I am a fan of advisory boards when family-owned companies are transitioning from a board of directors consisting solely of family members. It is a good way to test the waters before moving to a board of directors that includes independent (non-family) members in a fiduciary capacity. I am also a fan of individuals who are willing to serve as members of advisory boards. They play an important role in the life of a family-owned company by bringing new perspective and business expertise. Typically, advisory board members find the work rewarding. However, the role is not without risk.
Although a member of a corporation’s advisory board does not owe statutory fiduciary duties to the corporation or its shareholders, she may unintentionally adopt such duties if, by her actions, she becomes a de facto director of the corporation. In addition, if the corporation and advisory board adopt an engagement letter that spells out the advisory board’s functions, members of the advisory board may be subject to liability if they stray from the boundaries set out in the engagement letter.
If an advisory board member begins to act as a member of the board of directors, she will be considered a “de facto” director. A de facto director’s actions are binding on the corporation so far as third persons are concerned and, thus, an advisory board member who becomes a de facto director would likely owe fiduciary duties like those of an actual director. In order to avoid the danger of an advisory board member becoming a de facto director, each member of the advisory board should take care to avoid taking on responsibilities and performing functions reserved for the board of directors.
If a corporation and its advisory board wish to shield the advisory board members from the various fiduciary duties and potential liabilities of a legal board of directors they should adopt an engagement letter that clearly delineates the advisory board’s roles and the standards by which those roles are to be performed. The letter should also make clear that the advisory board is not to perform roles reserved for the board of directors. The letter should require that the advisory board keep certain legal matters confidential. Lastly, while any indemnification provision included in a corporation’s certificate of incorporation typically does not cover the advisory board, the corporation may (and should) contract to provide indemnification to advisory board members for liability that may arise from their service.
The following is a suggested list of provisions to be included in the engagement letter:
- The advisory board should not be referred to as a “board” but instead an “advisory committee” or other appropriate title.
- The advisory board does not have decision-making powers or voting authority.
- The recommendations of the advisory board are not binding and are subject to review by the corporation’s board of directors.
- The advisory board should hold meetings separate from the board of directors.
- Advisory board members should not be counted in determining whether a quorum is present at board of director meetings.
In addition to adopting an engagement letter, the corporation and its advisory board may wish to adopt certain behavioral safeguards. For example, advisory board members should not be informally referred to as “directors” or “the board,” but as “advisors” or another appropriate term. Also, when decisions are made by the board of directors after discussion with the advisory board, resolutions should be adopted by the directors and the meeting minutes should reflect that the advisory board members did not participate in the vote. These suggestions can help ensure that the advisory board remains in a purely advisory role without any semblance to the contrary.