Rarely mentioned by caselaw, or in such core corporate documents as articles of incorporation and bylaws, a “board observer” is a creature of contracts— including stockholder agreements, investment agreements, and board observer agreements—who attends board meetings to monitor the proceedings on behalf of her principal, an investor in the company.
Perhaps the highest-profile example of a board observer is Adam Neumann, the co-founder and former chairman and CEO of WeWork, who took on that role in 2019, after surrendering control of the company to investor SoftBank.
As the name suggests, during meetings an observer’s role is (overtly, at least) passive.
In Obasi Investment Ltd. v. Tibet Pharmaceuticals, Inc., 931 F.3d 179, 181 (3rd Cir. 2019), the Court of Appeals held, after an extended examination of the meanings of “director,” and “similar,” that “under Section 11 of the Securities Act of 1933, 15 U.S.C. §77k, a nonvoting board observer affiliated with an issuer’s placement agent is [not] a ‘person who, with his consent, is named in the registration statement as being or about to become a director[ ] [or] person performing similar functions.’”
The registration statement at issue indicated that although the two board observers “will not be able to vote, they may nevertheless significantly influence the outcome of matters submitted to the Board of Directors for approval,” id. at 183.
Yet the Court found that “Three features differentiate [the observers] from directors. First, and most fundamentally, [they] cannot vote for board action. Second, they are aligned with the placement agent, . . . not [the corporation]. And third, their tenures are set to end automatically [based on dilution of the initial investors’ share ownership, or on the trading price of the shares], with no opportunity to vote them out.” Id. In addition, the registration statement referred to the fiduciary duties of directors, but not of the observers.
Investors and companies arranging for the presence of board observers should consider clarifying issues in following categories, among others:
● First, the observer’s qualifications. What criteria can, should, the company insist on in board observers?
For example, should observers meet any specific definitions of independence? What restrictions should be placed on their past, current, and future employment by, or board membership of, competitors of the corporation?
Can, and should, counsel for the investor serve as an observer? Can the corporation require, for one or more specified reasons—or for no reason—that the investor replace a particular observer with someone else? Should the investor designate in advance one or more alternate observers, in case one cannot attend a meeting?
Can one investor be granted a veto power over a second investor’s selection of a specific person as the second investor’s observer? (Should there be any restrictions on different investors’ observers talking with each other about the company and its management?)
● Second, the observer’s (non-)participation. Observer agreements generally provide that the observer is not able to vote during board deliberations; some add that the observer cannot “participate” in the meetings.
Does this mean that, unlike directors, observers cannot ask before or during a meeting that an item be added to the agenda, or that one or more officers be invited to make a presentation to the board on a certain topic? Although observers are usually prohibited from making motions or offering resolutions, are they allowed to make informal suggestions or recommendations, before and/or during meetings, to the directors as a group, to subsets of the board members, and/or to individual directors?
Is a board observer authorized to distribute to the board, for their information, material that she (or he principal) has prepared and/or collected?
● Third, the observer’s access to, or exclusion from, meetings. Are observers, who must usually receive the same meeting notices as do directors, allowed to attend all portions of each session—including executive sessions—of every board and committee meeting?
Some observer arrangements allow for the exclusion of the observer from those parts of a meeting that involve the company’s attorney-client communications, to preserve the privilege. See Finjan, Inc. v. Sonicwall, Inc., 2020 WL 4192285 (N.D. Cal.), at *5 (company waived attorney-client privilege by discussing otherwise privileged-material in the presence of a board observer from an investor who did not have a common legal interest, as opposed to a common commercial interest, with the company).
These documents also enable the observer to be excluded from discussions of the company’s relationship with the investor whom the observer represents, to prevent the observer from having a conflict of interest; and from proceedings involving the company’s trade secrets and/or material furnished to the company subject to a nondisclosure agreement requiring the company to restrict its dissemination.
More vaguely, an agreement could prevent an observer from attending “if the Observer’s presence at such meeting would. . . be deemed by a majority of the Board of Directors of the Company to be detrimental to the Company or the Board of Directors’ deliberations.” Alarm.com Holdings, Inc. v. ABS Capital Partners Inc., 2018 WL 3006118 (Del. Ch.), at *3 (quoting a document granting board observer rights to the preferred stockholders).
By what process can any of those circumstances be declared? By a majority vote of the directors (in attendance), or simply at the discretion of the director presiding at that meeting? Must the company always furnish the observer with a reason for her exclusion? Is there any immediate way for the observer to apply for reconsideration of that decision?
And, what constitutes a “meeting” for these purposes? Might not directors or committee members, without formal notice to each other or the board observer, simply gather “informally,” whether face-to-face or virtually, to “share our thoughts on different matters”— without actually voting? How can the observer’s principal avoid— and/or detect—such a sub rosa meeting?
● Fourth, the observer’s access to materials. In Braga Investment & Advisory, LLC v. Yenni Income Opportunities Fund I, L.P., 2020 WL 3042236 (Del. Ch.) at *16, the relevant agreement called for the board observer to “receive copies of all Board packages prepared for Board members concurrent with receipt thereof by all Board members.”
Although the observer’s principal argued that it was thereby entitled to what the court categorized as “a sweeping amount of information,” including: “documents ‘uploaded to the Board Data Room,’”; any information provided to other board observers; and all information “related to [the company’s] operations and finances, to which [a director] is entitled,” the Court of Chancery agreed with the company that “the language at issue reflects no more than an intention to include [the observer] as part of [the company’s] normal distribution of its Board packages.” Id. at *17.
Recognizing that “[t]he term ‘Board package’ is not static and does not equate to an unvarying checklist of items,” the Court found that in this context its “ordinary and usual meaning” was, the “set of materials that [the company’s] management determines, in good faith, are necessary to provide to Board members in connection with a Board meeting so that they can perform their duties in an informed manner.” Id. at *18. Therefore, the observer was not entitled to “every scrap of paper that a Board member theoretically could ask to see untethered to” such materials. Id.
Observer agreements clarifying the scope of the observer’s access to material might address her ability to obtain material that is usually available to directors on request but that has not (yet) been distributed to them as part of a meeting “package”; and whether she minutes of board and committee meetings held (during a specified time period) before she became involved with the company will be made available to her.
● Fifth, the observer’s confidentiality obligations. Like directors, who have a fiduciary duty of loyalty, observers are normally prohibited from taking corporate opportunities and from insider trading. However, their confidentiality obligations (and any exceptions), are often set forth in extreme detail, especially since their role calls for them to share information with their principals. See Alarm.com Holdings, Inc, supra, at *3-4 (reproducing an observer agreement’s confidentiality provisions).
Are observers subject to the same restrictions, if any, that the company may impose on directors with regard to taking, and retaining, notes of meetings? Would such notes be subject to disclosure to shareholders of the company, and/or to shareholders or others bringing actions against the principals?
Are previous observers allowed to share their recollections and insights with current observers of the same board? With the permission of their principals (if necessary), are observers authorized to discuss with third parties their broad impressions of the capabilities and effectiveness of—and their assessments of the mental and/or physical health of—particular members of the board and of the company’s senior management?
Are observers permitted to discuss with anyone other than their principals the board’s and management’s general approach to decision-making, especially if it is particularly distinctive and effective?
● Sixth, the insulation of the observer from liability. Although exculpation provisions generally apply only to directors, observer agreements typically call for the company to provide both insurance and indemnification to observers. See Zimmerman v. Crothall, 62 A.3d 676, 715 (Del. Ch. 2013) (quoting a purchase agreement that provides indemnification for board observers). Must this be the same type and coverage of insurance as the company’s directors receive?
(Finally, can an analogy be made to elements of quantum mechanics, and/or of Eastern philosophies and religions, in which the mere presence of the observer affects the system being observed?)