Loyalty and Duty
By: Nena Groskind
Newly elected condominium trustees are instructed somberly that they have a “fiduciary duty” to the association and its members; assured that they will not have to worry about personal liability (too much) because the “business judgment rule” will protect them, as long as they exercise “good judgment” and avoid “conflicts of interest”; and admonished sternly never to breach the “attorney-client privilege” that protects communications between the board and the association’s attorney.
Most trustees will tell you they are at least familiar with these concepts. Whether they understand them is another matter.
“You hope board members understand their responsibilities, but that’s not always the case,” notes Clive Martin, counsel in the Boston office of Robinson & Cole LLP. “Some have to be enlightened about what it means to be a trustee.”
We’re going to try to do a little enlightening here, starting with the concept that, more than any other, defines the role of trustees and governs, or should govern, their decision-making process: Fiduciary Responsibility.
It’s a legal term, Martin notes, and “trustees throw it around like crazy without really understanding what it means.”
A Duty to Others
Defined most simply, a fiduciary duty is “a duty to other people,” Bruce McGlauflin, a partner in Petrucelli, Martin & Haddow, LLP, explains. “That means making decisions based on what is in the interests of others, not based on your self-interest.” For condominium trustees, it means never benefiting more from board decisions nor being burdened less by them than other members of the community.
Martin explains the fiduciary obligation this way: “Board members must be serious about what they are doing. They must make reasonable decisions that are neither arbitrary nor high-handed.” Being serious, he adds, means ‘paying attention to the procedural details some dismiss as technicalities – holding meetings, recording votes, taking minutes, and consulting professionals for advice.”
Fiduciary duty actually imposes two separate legal obligations on board members:
• A duty of care, requiring them to exercise good judgment and make sound business decisions on the community’s behalf. This is the duty to act reasonably that Martin describes; and
• A duty of loyalty, requiring them to act in good faith, making decisions that they reasonably believe to be in the best interest of the association.
The Community Comes First
While trustees don’t always understand the scope and impact of their fiduciary obligations, Sandy Moskowitz, a shareholder in the Boston law firm Davis, Malm & D’Agostine, P.C., has found that owners are even more likely to misinterpret the concept, assuming incorrectly that board members owe a duty to owners individually. The duty, Moskowitz emphasizes, runs to the community as a whole.
“When the interests of an individual don’t align with those of the community,” he explains, for board members, “the community must come first.” That doesn’t mean trustees should ignore individual concerns, he emphasizes. “It just means the board must look at any issue first from the perspective of the association,” and then look for ways to mitigate any negative impacts a decision may have on individual owners.
The duty of loyalty is also often misunderstood. It means trustees should not use their position to obtain benefits that are denied to other owners or to evade burdens imposed on them. It doesn’t mean board members can never benefit from decisions they make, which would be an impossible standard for them to meet.
As homeowners in the community, board members will necessarily benefit from any decisions that benefit the community as a whole. If the board approves the addition of a swimming pool, trustees will enjoy that amenity as much, or as little, as other residents. Their duty of loyalty wouldn’t preclude them from swimming in the community pool, but it would bar them from installing a swimming pool that only the trustees were allowed to use, or were allowed to use under terms more favorable to them than to other owners. And it would clearly prohibit trustees from exempting themselves from a special assessment they approve.
Conflicts of Interest
The fiduciary duty of trustees sometimes creates conflicts of interest for them. For example, as a trustee, John has an obligation to support the vendor who can do the best work for the community at the best price. If John pressures the board to select his construction company — or a company owned by a close friend or relative — over another company offering comparable work at a lower price, John violates his fiduciary duty. And if other board members go along, because they like John or don’t want to offend him, they violate their fiduciary duty as well.
If John’s firm can do the best work at the best price, there is still a conflict between John’s position on the board and his position as owner of the construction firm. But the duty of loyalty doesn’t require board members to avoid conflicts, association attorneys emphasize; it just requires them to disclose conflicts or potential conflicts when they arise.
As long as John discloses his interest in the construction company (and does not vote on it) and the other trustees conclude that the contract is in the community’s best interest, then John and the other board members have fulfilled their duty of loyalty and their fiduciary duty to the community. They have acted in good faith, making, or attempting to make, a sound business decision based on their assessment of what is best for the association. Although John will benefit from the decision, the community will benefit as well. And, crucially, John will not benefit at the community’s expense.
Of course, McGlauflin points out, if it turns out that John’s firm isn’t the best choice for the community, disclosing the existence of a conflict won’t take care of the problem. Conflicts must not only be disclosed he emphasizes; they must also be resolved fairly and in the community’s favor.
The Business Judgment Rule
For condominium owners considering whether to serve on the association’s board, a major concern is the potential liability they might incur by doing so. The ‘business judgment rule’ goes a long way toward assuaging those fears. Under this legal precept, the courts generally will not second-guess the actions of a corporation’s directors as long as they are undertaken in good faith and consistent with what the directors believe to be in the best interests of the corporation. This is known informally as the “good heart, weak mind” theory: Decisions can be wrong, unwise, inexpedient and even stupid; as long as they are not reckless or willfully negligent, trustees will not incur personal liability for problems their decisions may create.
“It doesn’t matter if someone else might have made a different decision,” Moskowitz explains. As long as the board acts in good faith, exercises ‘due care’ and makes a reasonable choice, “the court won’t second-guess them.”
In an interesting illustration of that principle, the Maine Supreme Judicial Court ruled in a 2013 case (Vitorino America v. Sunspray Condominium Association) that the board had acted consistently with the business judgment rule in enforcing a regulation barring smoking throughout the community, including within owners’ units. The plaintiff (Mr. America) didn’t argue that the smoking ban was illegal (because the board had imposed it through a rule rather than by securing owner approval of a bylaw amendment), America complained, rather, that the board wasn’t doing enough to enforce the ban.
But the court supported the board, finding that “the facts alleged in the complaint portray a disagreement between America and the board members over how to enforce the ban, not whether to enforce it. Disagreement is not bad faith,” the court emphasized. While the “absolute refusal” to enforce a rule might constitute evidence of bad faith that would not be protected by the judgement rule, the court said, the rule’s protections “are not lost simply because [the plaintiff alleges] that the board has not reacted with sufficient speed or vigor.”
A Different Standard
Unlike the courts in Maine and many other states, the Massachusetts courts have not specifically applied the business judgment rule to condominiums, although most industry attorneys think they would if presented squarely with that question. While Massachusetts courts generally tend to be “deferential to trustees,” Martin notes, the legal standard here, is whether a decision is “reasonable,” not whether it falls within the business judgment rule, and that, he says, is a distinction with a difference.
Under the business judgment rule, he explains, a court will consider only whether a board’s decision-making process was “above-board” and not arbitrary or fraudulent. Under the reasonableness standard, courts will look more closely “at the details of the decision-making process. It’s a much broader inquiry,” Martin notes, and it sets a somewhat higher legal bar. It is easier to defend a decision under the business judgment rule, he says.
This should not create out-sized liability concerns for Massachusetts board members, however. The condominium associations they serve typically indemnify them (agreeing to pay defense costs and judgments awarded in litigations stemming from their actions as trustees); and directors and officers liability insurance policies provide (or should provide) financial backing for the indemnification promise.
Advice for Board Members
There is an important caveat, however: Indemnification provisions and directors and officers (D&O) policies typically exclude actions that are criminal, willfully erroneous, knowingly not in the association’s best interests, reckless, “grossly negligent,” or outside the purview of the trustee’s role. Those exclusions underscore the importance for trustees of understanding the scope and limits of their responsibilities as well as the implications of the legal obligations they assume. Industry executives offer this general advice to board members:
1. Educate yourself about the association and about how the board operates. Read the association’s governing documents; verify that the association has D&O liability coverage for board members and make sure you understand what it covers and what it excludes.
2. Take your position as a trustee seriously. Recognize that you are running a business, overseeing a budget that could amount to hundreds of thousands or even millions of dollars, and assuming responsibility for protecting what is probably the most important asset for most association members (including board members) – their home.
3. Weigh decisions carefully, seek professional advice when you need it and rely on it when appropriate. You aren’t expected to know everything, but you are expected to obtain the information and input you need to make reasonable and well-reasoned decisions.
4. Establish a policy for dealing with conflicts of interest. The policy should define conflicts clearly, specify whether and under what circumstances they will be allowed, require disclosure (if conflicts are allowed) and specify how that disclosure is to be provided. The policy should also require trustees to document the disclosure of a conflict and their handling of it.
5. Be cautious, be conscientious and use common sense. As long as you fulfill your fiduciary obligation to exercise due care, act in good faith, and in accordance with the best interests of the association, as you perceive them, you will be doing what owners elected you to do (though they won’t always thank you for it). And the community and its residents will be well-served.