Beaumont Tashjian Law Blog

Thursday, June 1, 2017

Making Decisions to Protect the Association, Board and Volunteers: The Business Judgement Rule

Board members face decisions every day in performing their duties on the Board of their association. These decisions range from maintenance decisions, such as hiring contractors to perform work, to enforcing governing documents. As we all know, every decision can be second-guessed by someone and can lead to litigation and potential exposure to personal liability. It is important for board members to know what steps they need to take to make sure their decisions are not second-guessed by another member of the association (or by the court if the decision is challenged in litigation). Fortunately for directors, there are rules that will assist a director if their decision is second-guessed by an owner, provided certain obligations are satisfied by the director.

The Business Judgment Rule is set forth in the California Corporations Code and requires a director to perform his or her duties (1) in “good faith”, (2) in a manner he or she believes is in the corporation’s best interest, and (3) with such care, including “reasonable inquiry”, as an ordinarily prudent person in a like position would use under similar circumstances. If a director establishes he or she complied with these three requirements the director will be protected from personal liability. Courts will not second-guess the decision even if another person (or the court itself) would have reached a different decision, as long as the director acted in good faith and in a reasonably prudent manner.

In Lamden v. La Jolla Shores Clubdominium Homeowners Ass’n (1999) 21 Cal. App 4th 249, a residential condominium complex had a termite infestation and the board responded to the termite problem with spot treatment of known infested areas as opposed to tenting and fumigating the buildings, which would have required the residents to temporary relocate. An owner of one of the condominium units filed a lawsuit challenging the board’s decision, claiming the decision diminished the value of her unit by failing to adequately repair the damage. The Supreme Court concluded the board’s decision was entitled to “deference” because the board did not just randomly reach its decision choosing one manner to treat the termite infestation over another but had instead conducted an investigation, consulted with contractors and pest control experts and had a rational reason for selecting the manner of treatment it selected. Because the board took steps to investigate and acted in good faith, the court protected the board’s decision and refused to substitute its judgment for board’s judgment regarding the appropriate manner to treat the termites.

Note: Courts distinguish between the Business Judgement Rule and judicial deference regarding presumptions, etc.

Boards should take care to recognize the limits of the Business Judgment Rule. Directors should be cautious about making quick or uninformed decisions or ignoring an issue and failing to take any action at all. Courts will not defer to a director’s judgment if the court concludes that the director essentially abdicated his or her responsibilities. (Palm Springs Villas II Homeowners Association, Inc. v. Parth (2016) 248 Cal.App.4th 268.) Courts will not protect a director who closes his or her eyes or sticks his or her head in the sand and fails to investigate. Similarly, courts will not defer to the judgment of a director who conducts business but fails to exercise even basic business judgment in doing so. In one example (Palm Springs Villas) the court found a director chose to be willfully ignorant by failing to review the governing documents to determine what power she had to enter into specific contracts without obtaining the vote of the owners or the full board’s approval or by failing to make even a basic inquiry to confirm a roofing company held a valid license. Where a director chooses to act, but does so in an unreasonable manner (failing to exercise any diligence, make any inquiry or conduct any investigation), the director will not be protected by the Business Judgment Rule from personal liability.

Finally, a director is entitled to rely on information, opinions, reports or statements by counsel and other professionals or experts with expertise in a certain area. (Corp. Code §7231(b).) There is no doubt that a qualified professional or expert is necessary and helpful to directors in fulfilling their duties. For example, directors can and should rely on accountants, construction experts, attorneys, etc. However, a director must use care in selecting the right expert, ensuring the expert is qualified and that the expert has the information necessary to give an informed opinion. The director must then be sure to evaluate and follow, if appropriate, the experts’ opinion in reaching their decision to be protected under the Business Judgment Rule.

Ultimately, a director should be prepared to show he or she investigated a matter, consulted with qualified experts where appropriate and exercised his or her reasonable judgment to reach a decision. If so, courts will defer to the director’s decision even if a reasonable person (or the judge) would have acted differently, and the director will be immunized from personal liability for his or her decision.

Christy Gargalis is a member of the firm's litigation department and primarily handles litigation matters, in addition to providing general counsel services to the firm's community association clients.

Christy has been practicing law for over 15 years and is an experienced litigator, having handled matters in state and federal court from inception through trial and on appeal.

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