As anyone familiar with community associations knows, the term “fiduciary” and “fiduciary duty” are commonly thrown around by managers, board members, and owners as generic “catch-alls” to describe board member obligations. Although they are undoubtedly popular buzzwords, their prevalence often oversimplifies their meaning – to the detriment of unwary board members. While some fiduciary duties are straightforward and easy to fulfill, others are more nuanced and have proven treacherous for even well-meaning and cautious board members. Thus, it is imperative for board members to understand their duties to protect both themselves and their associations from potential liability.
Despite common usage, the term “fiduciary” actually applies to a class of duties as opposed to a singular, fiduciary duty.
Namely, there are three fiduciary duties: (i) the duty of obedience, (ii) the duty of care, and (iii) the duty of loyalty. While the duty of loyalty and the duty of obedience are fairly self-explanatory and straightforward, the duty of care can be far more tricky to navigate. Consequently, this article will help to elucidate what the duty of care entails and what the law requires of board members.
Duty of Care: Reasonableness Standard
In laymen’s terms, duty of care stands for the principle that the directors and officers of an association, in making decisions in their official capacities, must act in the same manner as a reasonably prudent person would for themselves under similar circumstances. As such, every decision made by the board of directors should be (i) within the confines of the authority granted to the board by an association’s governing documents (i.e., Declaration, Article of Incorporation, and/or Bylaws); (ii) made after reviewing all pertinent information and conducting reasonable due diligence; (iii) supported by advice of experts (where appropriate); and (iv) reasonably believed to be in the best interests of the association.
Business Judgment Rule
From a practical perspective, the reasonableness standard is often parred down even further to focus specifically on the last prong. Better known as the Business Judgment Rule, this narrow focus on the last prong creates a presumption that board decisions are based on sound business judgment and entitled to deference, which can be rebutted only by a factual showing of fraud or bad faith. Under the Business Judgment Rule, courts will defer to a board’s judgment as long as the board’s decisions are made in good faith and the board members reasonably believe they are in the best interest of the association. A decision need not be “correct” or successful; rather, so long as a board acted in good faith after conducting reasonable due diligence, courts will not question the action of the board.
In Virginia, the Business Judgment Rule is codified in the Virginia Nonstock Corporation Act. Specifically, Section 13.1-870 of the Nonstock Corporation Act sets forth the general standard of conduct for directors of nonstock corporations. Section 13.1-870 (A) states that a “director shall discharge his duties as a director, including his duties as a member of a committee, in accordance with his good faith business judgment of the best interests of the corporation” and Section 13.1-870(B) states that a director is entitled to rely on information, opinions, reports or statements of various experts – legal counsel, public accountants, or other professionals. Finally, Sub-Section C exculpates a director from any liability for an action or a failure to take an action if he performed the duties in compliance with the duty of care.
Washington, D.C. and Maryland have similarly codified the Business Judgment Rule to protect board members from personal liability for bad decisions made in good faith after reasonable due diligence. Furthermore, many governing documents incorporate the Business Judgment Rule and expressly immunize board members from personal liability for poor decisions – provided they are made in good faith after reasonable due diligence.
Although the duty of care applies to every board decision, it is most-often scrutinized when those decisions concern controversial matters such as: (i) budgetary and fiscal management of an association; (b) common area maintenance; and (iii) rules adoption and enforcement. Indeed, all but the most-fortunate board members have likely heard murmurs or outrights allegations concerning fiduciary duties when making unpopular decisions or taking enforcement action against individual owners.
A few real-world examples help flush out the concepts set above. For example, a board member who recently lost a job and is experiencing personal financial hardship should not vote against a proposed increase in annual assessments to protect their personal interests when he knows that the increase is necessary to meet the association’s obligations. The duty of care dictates that any decision made for the association must be in its best interest regardless of the personal interests of a board member.
Similarly, a board member cannot single out one community member for a covenant violation out of personal prejudice or other negative motivations while ignoring similar violations by others. Rule adoption and enforcement must be fair, equitable and uniform. Often times, these types of actions result in claims of “selective enforcement” and allegations that the board is acting arbitrary and capriciously.
Finally, the boards should not ignore maintenance obligations solely to keep the budget low – if community property requires a repair or replacement, adequate steps should be taken by the board to care for the association’s property. Typically, a board’s failure to properly maintain common areas or common elements comes to light after a casualty loss and involve claims for both breach of contract and breach of fiduciary duty. Given that the latter carries the risk of personal liability for board members, it is best to ensure that board members do all they can to ensure that their associations fulfill their maintenance obligations.
How to Meet Your Duty of Care
If this article has completely discouraged you from serving on a board – don’t be! Meeting duty of care is fairly simple if one adheres to the following rules:
- regularly attend meetings;
- review board package/agenda ahead of time;
- do your research! (g., when selecting a contractor for a specific job, you should always review bids, check references, reviews, interview people, etc.);
- consult with experts – ask you manager, call your lawyer;
- have a working knowledge of the association’s documents;
- be familiar with the association’s issues, budget and concerns of the community
- vote at Board meetings; and,
- always keep “best interests” of the association in mind.
In short, as a board member, one should be actively involved in their association’s affairs, always conduct appropriate research, utilize experts and consider all options, and carefully weigh which course of action would be in the best interests of the association. Provided that one complies with the foregoing rules, they will have satisfied the duty of care and protected both themselves and their associations from potential liability.
By Olga Tseliak, ESQ.
Olga is an associate attorney with the law firm of Chadwick, Washington, Moriarty, Elmore & Bunn P.C. Her practice is devoted to community association representation, including such matters of covenant interpretation and enforcement, contract law and collections. She is an active member of WMCCAI’s Quorum Editorial Committee.