December 2, 2014
Many companies look to outside advisors to supplement the experience of senior executives and members of the board of directors. Since advisors are not serving in positions recognized by statute or common law, such as director or officers, all of the duties and obligations of the company and the advisor are a matter of contract between the parties and it is important to have a carefully drafted advisor agreement in place before an advisor begins his or her service to the company. Such an agreement creates binding legal obligations on the advisor with regard to protecting the interests of the company, which is important since advisors do not have the fiduciary duties to the company and its shareholders that directors and officers do. Advisory agreements may sometimes be supplemented by written charters and procedures, similar to bylaws, which apply to a “board of advisors” that the company might create that includes all of the advisors that have been engaged.
The October 2014 Business Counselor Update includes several different examples of advisor agreements as part of the chapter on Entrepreneurship (§§ 18:1 et seq.). The library begins with a comprehensive form of advisory board agreement that addresses all the key issues discussed below that generally arise in an advisory relationship (see § 18:101). Counsel will also find an agreement with an advisor that will be providing services outlined in a separate consulting contract (see § 18:102); an agreement with an advisor who will also be providing consulting services that are described in the same agreement (see § 18:103); and an example of an agreement with a member of a scientific advisory board that includes confidentiality and ownership of proprietary information provisions (see § 18:104). When negotiating and drafting an advisory agreement the following issues should be considered:
Duties of the Advisor. The agreement should clearly describe the duties to be carried out by the advisor and this generally means setting out expectations regarding the number of meetings or other events the advisor will be expected to attend, either live or via teleconference; the type and amount of preparation that expected of the advisor to carry out his or her duties including reviewing of reports, business plans and/or budgets; and any other duties that fall within the specific competencies and experience of the advisor such as identifying business opportunities or working with executives and managers in a particular functional area. The description of duties should cover reporting and communications paths, such as whether the advisor will be reporting to the board of directors or to the members of the management team. The agreement should make it clear that the advisor is an independent contractor and how no power or authority to act for, or purport to bind, the company in interactions with third parties (and the should specific prohibit the advisor from making any representations that he or she has authority to bind the company).
Term and Termination. It is customary for the parties to agree on a specific term for the advisory relationship in order to clarify the expectations of both side regarding the duration of the advisor’s availability and the level of commitment expected of the advisor and facilitate planning for how the advisor’s time will be used and allocated. However, while the agreement may specify a term it should also be clear that the advisor’s service is “at will” and the company, as well as the advisor, has the right to terminate the relationship at any time with or without cause. At the end of the term the company can simply let the agreement lapse if the advisory arrangement has fell short of expectations or there is no longer a need for the advisor’s particular services and experience. If the company believes that it is still important to have the advisor on board at the end of the term the parties can extend the agreement.
Compensation for Advisory Services. There are a variety of methods that companies use for compensating their advisors. If cash compensation is offered the agreement should specify the amount and timing of payments and any conditions that will need to be satisfied in order for a payment to be earned and payable. If equity compensation is offered the agreement should address issues such as the number and type of securities, pricing (i.e., the exercise price if the advisor is to receive options) and vesting restrictions. Another issue to consider is reimbursement of expenses that the advisor may incur in carrying out his or her duties and it is common for the parties to include simple procedures for reporting expenses and pre-approval of expenses over a certain amount by an executive of the company.
Information Rights and Protection of Confidential Information. Unlike directors, advisors do not have any statutory or common law rights to receive information from the company or inspect the company’s books and records and it is therefore necessary to provide for information rights by contract in the advisory agreement. The company should be willing to provide the advisor with access to all of the information relevant to the advisor’s duties including copies of reports, meeting notices, minutes and other materials. Delivery of these items should be timely and is often tied to delivery of the same items to directors of the company. However, the company should reserve the right to withhold information from the advisor at its discretion and the agreement should include detailed duties and obligations on the advisor with respect to protecting “confidential information” of the company that he or she may receive or observe during the course of acting as an advisor.
Participation in Board Meetings. Some companies ask or expect their advisors to participate in meetings of the board of directors, particularly in those situations where an advisor is brought on board specifically to provide advice to the directors as a group as opposed to management of the company. In that situation it is important for advisors to be given sufficient information in advance of board meetings to allow them to make a meaningful contribution when asked; however, it should be clear to everyone that participation in board meeting and access to information provided to directors does not give any advisor a right to vote on matters that come before the board. The company and the board of directors should have the absolute right to ask an advisor to leave a board meeting at any time and, in fact, advisors should probably be asked to leave a meeting whenever the boards will be receiving advice from counsel on privileged matters since case law indicates that the attorney-client privilege does not extend to advisors. Another issue that needs to be considered if advisors are providing guidance directly to the directors at board meetings is providing advisors with indemnification in the event they are named as defendants in shareholders’ litigation or other lawsuits that may be brought against the company. If indemnification is offered the agreement should make it clear that the rights of the advisor are being granted to him or her as a “third party” and not as a director or officer of the company.
Ownership of Intellectual Property Created by Advisor. Since it is not always clear whether intellectual property created by advisors during the advisory relationship would be considered to be “work-for-hire”, and thus owned by the company, the agreement should include an express assignment by the advisor to the company of any developments or works that the advisor might create while carrying out his duties and responsibilities to the company under the agreement.
Conflicts of Interest. Advisors are generally recruited and engaged on the basis of their broader experience and contacts within a particular industry or market sector and, as such, the agreement should address the possibility of conflicts of interest between the advisor’s relationship with the company and his or her other business interests and activities including advisory or consulting relationships with an actual or potential competitor of the company. At a minimum the advisor should be required to disclose any relationships with third parties that might create a conflict of interest. If desired, the company could insist that the advisor’s relationship be “exclusive” and prohibit the advisor from doing business with any actual or potential competitor of the company without first obtaining the company’s consent, which could be withheld for any reason or no reason by the company. Obvious concerns for the company with regard to these types of relationships with actual or potential competitors include the leakage of the company’s confidential information, disputes regarding ownership of the intellectual property created by the advisor and dilution of the advisor’s attention to, and interest in, the company and its business.
Governing Law and Dispute Resolution. As with any other contract the parties should specify the governing law and the procedures for resolving disputes that may arise under the terms of the agreement. The governing law will generally be either the law of the state where the company is incorporated or the law of the state where the company’s principal headquarters is located. Venue will typically be in close proximity to the company’s headquarters. If disputes are to be resolved in court it is common for the parties to waive their right to a jury given that the parties are presumably sophisticated with respect to business matters. Mediation and arbitration may be appropriate for resolving most of the disputes that may arise in an advisory relationship; however, if alternative dispute resolution is selected the company should still reserve the right to go in front of a judge for injunctive relief in the event the advisor violates restrictions in the agreement relating to protection of confidential information.