What does "fiduciary duty" mean for board members and managers?
Question: I hear and read a lot about the “fiduciary duty” of community association board members and managers. Can you explain exactly what this means for both?
Answer: It doesn’t mean anything for managers (which we’ll explain later) but it means a great deal for board members, as Daniel Polvere, a founding partner of McCullough Stievater and Polvere (now MPD Law, LLC), explains. Specifically, the fiduciary obligation of board members means they can be sued and held individually liable for damages resulting from their failure to exercise “ordinary care” and fulfill the “duty of loyalty” they owe to the association – the two key obligations of a fiduciary.
The duty of loyalty means that board members must in all circumstances put the interests of the community ahead of their own, avoiding conflicts of interest or “self-dealing¯ benefiting personally from the decisions they make as trustees.
The duty of ordinary care is closely related to loyalty but separate from it. It means trustees must perform their duties “in good faith,” Polvere explains, exercising the level of care and due diligence that “an ordinarily prudent person would use” in making similar decisions in similar circumstances. What exactly must trustees do to demonstrate “reasonable care?” Polvere offers these examples:
• Attend meetings
• Enforce the association’s rules reasonably and fairly ¯ “not arbitrarily,” Polvere emphasizes.
• Ensure that the association is adequately insured, that the budget is appropriate and that reserves are properly funded.
• Maintain common areas and facilities.
• Evaluate vendors and contractors, checking their references, verifying their licenses, insurance and capabilities, before hiring them.
• Obtain professional advice, when necessary.
There is no “litmus test” that defines ordinary care precisely, Polvere says – no blueprint specifying how many references a board should check, how many competitive bids they should solicit, or how much due diligence is enough. Common sense and attention to detail are the best guides, he suggests.
Role of Fiduciaries
Courts typically apply what is known as the “business judgment rule” in determining whether board members have exercised ordinary care, which means the courts won’t typically second guess decisions, Polvere says, even if those decisions turn out to be wrong, as long as trustees have demonstrated good faith, exercised reasonable diligence, and were acting in what they thought to be the association’s best interests.
While the business judgment rule insulates the board from liability, trustees shouldn’t rely on it entirely, Polvere says. They should also be sure the association’s bylaws include an “exculpation” provision, releasing trustees from liability to unit owners or the association for decisions that turn out badly, and an indemnification provision, requiring the association to pay the damages if trustees are found to have liability for a claim. The board should also carry Directors and Officers (D&O) insurance “in a substantial amount,” Polvere advises.
The law imposes a fiduciary obligation not just on community association board members but on all trustees, Polvere explains. “Executors of estates, directors of a company, partners in a partnership ¯ all are involved in fiduciary relationships requiring them to exercise a high duty of care to others.”
Association managers are not fiduciaries, however, Polvere emphasizes. They are agents of the board, hired to advise the trustees and to implement their decisions, but not responsible for making those decisions. That buck – and the liabilities related to it — stops with board members, which is why “any management contract worth its salt,” Polvere says, will include a provision requiring the association to indemnify the manager against any claims, the only exceptions being for bad faith or “gross negligence.”
Managers have an obligation to be capable and conscientious, to give boards their best advice, to execute the decisions the board makes and implement the policies it establishes. But these are the professional and ethical responsibilities of an agent, Polvere says, not the statutory obligations of a fiduciary. And the distinction is important: Agents who fall short can be fired for violating a contract; fiduciaries who fall short can be sued and held liable for violating a law.
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