Fiduciary Duty and Community Association Boards: A Five Part Series

 

By Mary M. Howell, Esq.

Introduction

An association’s attorney typically spends a great deal of time explaining to volunteer board members how a corporation operates legally, the impact of various laws and the governing documents on what an individual director may, may not, and must do, and–tellingly–how a director properly discharges his/her duties to the association.  But this is often not enough.

Increasingly associations are crippled by severe board dysfunction–by rogue directors who seek to expose association confidences to their constituents, to publicly question every decision made by the majority, and to hold fellow directors and management up to contempt.   This article discusses the nature of fiduciary duty in the community association context, some of the legal bases for the conclusion that such behavior violates an association director’s fiduciary obligation to the community, and some thoughts on how the association may address these problems.

This article is broken into five parts:

  1. How the Association is Governed.
  2. Essential Components of Fiduciary Duty.
  3. To Whom is the Fiduciary’s Duty Owed?
  4. Legal Standards Governing the Director’s Acts and Omissions.
  5. The Association’s Remedies for Breach of the Fiduciary Duty of a Director.

 

PART I:  How the Association is Governed

Nearly every community association is organized as a corporation (typically a “nonprofit mutual benefit corporation”) and even for those few associations which are not incorporated, the Davis-Stirling Act[1] specifically includes those associations being covered by the Act.  (Civil Code § 4080.)  And while Davis-Stirling has very particular things to say about how a homeowners association operates, much of what a board needs to know about its day to day activities is contained not in the Davis-Stirling Act, but in the Corporations Code and case law.

A corporation operates under what is historically known as the “corporate model.”  In a corporation, three different bodies co-exist, each with well-defined duties and rights: the directors, the officers and the members.  The board of directors (or governors or trustees) is elected by the members (shareholders).  The directors then select officers.  Because the members elect the directors, generally (though not always) a vote of the membership is required to remove the directors.  But, as discussed below, it’s different for officers.

The directors are collectively responsible for long-range planning and goals, while officers are responsible for implementing those plans on a short-term basis.

In the association context, directors are elected by the members (though sometimes they are appointed by a developer, or by the board to fill a vacancy), while officers are normally chosen by the board from its own members.  Unless the bylaws of the association specifically restrict officers to persons who are directors, it is not absolutely required that an officer be a director.  Nor does the Corporations Code say that no person may hold two offices.  The Corporations Code instead says that unless the bylaws otherwise provide, any person may hold more than one office.  (As a practical matter, the president and the secretary should be different persons, even in the absence of a bylaw provision, because the Corporations Code looks for two different signatures on binding contracts.)

What about the members?  In a community association-corporation, the members (owners) have the following statutory rights: the right to elect (and remove) directors (but not officers), the right to approve large assessment increases or large special assessments, the right to approve certain grants of exclusive use for the common areas, and the right to approve most changes to the governing documents (but not the rules.)  In short, the members have limited rights to control board decision-making–and that’s what the legislature intended.  That’s how a corporation is intended to operate, in the interests of efficiency and cost-controls.

The Corporations Code vests the authority to run the corporation wholly in the board:

“Subject to the provisions of this part and any limitations in the articles or bylaws relating to action required to be approved by the members … the activities and affairs of a corporation shall be conducted and all corporate powers shall be exercised under the direction of the board.  The board may delegate the management of the activities of the corporation to any person or persons, management company, or committee however composed, provided that the activities and affairs of the corporation shall be managed and all corporate powers shall be exercised under the ultimate direction of the board.”  (Corp. Code § 7210.)

In other words, the buck stops with the board.[2]

The board makes decisions as a result of collective deliberation and a vote.  A majority vote of the board, where at least a quorum of directors meets, binds the corporation.  While the Davis-Stirling Act does not require the use of parliamentary procedure for board meetings (as opposed to member meetings), it is generally accepted that adherence to some basic form of procedure (motion, second, debate, vote) is wise, in order to allow for the viewpoint of ALL directors on a particular issue to be heard and considered.

[1] Civ. Code §§4000-6150

[2] The historical, legal reason for this arrangement (no residual management power in the shareholder-members) was to insulate shareholders from personal liability for the corporation’s debts.