By Karyn A. Larko, Esq.
*Originally published in the Summer 2018 CACM Law Journal

A conflict of interest (“Conflict”) exists between a director and the director’s association any time the personal, professional or financial interests of the director (who is referred to as the “Interested Director”) differ from those of the association. Stated another way, a Conflict exists when a director’s loyalty to the association is compromised by the director’s own interests.
California Civil Code §5350 identifies some of the most common Conflicts faced by directors, which arise when:

• A director requests to make architectural alterations to his/her property
• A director requests the exclusive use of a portion of the common area
• A director is in violation of the association’s governing documents and the board is faced with deciding what, if any, disciplinary action to take
• A board is faced with the decision on whether to assess a director for damage caused to the common area
• A director requests a payment plan for delinquent assessments
• A board must vote on whether to foreclose on a director’s property

If not handled properly, a Conflict can lead to liability for the association based upon such claims as failure to enforce the governing documents, violation of the governing documents, and discrimination. It can also lead to personal liability for the Interested Director and even the other board members under a claim of breach of fiduciary duty.

Handling Short Term Conflicts

Civil Code §5350 prohibits an Interested Director from voting on those matters identified by the statute. However, even when an Interested Director is not prohibited from voting, the Interested Director should be encouraged to abstain from voting on the Conflict matter in order to protect against a breach of fiduciary duty claim. Further, the Interested Director should be encouraged to leave the board meeting during the vote, because if he/she does not, the director’s abstention effectively acts as a vote against whatever matter is being voted on. For example, if a vote is conducted on whether to deny an Interested Director’s proposed payment plan and there are four directors present, including the Interested Director, and two directors vote in favor of rejecting the plan, one director votes against rejecting the plan and the Interested Director abstains from voting, the motion fails. However, if the Interested Director steps out of the meeting during the vote, the motion passes two-to-one.

While leaving the meeting during the vote on the Conflict matter may be contrary to the interests of the Interested Director, this action is important to protect the association’s interests.
If your board is required to vote on a Conflict matter that could lead to litigation between the Interested Director and association, or that is or could foreseeably become contentious within the membership, the directors who vote should clearly identify the reasons for their decision and these reasons should be recorded in the meeting minutes. Taking this action will help the board defend its decision should the board later be accused of breaching its fiduciary duty or otherwise acting improperly in coming to its decision.

If the Interested Director refuses to abstain from voting on the Conflict matter, encourage your board to consult with the association’s attorney for guidance.

When in doubt as to whether a Conflict exists, the board should seek the opinion of the association’s legal counsel or assume the issue as a Conflict.

Handling Long Term Conflicts

Disputes occasionally arise between a director (“Interested Director”) and a majority of the directors regarding an association matter. These disputes usually result from the board’s decision on a Conflict matter pertaining to the Interested Director, such as a decision to deny the Interested Director’s architectural alteration request. However, they can also occur when an Interested Director strongly disagrees with a broader decision made by the board, such as a decision to incur a large capital expense.

When faced with a Conflict that is not limited to one vote, especially a matter that could lead to litigation, encourage your board to promptly establish an executive committee to handle the Conflict only. This committee must be comprised of at least two current directors, but it cannot include the Interested Director. Only current directors may be appointed to the committee.

All discussions pertaining to the Conflict, including all attorney-client privileged communications, should be discussed with, and considered exclusively by the committee. Non-committee members, including the Interested Director, should not be included in committee meetings, copied on committee communications, or provided committee meeting minutes.

Committee meetings should be treated as executive session meetings. This means that a notice and agenda must be provided to the membership no less than two days in advance of the meeting.

Utilizing a committee to handle the Conflict will help avoid the appearance that the directors, including the Interested Director, are somehow acting improperly and reduce the likelihood of directors having to defend against a claim of breach of fiduciary duty. Additionally, it will help protect the association’s attorney-client privilege with regard to the Conflict because the opposing party (i.e., Interested Director) will not be privy to the legal advice given by the association’s attorney.

Additionally, if a Conflict involves any allegations of board wrongdoing, encourage your board to immediately file a claim with the association’s D&O carrier. If the carrier accepts the claim, the carrier may appoint insurance defense counsel, thereby saving the association in legal fees.

One final piece of advice you should give your board; Perception is everything. When faced with an issue that is or will likely be perceived by the membership as a Conflict, the safest course of action is to treat it as one.

Q & A:
1. When a Civil Code §5350 Conflict arises, the Interested Director:
a. Is encouraged to abstain from voting on the Conflict matter.
b. Is encouraged to abstain from voting on the Conflict matter and step out of the meeting during the vote.
c. Is required to abstain from voting on the Conflict matter and step out of the meeting during the vote.
d. Is required to abstain from voting on the Conflict matter and is encouraged to step out of the meeting during the vote.

2. If an executive committee is established to handle a Conflict, the board may appoint the following people to serve on the committee:
a. Two or more former or current board members, excepting the Interested Director.
b. Two or more current board members only, excepting the Interested Director.
c. Two or more current board members, excepting the Interested Director, and one or more members of the association who are not on the board.
d. Both A and D above.

3. While an Interested Director may not serve on an executive committee appointed to address the Conflict, the Interested Director may inspect Board communications pertaining to the Conflict and the executive committee meeting minutes. True / False