Q&A: A board director who acts unilaterally may not be protected by the business judgment rule
Question: I am one of five board directors at our homeowners association. The problem is that one director thinks he knows it all and goes it alone. He decides what invoices to pay. He decides what contracts we need and signs them. He decides which security guard company, attorney and manager to hire and hires them. But he does not investigate these contractors; he just takes the manager’s word that they’re good. We learn after the fact that needed permits were never pulled on construction projects or that the work was shoddy.
Now this director wants the association to enter into a multimillion-dollar loan for “projects” he and the manager decided we need. The association has its own attorney, but he meets constantly with another attorney he hired “on behalf of” the association without the rest of the board. The association pays the bills, but we don’t have a clue what he’s up to. He continues to make unilateral decisions binding the association without our knowledge.
At the last meeting, one director said if he continues acting on his own he will not be covered by the business judgment rule if we are sued. The attorney this errant director consults says “that is nonsense, he is covered by the business judgment rule.” Is he, and are we, still covered by the business judgment rule?
Answer: Even though court decisions have recognized that the business judgment rule generally creates a presumption that directors’ decisions are protected against liability in the event of a lawsuit, your director’s actions could be creating a liability for the association and other board members.
Each titleholder and director can sue the errant director for a variety of actions, including breach of governing documents, failure to act in good faith and breach of fiduciary duty. Even worse, titleholders can file lawsuits against each individual director for failure to rein in this rogue director
Generally, courts will refrain from reviewing or second-guessing a director’s impartial decisions performed in good faith, even if those decisions ended up being wrong — but not when the director acts negligently. And the description of your board director’s actions appears to imply negligence.
In California, there is a statutory business judgment rule in Corporations Code section 7231 that applies to nonprofit corporations. It provides that a director shall perform the duties of a director in good faith, in a manner that a director believes to be in the best interests of the corporation and with such care as an ordinarily prudent person in a like position would use under similar circumstances. The statute goes on to state that a person who performs the duties of a director in accordance with the law shall have no liability based upon any alleged failure to perform the duties of a director.
However, the rule does not immunize a director from liability. The protection afforded by the rule is no more than a presumption that the director acted in accordance with the law. A plaintiff challenging the director’s actions can present evidence that the actions were not impartial or made in good faith. The rule will not protect a director when the decision is unilateral or spurred by a personal interest.
This year, the reckless and unilateral conduct you described was considered in Palm Springs Villas II Homeowners Assn vs. Erna Parth, in which the association sued the board president for breach of fiduciary duty. The trial court granted Parth’s motion for summary judgment, contending that the claim of breach of fiduciary duty was barred by the business judgment rule. The trial court said that directors are not liable for errors in judgment as long as the directors were: “(1) disinterested and independent; (2) acting in good faith; and (3) reasonably diligent in informing themselves of the facts.”
However, the state Court of Appeals reversed the decision and sent the case back to the lower court for a trial. It held that this type of conduct created a question of fact concerning whether the presumption created by the business judgment rule could be rebutted at trial. In other words, the association’s president could not avail herself of the protections afforded by the rule merely because she was a sitting board director making decisions.
The appellate court decided that Parth failed to understand the scope of her authority and that the evidence suggested she made no effort to ascertain what authority she did possess. The justices continued by driving the point home that “the business judgment rule would not extend to such willful ignorance.”
Your board director needs to be reminded that he is but one-fifth of the decision-making power on that board, and whether or not his actions would be immune from judicial review could be left up to a judge — a risk your association owners might not be able to afford.
Zachary Levine, a partner at Wolk & Levine, a business and intellectual property law firm, co-wrote this column. Vanitzian is an arbitrator and mediator. Send questions to Donie Vanitzian, JD, P.O. Box 10490, Marina del Rey, CA 90295 or noexit@mindspring.com
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