Directors of community associations, like directors of other nonprofit corporations, are not guarantors of the success of the association and are not typically liable for mere mistakes in judgment. Courts require only that directors act as ordinary, prudent people and do not hold them to a standard of prudent business people. They recognize that directors must sometimes make difficult cost-benefit decisions and will not generally second-guess those decisions as long as the directors acted in good faith, and in a manner they believed to be in the best interests of the association, and as reasonably prudent people.
Duty of Ordinary Care
The directors of a homeowners association are held to a duty to exercise ordinary care in their actions as directors, and are further obligated to avoid self-dealing and conflicts of interest. Examples of cases where a director breaches his or her duty of care might include mismanagement of association funds, failure to enforce the governing documents, and failure to maintain the association’s premises. A determination of whether or not a director has exercised ordinary care in his or her actions necessitates consideration of the following three factors:
- Was the act performed in good faith;
- Was the act performed in a manner that the director believed to be in the best interests of the association; and
- Was the act performed with such care as an ordinarily prudent person in a like position would use in similar circumstances, including reasonable inquiry.
If a volunteer director satisfies the above elements, he or she should not be subject to liability for damages arising out of their conduct by virtue of the “business judgment rule.” However, directors could lose the protection of the business judgment rule by delegating too many duties. Although directors are generally authorized by state statutes and/or the association’s bylaws to delegate certain management responsibilities to another person, management company or a committee, the ultimate responsibility for the management of the homeowners association still rests with the board of directors. Another exception to the general rule where a director could have potential exposure to liability is a situation where he or she, in seeking election to the board, may have represented that they have special expertise such as an attorney, architect, or accountant. Such a director could conceivably be held to a higher standard of care on the basis of their representations.
A director’s corporate duty of ordinary care is typically created by state statutes and is owed to the association’s members and not to third parties or other members of the public. Thus, a director may generally be held liable to a third party under common law theories of negligence for breaches of their common law duty to exercise ordinary care when he or she has engaged in tortuous conduct that has caused injuries to a third person. Such liability is independent of whether the director was acting on behalf of the association, which may also be exposed to liability as a result of the director’s actions.
Doctrine of Judicial Deference
In some cases involving an issue of liability for directors’ actions, the courts have applied a doctrine of “judicial deference” where the court has made a decision to defer to the association’s board of directors’ authority and presumed expertise. The judicial deference doctrine has been applied where an association’s properly constituted board has exercised discretion within the scope of its authority and has taken action that was based on a reasonable investigation, in good faith and with regard for the best interests of the homeowners association and its members. In cases that have applied the judicial deference doctrine, the association’s board of directors have taken certain action that has been challenged. Other cases have held that the doctrine does not apply when the association failed to make any decision to which the court could defer.
Duty of Loyalty
Incorporated into the business judgment rule is a duty of loyalty on the part of the association’s directors. Directors can be exposed to liability for actions that may constitute a breach of fiduciary duty, including conflicts of interest. Courts have held that directors owe a duty of undivided loyalty to the association and may not make decisions for the association that benefit their own interests at the expense of the association and its members. If a court finds that an association’s directors breached their fiduciary duty, it may rule the board’s action to be invalid and also hold interested directors individually liable for damages caused by his or her actions.
To avoid conflict of interest situations, state statutes may specify certain situations where a director must not vote (i.e. discipline of that director or the imposition of an assessment against that director, or matters involving the director’s separate interest). In such situations, the director can be present during the board’s consideration of the matter and can argue for a particular vote, but the director must not actually vote on the matter in question. A better practice would be for the interested director to excuse themselves from deliberations on the issue and to make sure their non-involvement is noted in the minutes of the meeting. State laws also address transactions in which a director has a “material financial interest.” Actions taken by an association pertaining to a transaction in which a director has a material financial interest are potentially voidable if they are not approved by either the members or the board of directors after full disclosure by the director, and with the interested director abstaining from a vote on the matter. A board’s decision to approve a transaction where a director has a material financial interest must be made in good faith, and the transaction must be just and reasonable to the corporation at the time that it is authorized, approved, or ratified.
Some associations adopt policies that specify conflicts of interest beyond those that are contained in their state statutes and the ethical responsibilities of the volunteer members of the association that serve as directors. A sample of such a policy and a sample resolution by an association’s board of directors adopting the policy are linked hereto.
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