Call of Duty
Common Ground, May/June 2004

Linda A. Bartel, PCAM

If you've been involved in community association operations for more than a few years, you'll likely recognize these situations all too well. Maybe you've known board members who have used their position to increase their personal income or their sense of power and self-worth. But did you know this is a violation of their fiduciary duty? And are you familiar with the specific obligations of that duty?

SIMPLY FIDUCIARY

A fiduciary, as defined by Webster's Dictionary, is "a person to whom property or power is entrusted for the benefit of another." Such a relationship exists where people place a special confidence in someone who is bound to act in good faith and with due regard for their interests. In an association, where homeowners pay assessments to an organization that is tasked with administering their community and safeguarding property values, the need for such a binding role is obvious.

What does fiduciary duty specifically mean for board members? That they are bound under state law--usually a general not-for-profit/nonprofit corporation act or a specific condominium or homeowner association statute--to act within their authority, to exercise due care, and to act in good faith and with ordinary care that they believe to be in the best interests of the association. Under the fiduciary model, board members do not have individual power or authority. Rather, decision-making ability rests with the full board. Typically, a breach of fiduciary duty occurs when directors or officers pursue a personal agenda that will benefit only themselves and be a detriment to the association. This can open up the entire board to liability.

Uncompromising fiduciary responsibility may seem like a lot to expect from a bunch of homeowners who have volunteered their time to help lead their community. Indeed, one school of thought suggests that, because of the part-time, uncompensated nature of their job, association board members should be held to a less-stringent standard of care than board members of for-profit corporations. But, in fact, it makes sense that a stricter standard of care is imposed, because association board members represent public rather than private trust. Your residents depend on their association to maintain, protect, preserve, and enhance the common areas, which as a result protects property values. The last thing they want to hear from a board member when things go wrong is, "Hey, I'm just a volunteer."

Among other things, your board is responsible for protecting the association from liability through the purchase of insurance against both foreseeable and unforeseeable risks, maintaining the common areas, adequately funding a reserve for the repair and replacement of major components, promulgating reasonable rules and procedures, adopting policies to collect assessments, enforcing the association's documents and otherwise administering its affairs, and ensuring that a system of internal controls is in place. At bottom, fiduciary duty obligates your board members to measure their performance in these areas against certain very strict benchmarks: the fiduciary standard and the business judgment rule.

Fiduciary standard. The law imposes fiduciary responsibilities to ensure that power is exercised conscientiously. Thus, the fiduciary standard demands that board members possess good communications skills, plan carefully in advance, delegate work to qualified committees or advisers, exercise initiative and independent thinking, and work well together.

Business judgment rule. A more specific fiduciary benchmark is the business judgment rule, which imposes on boards the responsibility for understanding association operations and researching every business decision they make before acting. It also offers some protection, because essentially the business judgment rule says that if board members act in what they believe to be the best interests of the association--in an ordinarily prudent manner, after reasonable inquiry--then they're not liable, even if the decision turns out to have been a poor one. Indeed, the protection afforded by the business judg.ment rule highlights the importance of documenting in your minutes every step you've taken to conduct a reasonable inquiry.

JUDGMENT CALL

Specifically, the business judgment rule requires board members to exercise two more fiduciary duties: the duty of care and the duty of undivided loyalty. Together these obligations give you a series of helpful performance markers.

Duty of care. Under the duty of care, board members are expected to act in accordance with both the law and your association's articles and bylaws, and to use the care and skill that a prudent person would use in similar circumstances. Not that they're completely on their own. Board members can also rely on information, opinions, reports, and statements prepared by their committees, management company, legal counsel, and other advisers--provided they use this input to act in good faith, with no knowledge that their actions are inappropriate.

This may seem abstract, but the duty of care applies to board members in very tangible ways:

Active participation. A board member must actively participate in the governance of the association by attending meetings, evaluating financial reports, reviewing minutes, and so on. Volunteers who don't have the time to participate to this degree should not agree to serve on the board.

Board actions. Board members who are present at a meeting when an action is approved by the board are presumed to have agreed to the action unless they vote against it or are prohibited from voting because of a conflict of interest.

Books, records, and governing documents. Board members have two responsibilities when it comes to an association's documents. First, they should have general knowledge of the books and records, including bylaws, articles of incorporation, and accounting statements, and make them available to residents who wish to inspect them. Second, board members must verify that association records are accurate.

Minutes. State laws usually require associations to keep accurate minutes of any meetings, including board, member, and committee meetings. Too often, the importance of taking minutes and preparing resolutions is minimized. But, in fact, both functions are based on sound business practices that stress how vital accurate records are to the operation and longevity of the association. Good minutes allow a board to research past issues and decisions. Plus, in the event that a board decision becomes a legal issue, your attorney may need to review your minutes to verify that you followed proper procedure.

Restrictions. Among your board's most important fiduciary duties is covenants enforcement. As fiduciaries, board members must take into consideration many factors when deciding whether to take enforcement action against a member. If you make a business decision not to enforce a particular violation because it's unpopular or will affect a large number of people, you must appreciate the consequences of that decision. You may establish a precedent that would make it difficult for future boards to enforce that same restriction or other restrictions. You could face potential liability for failing to discharge your fiduciary responsibilities. Remember, the fact that a restriction is unpopular doesn't absolve the board of its duty to enforce that restriction.

Duty of undivided loyalty. Undivided loyalty is what your attorney would call a "true aspect" of the fiduciary relationship, because it gets at the heart of the issue. Indeed, because the fiduciary relationship is about trust, undivided loyalty is the most stringent duty the law imposes on board members. Thus, as a fiduciary, a board member cannot in any sense be in conflict; he or she must act for the sole good of the association at all times.

To exercise its duty of undivided loyalty, a board obviously should avoid conflicts of interest, which occur when board members permit self-interest to interfere with their duty to the association. Consider the board that votes to employ the president's son as the community manager, or contracts with a board member's company to replace the roof. In each case, meeting the duty of undivided loyalty would mean--at the very least--certain board members fully disclosing these relationships and abstaining from voting, and the board soliciting additional bids. Only then would the liability arising from a potential conflict of interest be abated.

PENALTY SHOTS

Serving on the board of an association is an honor, but it's also a responsibility that, as the many facets of fiduciary duty suggest, cannot be taken lightly. What happens when a board member can't live up to the ideals of the fiduciary relationship? Nothing good.

First, from a practical point of view, by ignoring or neglecting your fiduciary duty, chances are you'll end up conducting the business of the association in a manner that eventually alienates residents and is harmful to the community. There are also legal consequences to consider. Courts have reacted negatively to boards that breached their fiduciary duty; and, while there have been proportionately few judgments, the law has repeatedly held that unless a board acts in a manner reasonably related to the exercise of that duty, both the association and individual board members can be held liable.

For example, in one recent case, LaSalle National Trust v. Board of Directors of 1100 Lake Shore Drive Condominium, Illinois' First District Appellate Court upheld an $800,000 judgment against a condo board. The case stemmed from an owner who, as part of a renovation project, demolished the interior of her rooftop penthouse unit without board approval, in the process damaging the condominium's elevator and several other units, cutting off the alarm system, and violating several city ordinances, for which the association was cited.

After this, the owner finally submitted her plans for approval. Then the board insisted she pay for the damage caused by the renovation, post a security deposit to cover any future damages, pay nearly $11,000 for expenses the board incurred in reviewing her plans, pay for a full-time, on-site supervisor to oversee the project, and agree to maintain, repair, and replace the roof. In the resulting legal case, the court found that the board had breached its fiduciary duty through its "extreme lack of cooperation." According to the court, the owner had placed her confidence in the board, which in return practically held her penthouse for ransom. Thus, the board did not act in good faith or with due regard to the owner's interests.

But the idea of personal liability shouldn't frighten you away from board service or paralyze you with indecision. Nor should the political and emotional stress of acting in the best interests of the community--including raising assessments and enforcing deed restrictions--when that means the disapproval of your neighbors. The courts will protect an association and its board members when they have acted reasonably and in good faith.

Some states offer other legal protections as well. Under the California Civil Code, for example, a board member has no liability in excess of insurance for bodily injury, emotional distress, wrongful death, or property damage, provided that the association is exclusively residential, that the act or omission was within the scope of the board member's duties, performed in good faith, and not grossly negligent, and that the board member has no developer or lender affiliation, is either a tenant or owner of not more than two units, and serves without compensation.

Ideally, none of these special protections will be necessary, since the best way for your board members to shield themselves from liability is by exercising sound business judgment. To review, that means acting prudently, carefully considering all the facts and circumstances for each decision, obtaining the advice of legal counsel and the assistance of other professionals, and acting strictly within the scope of your authority and in compliance with the association's declaration, bylaws, and applicable law. And it means refraining from decisions based on anything other than the proper purpose of the association.

If that sounds difficult, well, it is. Boards do not have an easy job, and the homeowners who volunteer their time to do it often receive little gratitude from members. But successful associations do have a common thread: Their leaders--in addition to ensuring that the community looks appealing and maintaining property values--have focused on building a strong sense of community among residents.