Business Judgment Rule Protections Can Vanish Amid Conflicts of Interest
Conflicts of interest can strip board members of the protections they otherwise might have under the business judgment rule. A case involving a California HOA recently drove that point home.
“The case really demonstrates the limits of the business judgment rule and how it’s very easy to step outside the limits of the law if you’re not being very careful,” says Kelly Richardson, a partner in the law firm Richardson Ober De Nichilo in Pasadena, Calif.
The association in the case had a five-member board. Three directors were employees of corporate entities that developed and managed the community.
The HOA comprised 267 units — 137 lodge units and 130 patio units. The entities owned all of the lodge units, giving them the majority vote in every election, which they used to consistently elect three employees to the board. The salaries of the employee-directors depended in part on the performance of the properties managed by the entities.
“The employee-directors made bad decisions that affected the ownership of the property,” says Sandra Gottlieb, a founding partner of California homeowner association law firm SwedelsonGottlieb. For example, they approved a budget that made patio unit owners responsible for about 83 percent of the total costs for security services, with lodge owners charged for only 17 percent.
An owner sued the HOA, the entities, and two of their employee-directors, alleging those directors ran the association for the benefit of the entities, rather than the association and its members. By doing so, he claimed, they breached their fiduciary duties to the association and its members.
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