Board Operation, Some Examples and Fiduciary Duties revisited - Part III

Aspects of Fiduciary Duties 

(3) "A fiduciary duty arises out of a relationship in which one person or entity is entrusted to make decisions for, and control the interests of, another person or persons. Boards of directors owe a fiduciary duty to the association’s members. Most jurisdictions have either enacted statutes or have specific case law that establishes directors of nonprofit and non-stock corporations as fiduciaries.

There are two aspects of fiduciary duty. The first relates to a director’s responsibility to perform his duties in good faith, in a manner each director believes to be in the best interest of the association, and with such care, including reasonable inquiry, as a prudent person in a like position would ordinarily use under similar circumstances. This standard of care has been adopted in most jurisdictions and is often cited as the “prudent person standard” or the “business judgment rule.” Directors will not be liable for mere mistakes in judgment so long as they act in good faith and have a rational and informed basis for their decision.

The second aspect relates to a 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 or her own interest or with a conflicting interest. Not only must directors perform their duties in good faith and in the association’s best interest, but they also must exercise undivided loyalty and honesty and avoid any conflict of interest or self dealing.

• A director can comply with the standard of due care by following the business judgment rule requirements. Courts will not second-guess a director’s decision that is made with reasonable diligence and is believed to be in the association’s best interest. The business judgment rule requires directors to:
• Be informed about the association’s business at all times.
• Attend and participate in all meetings.
• Register a dissent in the minutes.
• Remain knowledgeable about the declaration, bylaws, rules and other documents essential to the association’s operation.

As to the avoidance of conflicts of interest, failure to meet the standard of undivided loyalty and honesty could expose the director to liability for a breach of fiduciary duty. When faced with a decision involving a potential conflict of interest, the director should disclose the conflict of interest in writing and abstain from voting on the issue."

(4) "The law of fiduciary responsibility can be viewed as having two purposes. The first is moral or educational in nature. The law sets a standard for appropriate conduct of association directors. It is intended to guide proper conduct and avoid inappropriate actions. The other role of the law of fiduciary duty is to act as a practical tool for restitution. If a homeowners association is damaged because of a breach of fiduciary duty by the director, the law affords a remedy to recover the resulting damages. A wealth of resources are available to directors to assist in understanding and meeting their fiduciary responsibilities. Books, pamphlets, magazines and newsletters are one source of information. Professional advisors, including attorneys, accountants, reserve study consultants, engineers, architects, insurance brokers and community association management consultants are among the paid advisors who may be engaged to advise on either a narrow issue or more broadly to help directors understand and comply with their legal standard of care.

The ability of volunteer directors to effectively perform their fiduciary duties will ultimately determine the success of common interest developments as a form of housing. While there are widespread examples of successfully run subdivisions, there are unfortunately also well known instances of leadership failures where homeowners associations are in political turmoil, financial collapse and physical deterioration. The challenge to each director is to exercise good leadership to avoid such a downward spiral of economic and political self-destruction.

(5) Recipes for Success and Failure

From the legal standpoint, directors incur liability when they breach the standard of care to which they are held under the statutory and case law which are discussed below. In reality, however, suits for breach of fiduciary duty can be viewed as arising from a lack of leadership and management skills by the board of directors. It is appropriate, therefore, to pause and consider the characteristics of successful leadership and management.

In successfully run homeowners associations, members of the board of directors possess good communication skills, carefully plan in advance, make good judgments based on sound decision making practices, delegate work to qualified committees or advisors, exercise initiative and independent thinking, and work well together as a team. In contrast, political or fiscal failures often result from the acts or omissions of boards of directors lacking good communication skills, procrastinating necessary work, making bad judgments without seeking input from committees or advisors, stagnating for lack of initiative, or political stalemates caused by dysfunctional personal relationships among the board members. From this perspective, the exercise of fiduciary duty flows naturally from effective business management, and it is the breakdown of good management practices, and the lack of skilled leadership, that breeds claims for breach of fiduciary duty.

(6) What is Fiduciary Duty

Fiduciary duty is a standard of care which inheres in a legal relationship of trust and confidence between one in a position of power, dominance or authority, and another who is dependent on the proper exercise of that authority. Fiduciary duty exists in relationships between directors and their corporation, trustees and their trusts, and attorneys and their clients. Inherent in fiduciary duty is the responsibility to act in good faith and candor, the duty to act in the interests of another and to avoid self-dealing transactions, and the obligation to not exert undo pressure or to act without the knowledge and consent of the "beneficiary".

The law imposes fiduciary responsibilities to ensure that power is exercised responsibly. Directors are expected to act in the best interests of the corporation, and not to exploit their position of power for personal gain or advantage. No one argues with the soundness of this principle in the abstract. Experience demonstrates, however, that directors can become paralyzed in the stressful situation where the responsibility to act in the best interests of the corporation conflicts with personal or emotional needs, such as the basic human need for personal approval from one's neighbors and friends. Enforcing the governing instruments, properly funding the economic needs of the association, or pursuing causes of action for defective construction potentially place the director in the position of controversy and criticism. The good people who volunteer to serve their community through election or appointment to the board of directors are often unprepared for the emotional and political crossfires that can easily arise in the performance of these duties. Even the anticipation of such controversy is sufficient to keep many directors from taking difficult short term actions that are important to the long term well being of the homeowners association."

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I encourage the reader to visit the following sites and continue and expand their education. The more informed our unit owners and our Board of Directors are, the better run our HOA will be.

References:

(3)   Harborview HOA blog

(4), (5), (6)  HOA Law - Jeffry A. Barnett, APC