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Steering Clear of Fiduciary Dangers What Boards of Directors Need to Know

What is the standard of fiduciary responsibility for directors of a community association?

(a) The duty to perform the responsibilities of a director and officer in good faith, in a manner each director believes to be in the best interest of the corporation (association) and with such care, including reasonable inquiry, as a prudent person in a like position would ordinarily use under similar circumstances. Stated succinctly, directors owe a duty of care to the association and its members and will not be liable for mere mistakes in judgment so long as they were acting in good faith and had a rational basis for their decision.

(b) The second level of performance relates to the director’s duty, of undivided loyalty to the association and its membership. This higher standard of performance is breached when a director acts in his/her own interest or with a conflicting interest; for example, failure of a developer controlled board to take collection action on delinquent assessments from developer owned units.

Thus, a director not only has to perform his/her duties in good faith and in a manner each director believes to be in the best interest of the association, but also the director owes a duty of undivided loyalty and honesty and must, at all times, avoid any conflict of interest or self-dealing.

Will a director be held liable for breach of fiduciary duty if the director is not compensated and is volunteering his/her efforts?

As stated above, the concept of fiduciary duty arises from a relationship wherein one person controls the interest of another; it certainly is not contingent upon compensation or any other form of payment being made to a director. As such, the application of the fiduciary duty standard would not depend on whether a director is a volunteer or is being paid compensation but is premised upon the control and authority granted to the director over the interest of another. Accordingly, volunteer directors of a community association are subject to the fiduciary standards enumerated above.

In general, how can a director insulate himself/herself from liability for breach of fiduciary duty?

Directors can reduce their liability exposure and can better protect themselves under the business judgment rule as follows: (a) Be informed about the association’s business at all times; (b) Attend and participate in all meetings and, if absent, have the minutes reflect the fact of, and the reason for, the absence. In addition, the director should review the minutes and endeavor to remain fully informed of the activities of the association being conducted in his or her absence; (c) A director who disagrees with an action being taken should register a dissent in the minutes and, in appropriate cases, should explain that dissent; (d) All directors should be knowledgeable about the declaration, bylaws, corporate charter and other documents essential to the association’s operation; (e) Remember that the exercise of sound business judgment is not simply a control and limitation upon action but it also involves the necessity of taking action when action is required. 

What are some common examples in which directors expose themselves to personal liability for breach of fiduciary duty? Also, how can directors avoid such liability in these particular instances?

Failure to Procure Adequate Insurance

A fundamental responsibility of a board of directors is to secure adequate general liability and property insurance. The board of directors has the responsibility and the obligation to protect the common interests of the association membership and has a fiduciary duty to procure adequate insurance. Additionally, directors and officer’s liability insurance should be procured to protect the officers and directors from potential personal liability to the association, its members or third parties.

Failure to enforce the association’s governing documents (CC&Rs, bylaws) or the enforcement of the governing documents in an arbitrary or capricious manner.

Again, many boards of directors can find themselves between a rock and a hard place in its attempt to enforce their governing documents. On the one hand, a board of directors can breach their fiduciary duty by failing to enforce the association’s governing documents. Similarly, directors can be found in breach of their fiduciary duty when they enforce the restrictions in an arbitrary and capricious manner. In light of the foregoing, when boards of directors (or architectural committees) are reviewing homeowners’ architectural requests, great care should be exercised by the governing body to make sure they are complying with their own CC&Rs and bylaws and that their decisions are made in good faith and not exercised capriciously or arbitrarily. Consistency is important here and the governing bodies should at all times attempt to apply the CC&Rs and any architectural rules and regulations in a uniform manner. Written findings of fact to support the decisions of the architectural committee or the board of directors should be maintained at all times. When expertise appears to be beyond the scope of the governing body or there is a substantial controversy involving the architectural request, reference to, or reliance upon professional advice might be prudent.

Additional Miscellaneous Examples

Additional potential areas exposing the board to liability for breach of fiduciary duty are as follows:

(i) Failure to file a lawsuit before the statute of limitations has run; (ii) Failure to supervise employees properly; (iii)Failure to use due care in hiring responsible personnel; (iv) Failure to maintain the common area; (v) Failure to provide adequate safety measures for common areas facilities, especially the recreational facilities; and (vi) Failure to fund reserves adequately.

If a director doubts whether he is acting properly, he or she should ask himself or herself the following question:

“Would a prudent person (reasonable man/woman) in a similar circumstance be making the same decision or taking the same action as I am?”

If the answer is yes and there is no conflict of interest or self dealing, then the fiduciary duties should not have been breached.

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