Feature: The dangers of advisory boards

Friday, 01 August 2008


    There’s no hiding behind the title of advisor. Ben McLaughlin and Antonia Abelson warn that being on an advisory board may come with fiduciary obligations.

    We predict a growing trend in Australia for people to be invited to join an advisory board of a company, not-for-profit entity, government agency or other firm. An advisory board is usually formed by a company appointing a number of individuals to provide advice on a strategic topic on a periodic basis. Such individuals may be alarmed to learn that they risk owing a fiduciary duty to the appointer company.

    An individual invited to join an advisory board of an Australian company has a number of legal issues to consider beyond the usual issues when being engaged as an advisor. In particular, they must ensure that they are not deemed to owe fiduciary duties to the company or be a director of the company.

    This article discusses how a member of an advisory board may be deemed to be a fiduciary or a director; the additional obligations which would apply if this does occur; and how an advisory board member, potential or incumbent, may act to reduce the danger of being considered a fiduciary or a director of a company.

    The why be’s and who are’s

    Often chosen by the CEO, members of an advisory board (usually three to five in number) come from outside the company and may have diverse skills and experience. High level executives and professionals who are reluctant to assume the liabilities of, or devote the necessary time to corporate boards may consider serving on advisory boards. Generally speaking, meetings will be periodic (say, four to six times a year). Membership will often provide valuable personal and professional experience with inspiring and talented peers in a variety of industries. Advisory boards offer the opportunity to stay involved, learn about new industries and share expertise with the leaders of the next generation. Many high-profile advisors have been hired by companies in different industries.

    A proponent of advisory boards, Geehan Advisory Boards, describes them, as follows: “A group of executives, professionals or customers appointed by a company to provide guidance and support on issues critical to the organisation.” It goes on to say that a board of advisors is a “working as opposed to an honorary body that offers guidance versus governance, which delivers great insight minus legal liability and statutory responsibility”. Geehan also asserts that an advisory board is not a board of directors that carries fiduciary responsibility to owners and shareholders, nor maintains organisational control over the CEO.

    Some examples include:

    • Biota, an anti-infective drug development company, which created a scientific advisory board to provide an independent periodical, technical review of Biota’s research and clinical programs. Members of the board include Dr Rob Fenton, the research strategy director of the Institute of Biomedical Engineering in London; Harry Greenberg, professor of medicine and microbiology and immunology at Stanford University School of Medicine; and Doug Richman, professor of pathology and medicine and director of the Centre for AIDS Research at University of California.
    • The British private equity firm, CVC Capital Partners, which formed an Asia-Pacific advisory board consisting of a small number of experienced business executives resident in Asia-Pacific who could advise CVC from time to time on the business climate and business opportunities in the Asia-Pacific.
    • The London hedge fund, Centaurus Capital, which appointed Kenneth Clarke, the former British chancellor, and José María Aznar, the Spanish ex-prime minister to join the existing members of its advisory board. These include Haruko Fukuda, former head of the World Gold Council and a Volvo non-executive, and Thierry de Montbrial, professor of economics at the Ecole Polytechnique in Paris and a director of Cap Gemini. Centaurus chairman and chief investment officer, Bernard Oppetit, noted: “The advisory board will add a much better understanding of large, macro issues ... like global warming, what’s happening in the utilities world in Europe and Asia and banking consolidation in Europe”.
    • Chase Manhattan’s international advisory council, which includes David Rockefeller; Henry Kissinger, former US Secretary of State; Brian Mulroney, former Canadian Prime Minister; Edzard Reuter, former chairman of Daimler-Benz AG; and Koichiro Ejiri, senior advisor to Mitsui & Co. The focus of the group is on policy, macro-economics and geographical trends and theories.
    • When AIG decided to increase its presence in California and Texas, it set up an advisory board consisting of James Miscoll, former vice chairman of Bank of America, and Whitley Hawkins, former president of Delta Air line, to help introduce AIG to key business and strengthen the firm’s reputation with local prospects.
    • Deloitte & Touche, which created a “diversity board” consisting of women and minority representatives as well as executives like Hicks Waldron from Avon Products, former US Secretary of Labor, Lynn Martin and her advisors to improve the retention of top, bright and dedicated professionals.

    From these examples, it can be seen that advisory boards are utilised by companies for many different purposes and the roles performed by the members may differ markedly.

    Fiduciary duty

    The word fiduciary comes from the Latin fides meaning faith. In law, the fiduciary relationship is one of trust and loyalty. The fiduciary duty is to act with such propriety that the interests of the person or company to whom the duty is owed are paramount to any other interest the fiduciary may have. It is the most demanding standard of responsibility that the law prescribes.

    Without taking care, a member of an advisory board may be taken to have a fiduciary duty as an advisor to a client. Advisors need to be aware of the fiduciary duty because they may, and often do, have fiduciary duties to their clients.

    The main content of the fiduciary obligation is to avoid:
    (a) Misuse of the fiduciary position, such as obtaining any unauthorised profit; and
    (b) Occupying a position where the interests of the client conflict with the interests of the fiduciary whether those interests be personal interests or interests the fiduciary has because of duties to third parties, without the fully informed consent of the client.

    The prohibition on conflicts of interests applies where there is a “real or substantial possibility of a conflict.” The standard is high. If the advisor/client relationship is fiduciary, the question is not whether the advisor is affected by conflicting interests in advising the client, but whether any conflicting interests exist at all.

    Many advisors may find themselves in a position where there is a real or substantial possibility of a conflict of interests, especially where they act in more than one professional capacity. For example, it may be difficult for Thierry de Montbrial to advise in the interests of Centaurus Capital without considering the interests of Cap Gemini, the company on whose board he sits, or for Koichiro Ejiri to advise Chase Manhattan completely independently of the interests of Mitsui & Co which he also advises.

    Breach of fiduciary duty

    Where a fiduciary obligation exists and has been breached without the fully informed consent of the client, the fiduciary may be exposed to liabilities such as accounting for any profits the fiduciary has made as a result of breach, a finding that benefits are held on constructive trust for the party to whom the duty is owed, facing an injunction to stop a continuing breach, an award of damages or equitable compensation.

    Fiduciary relationships

    A fiduciary duty may arise in one of two ways: by established category of fiduciary relationship – for example, solicitor and client, director and company, and trustee and beneficiary – or if the circumstances are such that there is a reasonable expectation that a person will always act in the interests of another for the duration of a relationship.

    Mere advisors are not in an established class. An advisor may nonetheless be in a fiduciary relationship with their client if:
    (a) The advisor, due to the nature of their advice and functions, may be given another title that places them within an established class (the concern here is that an advisor may be considered a director of a company in certain circumstances); or
    (b) The circumstances are such that there is a reasonable expectation that the advisor will always act in the interests of the client for the duration of the relationship.

    An advisor as a director of the company

    A member of an advisory board is not appointed as a director. However, the Corporations Act recognises that a person may be a director if they have the same functionality as one, despite acting under another title. A director includes:
    (a) A de facto director – any person acting in the position of director of the company, by whatever name called and whether or not validly appointed to occupy or duly authorised to act in the position; or
    (b) A shadow director – any person who is not validly appointed and in accordance with whose instructions or wishes the directors of the company are accustomed to act.

    De facto director

    One could envisage a member or members of an advisory board being invited to take part in meetings of the company’s directors. Were this to become the rule, and those individuals were treated by company officers as if they were directors, there would be a risk that they could be held to be de facto directors. In this case, they would owe fiduciary and statutory duties to the company.

    Shadow director

    If the majority of the board of a company is accustomed to act on a regular basis in accordance with the instructions of an advisory board, it is conceivable that the members would be shadow directors and owe a fiduciary duty to the company by established category. On the other hand, the mere fact that directors of a company act on the advice of an advisory board, in the proper performance of the members’ professional functions, will not mean that the members are to be regarded as shadow directors.

    In addition to being obliged to comply with fiduciary duties, a shadow director or de facto director will be lumbered with the statutory duties of a director. These largely mirror the fiduciary duties, but also include the obligation to ensure the company does not trade while insolvent, the failure of which results in the director being personally liable for the company’s debts.

    A fiduciary other than by established category

    Australian courts have refrained from providing a general test to determine the existence of a fiduciary relationship. As recently noted by Justice Jacobson:

    perhaps the most that can be said is that a fiduciary relationship exists where a person has undertaken to act in the interests of another and not in his or her own interest but all of the facts and circumstances must be carefully examined to see whether the relationship is, in substance, fiduciary.

    The test has been framed by Professor Finn (as his Honour then was) as follows:

    The critical matter in the end is the role that the alleged fiduciary has, or should be taken to have, in the relationship. It must so implicate that party in the other’s affairs or so align him with the protection or advancement of that other’s interests that foundation exists for the fiduciary expectation.

    Indications of a fiduciary relationship include:

    • The advisors hold themselves out to be experts in the field of advice given;
    • The advisors undertake to provide advice in that field of expertise to the client;
    • In providing advice, the advisors create an expectation in the client that they will advise in the client’s interests;
    • The client relies on the advisors generally, although no pre-contractual relationship is necessary; and
    • The relationship is vertical, in that the client places trust, confidence or dependence in the advisors providing counsel regardless of whether the parties are equally financially sophisticated.

    Scope of a fiduciary duty

    Unlike established categories of fiduciary relationship in which the duty automatically exists and certain obligations are necessarily incidental, the existence and scope of a de facto fiduciary relationship may be defined or modified by the terms of the contract creating the relationship. There are a few ways this may be done:

    • The parties may agree to a generalised advance disclosure clause which would give the fiduciary the informed consent of the client to act in a way that would otherwise be a breach of duty. To ensure the effectiveness of the provisions it is important that the contract clearly defines what duties are owed to the client and are being displaced by informed consent;
    • The parties might prefer to use an ad-hoc disclosure device as the need arises; or
    • The contract between the parties might include an exclusion clause whereby the client agrees not to rely on a claim of a breach of fiduciary duty against the advisors in court.

    Depending on the relationship in question, however, there are limits on the ability of parties to contract out of, or redefine the scope of their fiduciary relationship. There is a spectrum of relationships. At one end there are the status-based relationships for which policy dictates that fiduciary law may not be subject to negotiation in any circumstances. At the other extreme are parties of similar bargaining power who commercially negotiate contracts and, while there may be fiduciary implications from the characteristics of the relationship, there is less need for fiduciary law to add its protection and the contract should be sufficient to govern the basic rights and liabilities of the parties.

    In the writers’ view, members of an advisory board may positively exclude the creation of a fiduciary duty to the company in the contract of appointment, subject to two important provisos. Firstly, substance will override form – the advisory board must act in a way consistent with the terms of the contract. Secondly, the advisory board members must not act in such a way as to become de facto or shadow directors. For example, if the appointment contract calls for the advisory board to meet for four hours once a quarter to provide strategic advice but in practice, a member sits in at all board meetings and is treated as a director, the contractual statement that the member is not a fiduciary is nullified by the member’s contrary actions.

    ASIC v Citigroup – a commercial example

    The recent decision on the legal action taken by the Australian Securities and Investments Commission (ASIC) against the investment bank Citigroup discussed these issues in detail.

    Toll engaged Citigroup to act for it in the proposed takeover of Patrick “as an independent contractor and not in any other capacity including as a fiduciary”. A day before the planned takeover was announced, Citigroup’s equities trading arm bought over one million shares in Patrick. ASIC alleged that Citigroup, as an advisor to Toll, occupied a fiduciary relationship and that in purchasing the Patrick shares, Citigroup had placed itself in a position of conflict between its duty of loyalty to Toll and self interest that arose from the purchase of shares in Patrick. ASIC further alleged that Citigroup did not have in place adequate arrangements to manage this conflict of interest.

    As pointed out by Andrew Tuch, a director of the Ross Parsons Centre of Commercial, Corporate and Taxation Law in the faculty of law at the University of Sydney, the advisory role investment banks provide to clients in lucrative transactions such as mergers, acquisitions, leveraged buy-outs, public offerings and so on have fiduciary characteristics. Since amicable commercial dealings may deteriorate easily, parties to a transaction will generally engage their own financial and legal advisors, each of whom will act in the interests of their client within the scope of providing advice on the transaction. Ideas, information and documents are exchanged freely and client disclosures of non-public information will be made in the strictest confidence. Large transactions typically attract great speculation and media attention and involve highly market sensitive information requiring that companies have trust and confidence in their financial and legal advisors. Despite the investment bank/client relationship having these fiduciary characteristics, in ASIC v Citigroup, the court found that Citigroup had successfully contracted out of a fiduciary duty to Toll in providing advice on a planned takeover of Patrick.

    The core question in the case was whether the mandate letter between Toll and Citigroup was effective to exclude a fiduciary relationship between the parties. The Federal Court of Australia found that, but for the express terms of the mandate letter, the pre-contract dealings between Citigroup and Toll would have pointed strongly toward the existence of a fiduciary relationship in Citigroup’s role as advisor. The dealings included Citigroup giving Toll advice on the wisdom and merits of the Patrick bid, strategic advice using specific financial expertise about aspects of the bid such as bid price, and actively pitching for the mandate and seeking a primary advisory role. The question of whether there was a fiduciary relationship was to be determined, however, by the proper construction of the mandate or engagement letter. When the relationship was considered in light of the express exclusion found in the engagement letter, the Court could only conclude that Citigroup was retained solely as an advisor to Toll, as an independent contractor, and not as a fiduciary.

    Nullifying a fiduciary duty

    It is likely that the advisory board will have undertaken, either explicitly or implicitly, to act in the company’s interests. Prima facie, this would indicate that the advisory board members owe fiduciary obligations to the company.

    There are ways in which the advisor can proceed to avoid being considered a fiduciary.

    An advisor should:

    • Negotiate a contract of engagement which specifically states that the Advisor will not be in a fiduciary relationship with the company but will be an independent contractor;
    • Not commence work for the company until the contract of engagement has been signed. (Otherwise, there is a risk of becoming a fiduciary before the contract is signed);
    • Be sure to be engaged to perform specific functions, rather than being engaged to perform functions of the company generally;
    • Where the advisor is assisting a company in financial difficulties or in any investment decision which may overlap with the general management of the company, be particularly vigilant to ensure the relationship is limited to that of advisor and client;
    • Include in the contract of engagement a provision that the company will consider and deliberate upon any actions to be taken for the management of the company independently of the advice of the advisory board;
    • If the advisors attend a meeting of the directors ensure their attendance is correctly minuted as being a limited attendance by the advisory board for a specific purpose; and
    • Carry out their role consistently with the contract of engagement.

    The advisors should not:

    • Allow the company to be or become in a position of vulnerability, reliant on the advisor; or
    • Frequently or regularly attend meeting of directors or meetings of subcommittees of the board of directors.

    The establishment of an advisory board by a company is a growing trend. Advisory boards may go beyond providing advice by helping to cement key relationships in the industry or to improve client bases. Part of the attraction of an advisory board for a company is that members do not necessarily have the obligations and legal responsibilities of a board of directors which is likely to make them cheaper, more efficient and make their advice more independent. Moreover, the company can receive advice (on a limited basis) from an experienced person. In some industries, advisors may have many other roles, offer different services and have a broad client base and will thus face a variety of conflicting interests. A fiduciary duty in such circumstances may be very onerous. It is important that advisors are aware that they cannot hide behind the title of advisor and may be a fiduciary. They must know what being a fiduciary means and how they can exclude a fiduciary obligation.


    Ben McLaughlin is a partner at Baker & McKenzie, while Antonia Abelson is an associate at the firm.

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