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Advisory boards: legal tips and potential traps

July 19, 2013
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An advisory board for your family-owned company can be a great asset. But setting one up carelessly can create confusion, destroy confidence and expose board members to personal liability. Let’s examine how to set up an advisory board correctly to avoid those problems for you, your company and your newly appointed advisory board members (ABMs — not to be confused with anti-ballistic missiles).

An advisory board is intended to function as a board of directors, but without any voting rights. It gives your company access to wisdom and experience without affecting your company’s control. In fact, ABMs may appreciate being able to give advice without being responsible for making the hard decisions.

Here’s the challenge: The laws that govern true company directors do not apply to ABMs. And no other body of law exists to govern ABM responsibilities and legal liabilities. So you must create that structure when you design the advisory board.

Read on for a list of subjects your advisory board structure should cover and some suggestions on handling each of those subjects.

Duties and responsibilities. Describe the duties you place on ABMs. Do you want ABMs to have the same duties of due care and loyalty that corporate directors and LLC managers have?

Let’s examine the duty of due care, for example. Do you mean to place personal legal responsibility on an ABM who makes a careless recommendation? Do you intend to be able to pursue that ABM for the consequences of following a careless recommendation? Would anyone be willing to serve your company as an ABM with this exposure? Perhaps not; you may want to impose on the ABM a duty to act only in good faith.

What about imposing a duty of loyalty on the ABM? For example, should an ABM be allowed to participate in any competing enterprise? Should an ABM be allowed to take advantage of a business opportunity instead of offering it to the company first? Corporate directors and LLC managers may not take those actions under well-established statutes and court decisions. If you want the same standards to apply to ABMs, you will need to spell them out.

Protection from personal liability. Corporate and LLC statutes permit company owners to relieve directors and managers from personal liability for money damages in some situations. Will you offer similar protection to your ABMs? Do they even need this protection if you have not imposed director duties on them to begin with?

If you want them insulated from liability for money damages, you should spell that out in the same way that corporate and LLC statutes spell that out for directors and managers.

Insurance. Your company may or may not have director and officer insurance covering your directors, officers, managers and other key employees. Are you able to extend that coverage to ABMs? Will ABMs be willing to serve without that coverage?

To what extent have you exposed ABMs to liability for which they may need insurance? Should the insurance at least cover defense costs in the unlikely event that an ABM is personally named in a lawsuit involving the company and its directors and officers? Do any of the ABMs carry personal liability insurance that would protect them from company-related activities? Some personal liability policies will protect ABMs from true volunteer activities, but this would not be available if you compensate ABMs for their services.

Indemnification. Statutes and court decisions have created an extensive body of law governing the indemnification of corporate and LLC directors and managers. If you want to extend those indemnification protections to ABMs, you will need to say so. 

What standards of conduct must the ABM meet to be entitled to indemnification? Does the company’s director and officer policy provide insurance coverage for the company’s indemnification obligation?

Confidentiality. True directors and managers are bound to maintain confidentiality as part of their statutory duties of loyalty and due care. No such default rule applies to ABMs. You should require ABMs to sign a confidentiality agreement.

Term, resignation and removal. Any ABM structure should designate the term of service, provide a procedure for an ABM to resign, and address who and how an ABM may be removed from office.

ABM fees. Your ABM structure should specify what fees you will pay the ABM for services. You will probably want these payments treated as something other than employment compensation, so you should make that clear in the ABM structure. Fees might be based on the number of months of service, a per-meeting fixed fee, or other basis. Reserve your right to change that fee basis prospectively at any time.

Where and how to implement the structure. Your ABM structure should be written, but can be implemented in several different ways. It might be a series of sections in your corporate bylaws or LLC operating agreement. Or, it might be established in a board policy, accompanied by a standard form of agreement to be entered into between the company and each ABM.

What about the company’s directors and managers? In our experience, advising clients on advisory board structures usually offer a timely opportunity to make sure the company’s existing relationships with its current directors and managers are up to date. These might include taking advantage of Michigan’s latest liability and indemnification protections, updating old bylaws that contain outdated and incorrect procedures, etc. Often these subjects can be addressed much more efficiently at the same time the ABM structure is created.

In summary, an advisory board can be a tremendous asset to your company’s success. Invest the time and effort to structure the advisory board properly from the beginning.

Jeffrey S. Ammon is an attorney with Miller Johnson in Grand Rapids and has counseled many family-owned and closely held companies on advisory boards and other governance matters. He can be reached at (616) 831-1703 or ammonj@millerjohnson.com. To learn more about structuring an advisory board, contact the author or any other member of Miller Johnson’s business entity group.

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