Considerations in Drafting Board Observer 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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Although board observer arrangements are not uncommon, there is little case law squarely addressing the rights, duties, and potential liabilities of board observers. Reference to basic principles of corporate law, however, should provide corporations and investors sufficient guidance in structuring board observer arrangements. These arrangements may offer several advantages over a traditional designated board seat. From the investor’s standpoint, the arrangement may provide insight into a corporation that operates in a business line in which the investor is currently active or in which it is seeking to expand. At the same time, the arrangement helps to avoid subjecting the investor’s designee to traditional fiduciary duties. From the corporation’s standpoint, the arrangement may give the corporation access to an investor designee who has knowledge of the corporation’s business, and it may serve to promote a relationship with a potential strategic partner. The arrangement might also represent a compromise by which the corporation grants greater access and information to the investor in exchange for assurances that the investor will not be able to exert undue influence over corporate decisions or, in the event of intra-corporate disputes, gain access to privileged information. To function as all parties intend, a board observer arrangement should be carefully documented. This article sets forth some of the key issues that parties documenting board observer arrangements should consider. 
General – Fiduciary Duties
A board observer should not be considered a fiduciary of the corporation whose board he or she observes solely by virtue of his or her role as observer. The imposition of fiduciary duties on board observers 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. In the corporate law setting, the business and affairs of the corporation are managed by or under the direction of the board of directors, and the directors, in discharging their duties, owe fiduciary duties to the stockholders, as the residual beneficiaries of the corporation. Board observer arrangements generally do not confer upon the observer managerial discretion or control over the corporation’s assets, nor do they give rise to such discretion or control. Since board observers, as such, have no control over the corporation’s assets and business, they should not be bound by traditional fiduciary duties. 
The board observer agreement should nevertheless specify the limitations on the observer’s role and functions. Such limitations will help to constrain the observer, and thereby protect against claims that the observer is serving in a fiduciary capacity. Specifically, the board ob