
  • length of the board observer’s term;
  • remuneration and expenses; and
  • company protections.

Right to Appointment

A board observer agreement will usually specify who has the right to appoint a board observer (e.g. investors). It usually also confirms that the company has agreed to permit the person appointed as a board observer to take on that role.

Scope of Role

A board observer agreement will also contain clauses confirming the scope of the board observer’s role. In addition, it usually makes it clear that the board has no obligation to act on any of the board observer’s advice or guidance. The agreement will usually provide that a board observer:

  • has the right to attend and speak at any board meeting;
  • is unable to vote or exercise any other rights that a company director usually has;
  • has the right to provide advice and guidance to the board on the company’s strategic and operational matters;
  • is a consultant only and has no power or influence over the company. This makes it clear that the observer is not a director or shadow director;
  • cannot enter into contracts on behalf of the company or transact business in the company; and
  • will not be held liable for any loss suffered by the company from taking on board any of their advice. This indemnifies the board observer in respect of any such loss.

Procedural Matters

The board observer agreement will also state the meetings the board observer can attend, whether this is all or just a select few board meetings. In addition, it will cover what materials the company will provide the board observer in respect of board meetings.

For example, notices of meetings and board papers.

It will also stipulate the situations in which the company may withhold information and exclude the board observer from meetings. This may be appropriate where the board observer has a conflict of interest in a board matter.

Term

A term refers to the length of time a board observer will remain in the role for, usually agreed upon in the board observer agreement. With regard to the board observer’s term, the board observer agreement will usually cover:

  • the length of time the board observer can be appointed for (the length of the board observer’s term);
  • the bases of termination of the board observer’s appointment; and
  • what happens if the board observer’s appointment comes to an end or is terminated.

For example, a requirement that the board observer returns all confidential information upon termination.

Remuneration and Expenses

This clause covers whether the board observer is entitled to receive any remuneration or reimbursement of any or particular expenses.

Company Protections

A board observer is not subject to the same legal duties as a director.

For example, duties to act in the best interest of the company, to keep information confidential and to disclose conflicts of interest.

As a result, your company should protect itself by imposing these obligations through the board observer agreement. Common protection clauses include clause(s) requiring the board observer to:

  • notify the company if they intend to provide any services to a competitor;
  • confirm that they will not be in breach of any other duties or obligations they may have with other parties. It may also be necessary to include a non-competition clause depending on the circumstances;
  • maintain confidentiality in respect of any information provided; and
  • confirm that all intellectual property created by the board observer in the course of their appointment as board observer vests in, and is assigned to, the company.

Key Takeaways

A board observer is an alternative board role that your company may consider appropriate for the governance of the company and its relationship with investors. When appointing a board observer, both your company and the appointed board observer should be aware of the board observer’s rights and obligations.

By ensuring a board observer agreement is put in place you can properly document:

  • the role;
  • the board observer’s rights and obligations; and
  • provide legal protection for both your company and the board observer.

If you have any questions about drafting your board observer agreements, get in touch with LegalVision’s business lawyers on 1300 544 755 or fill out the form on this page.

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