Introduction
According to the recent Venture Capital Report 2025, private equity (PE) and venture capital (VC) investments in India have witnessed a strong resurgence. To protect their huge investment, these PE/VC investors usually appoint a Board Observer (Observer) with an aim to keep an oversight on their investment. Observers serve a strategic function, offering investors a window into the company’s governance while maintaining a non-interfering stance. However, the person appointed as Observer might influence some decisions on the company without being liable for the same because the concept of Observer is not formally defined and runs on the contractual agreement. Recently the Reserve Bank of India’s (RBI’s) decision for Non-Banking Financial Companies (NBFCs) to replace the Observer with a director dilutes the meaning of director. This decision raises questions on the regulatory treatment of the Observer. Therefore, in light of their increased prevalence amidst booming PE/VC activity, there arises a compelling need to formally define and regulate the role, rights, and liabilities of Observers. In this blog, the issue with the current RBI directive has first been critically examined to highlight the regulatory and legal concerns arising from its approach. Thereafter, in order to provide a holistic understanding of the concept of Board Observers, a comparative analysis of international practices has been undertaken. This comparative framework has served as a foundation for formulating a balanced and practical solution tailored to the Indian context.

Problem with RBI’s directive
The RBI’s perspective is reflected through the directive, which intends to make Observers liable for the influence they exert. PE/VC investors appoint an Observer through a contractual agreement for the purpose of keeping an oversight on their investment. These appointed Observers might influence the decision through their active participation without having legal implications. Therefore, RBI has made a step that will make the Observer liable for their influence/actions. Although the RBIs directive seems to be with the right intent, they might have overstepped while doing the same.

Appointing an Observer as a Director fundamentally alters the nature of their role, subjecting them to heightened responsibilities and legal obligations under the Companies Act, 2013. It results in an increase of risk and imposition of fiduciary duties. They may be held personally liable for acts such as breach of statutory duties, mismanagement, or fraud, with significant civil and even criminal consequences. Therefore, the appointment of an Observer as director dissolves the purpose and meaning of the Observer, which is restricted to keeping oversight of the investment. A balance needs to be observed while making the Observer liable for their influence, but also at the same time not imposing extreme liabilities and duties on them.

The RBI’s directive reflects one-size-fits-all approach which is based on an assumption that all Observer will influence decision. This generalisation by RBI has disregarded the diverse structures of Non-Banking Financial Companies (NBFCs) and the passive nature of many Observer roles, which are typically governed by the private contracts. This one-size-fits-all formula has not only failed to conduct stakeholder consultation but has also undermined contractual autonomy, imposing unnecessary compliance within a complex regulatory environment will demotivate the PE/VC investors to invest in NBFCs.

Comparative Analysis
It’s now crucial to consider the perspective of other developed jurisdictions when dealing with the matter of the Observer. In the United States of America (USA), the concept of Board Observer remains obscure, as it is mostly governed through contractual agreements that delineate their rights and liabilities. Statutory and common law guidance on Board Observer remains limited. Although the US Court of Appeals, through its order in the case of Obasi Investment Limited v. Tibet Pharmaceutical, delineated the liability of Observer in case of violation of Section 11 (Sec.) of the Securities Act of 1933. The court held that the Observers are not to be treated as directors because the Observer cannot vote, has no duties towards the company, because their main aim is to protect the investment made by the investors, and an Observer cannot be removed by shareholders. Although this order was centric to Sec. 11, the significance of this order is crucial because of the lack of statutory guidance. But the USA legislative model is non-interference model, where the rights and liabilities are left on the hands of people contracting. This non- interference model is also followed by countries like Singapore and Japan , there are no explicit laws regarding Board Observers, and their conduct is governed through contracts.

In the United Kingdom (UK), it is a common practice to appoint Board Observers through contracts, though there are no statutory provisions that specifically govern them. However, they are indirectly governed by a separate concept called the  Shadow Director.  The people who are not appointed as directors of the company but on whose instructions or directions the directors of the company are required to act are known as Shadow directors. As they have influence on the company’s decisions, the UK’s Companies Act 2006 mandates that the general duties of a director apply to a shadow director as well. This is a wide provision that keeps in check the powers of the Observers, as any person may be considered as a shadow director, no matter if that person has been instructed on some business decisions or all business decisions. Thus, an Observer in the UK exercises caution, as substantial involvement in decision making results in their classification as a shadow director, thereby attracting corresponding legal duties and liabilities.

After analysing all these jurisdictions, we come to conclusion that these nations follow a similar pattern i.e., they choose contractual freedom over regulation whereas India by mandating directorship, runs counter to this global practice and imposes disproportionate burdens on investors. India is in a middle ground where he can’t let things to contract and also can’t incorporate a position like the UK, wherein every case it has to be first proved that the conduct of the Board Observer falls under Shadow Director, and then further prove that he is liable. Terming Observer as a Shadow Director will not only impose fiduciary duties on them but will also increase their risk, which brings us back to the position that the RBI is trying to make. For India, a more suitable path lies between these extremes, recognising Observers through a clear statutory framework that safeguards contractual autonomy while ensuring accountability where oversight turns into interference.

Solution
India needs a more balanced approach while dealing with this situation. We should not leave the rights and liabilities to the contractual agreement, nor should we overstep by defining them as the Director. India needs an explicit and special provision for Board Observers that differentiates them from directors and holds them liable in cases where they influence the company’s decisions.

To ensure the right balance, a four-step structured approach can be followed. Firstly, defining the concept of Observer whereby limiting the definition to financial oversight where they will not have any voting rights or fiduciary responsibilities, but they will have the right to attend meetings and going through the documents of the company. Secondly, the RBI should issue disclosure requirements that should be fulfilled by the Observer. The disclosure should not be limited to minutes of the board meeting but should extend to all the communications made by the Observers through any means of communication. Thirdly, the RBI should be appointed as an investigation body that will flag actions that they think are influencing the decision of the company. Lastly, an annual certification of compliance, which should be countersigned by the Company Secretary, should be submitted to the RBI. Non-compliance of the same should result in blacklisting under RBI norms. Through this procedure, a mechanism can be established which will make Observer liable when they overstep their responsibilities, but also at the same time not overstepping my terming them director.

Conclusion
In light of the growing presence of Observers in Indian corporate governance, it becomes crucial to regulate the framework that will address their role with clarity and precision. The RBI’s recent directive, although well-intentioned, has ended overstepping by blurring the lines between observers and directors. Internationally, countries have decided not to impose much liability on Observers; instead, they chose to be governed by the contractual terms. India, through this Directive, has gone to extremes instead of finding a middle path. Instead of following a rigid solution of terming them as a director, the RBI should follow a structured approach that differentiates between passive oversight and active interference. The RBI, by adopting a structured framework that can clearly define observers’ responsibilities, ensure transparency through disclosures, and enable proportionate regulatory oversight, can strike the right balance. This model will keep a check on the influence of the Observer and will also protect the integrity of investor relationships. Therefore, a nuanced, well-defined regulatory regime is essential to align governance standards with market realities.