Use Business Judgment Rule to Avoid Association Lawsuits

Use Business Judgment Rule to Avoid Association Lawsuits

Typically, if decisions made by the board turn out well, members are happy. But if the decisions lead to unforeseen costly expenses to the community, some members might sue, regardless of the board members’ good intentions. That’s why it’s more important than ever that your board’s judgments be the result of a sound, deliberative decision-making process. If they are, there’s a much better chance that courts will defer to them in case of a lawsuit.

If a board can show that a decision was made as a result of such a process, the board can often rely on the “business judgment rule” when faced with a member’s lawsuit over a particularly unpopular board decision.

So how does this important legal framework operate? The business judgment rule is a part of corporation law. It holds that a judge or court of law will generally not interfere or hold liable the decisions of a board as long as that board is acting in good faith in the best interest of the shareholders.

The business judgment rule limits judicial scrutiny of actions of association boards when they act in good faith, exercise honest judgment, act with the best interests of the association, and in an informed, prudent manner. Although generally regarded as a rule of liability for corporate directors, courts have used the rule as a test to determine the validity of association board decisions.

One guideline to follow is to gather information and obtain expert advice. Directors should be informed. Directors should ask questions of management, legal counsel, engineers, or other experts as often as possible before making decisions. Getting the advice of appropriate professionals can help show that your board made an informed and reasonable judgment.

Obtaining expert advice is particularly important when dealing with an issue that’s clearly outside board members’ expertise, such as a structural problem with the physical components of your community. Although directors are not required to accept the advice of experts, that advice should be carefully considered in making decisions. If that advice is disregarded, the board should document the reasons.

Directors should consider alternative courses of action. When alternatives are proposed, the board should give appropriate consideration to the alternatives. Decisions made in good faith are likely to be upheld, whereas arbitrary decisions are not likely to survive challenge.

For two more guidelines an association board can implement to better ensure that a court will defer to the board’s decisions, see “How Business Judgment Rule Can Protect Association from Lawsuits,” available to subscribers here.