Being elected to the board of directors of a condominium association or cooperative comes with a great deal of power, and with that power also comes a great deal of responsibility. Whether they serve a condominium association or cooperative community, board members have a responsibility to govern and make decisions on behalf of that community—a burden often referred to as the board's “fiduciary duty.” Decisions made on behalf of their fellow residents must be made in good faith, with the best interests of the community firmly in mind, and violating this duty can lead to legal consequences for boards and individual board members who stray.
Fiduciary Duty in a Nutshell
The fiduciary duty in the condominium association or cooperative board context arises out of the special relationship that exists between directors and the shareholders and property owners who place their trust in these directors. A fiduciary relationship can be formed in other types of relationships such as attorney/broker-client, or even clergyman-congregation member.
“Most community associations in New Jersey are corporations. Each officer and member of an association board therefore owes a fiduciary duty—a duty of trust—to the association and its individual unit owner members,” says Eric F. Frizzell, a partner with the Glen Rock-based law firm Buckalew Frizzell & Crevina LLP. He continues, “This duty is comparable to the obligation that a corporation's board of directors owes its stockholders and includes a duty to preserve and protect the common elements and areas for the benefit of all of the association’s members.
“This fiduciary relationship also requires that a community association board act consistently with New Jersey law and the association’s own governing documents,” Frizzell continues. “A board must act in the best interests of the whole association and its unit owners, not out of personal interest, fraud, self-dealing, or in an unconscionable, arbitrary, discriminatory, or bad faith manner.”
“A fiduciary duty arises when one person places his trust in another person and as a result of that act of faith, another person gains a position of power and influence such that he is in the position to hurt the person who places faith in him,” says attorney Bruce Cholst, a partner with the law firm of Rosen Livingston & Cholst LLP, based in Manhattan. “At that point, he has a special legal obligation, which would not otherwise have existed but for the fiduciary duty, to refrain from doing anything that violates his fiduciary’s interest.”
The concept is the same for both condominium associations and cooperative boards. “In New Jersey, condominium associations are commonly incorporated pursuant to the Nonprofit Corporation Act, and co-ops are incorporated pursuant to the Business Corporation Act. The overall, basic fiduciary duty of board members in both kinds of associations is virtually identical,” explains Frizzell.
“Trustees who serve on a cooperative board have the same responsibilities to the members of the association. They are to discharge their duties in good faith and with that degree of diligence, care and skill which ordinary prudent persons would exercise under similar circumstances in like positions,” says New Jersey lawyer Thomas Vincent Giaimo, a partner with the law firm Giaimo & Associates in Rumson.
Thus, the fiduciary duty in the condominium association and cooperative board context illustrates the special responsibility that trustees have, given their position of influence over the property and lives of the shareholders and unit owners. The act of faith shareholders and property owners place in trustees is represented by their votes and proxies for board members at the annual meeting, explains Cholst. With that act of faith, shareholders and property owners trust that board members will look after their best interests and refrain from abusing their power.
Breaching Your Fiduciary Duty
So what exactly does it look like when a board member breaches their fiduciary duty? A great majority of the time, the business judgment rule protects most board action taken in good faith. “In making decisions for the community they serve, governing boards are to use their highest and best form of business judgment,” says Giaimo. “The proper exercise of business judgment in many instances serves to insulate a board from a claim of breach of fiduciary duties.”
“Directors of an association are not expected to be incapable of error,” explains Frizzell. “As noted frequently by New Jersey’s courts, all that is required is that persons in such positions act reasonably and in good faith in carrying out their duties. Courts will not second-guess the actions of directors unless it appears that they are the result of fraud, dishonesty, or incompetence.”
That said, according to Cholst, real-life breaches of fiduciary duty really just boil down to abuses of power. From his practice, he has seen that potential breaches of fiduciary duty fall into these categories: self-dealing, indulging personal vendettas, and selective enforcement of rules and regulations, and a failure to protect the community’s assets.
Self-dealing. Self-dealing occurs when board members obtain a personal advantage from their position on the board, and take an opportunity, no matter how big or small, that should have lawfully been available to the shareholders or unit owners of the co-op or condo. “The failure of a board member to subordinate his personal interests to those of the association or its constituent shareholders and unit owners is called self-dealing,” explains Cholst.
The most obvious case of self-dealing is when a board member steals money from the co-op or condo’s reserve fund. However, self-dealing is often more subtle than outright theft.
“The vast majority of boards of associations that our law firm represents are well aware of their fiduciary duty to their members, and strive to fulfill that obligation,” Frizzell says. He continues, “Years ago, however, in a hotly contested election, an incumbent board wanted to surreptitiously allow a sponsor to cast his many votes at the annual election, with the knowledge that the sponsor would vote for the incumbents and assure their re-election. I advised the board that the sponsor was limited by New Jersey law to appointing one representative to the board and could not vote for unit owner directors. The board persisted in its contrary position and relented only after I explained to them in the firmest terms that such conduct would not be condoned.”
Personal vendettas. Another abuse of power and breach of fiduciary duty can occur when an individual board member treats a shareholder or unit owner unfairly just because the board member has a personal issue with that person. “Board members have a lot of power to make life miserable for those people, and when they use it, that too is a form of self-dealing, certainly an abuse of power, and breach of fiduciary duty,” explains Cholst.
Cholst provides the example from his practice of a board member, head of the alterations committee, who was in an ongoing feud with his neighbor over loud parties the neighbor had and his refusal to quiet down. That neighbor submitted a request to do an alteration for his apartment, and the board member persuaded his colleagues to reject the alteration, since there was no legitimate reason for the decision other than to indulge the board member’s vendetta against his neighbor, the situation illustrates an abuse of power and breach of fiduciary duty.
Selective enforcement. The third kind of breach of fiduciary duty is when a board member plays favorites in enforcing building rules and regulations. Cholst explains that in order “to act in good faith and in a way that’s consistent with those to whom I owe a fiduciary duty, I can’t favor one board member at the expense of another; I have to treat everyone equally. For example, if I have a friend who wants to put an enclosure on his terrace, I can’t say ‘yes’ to him and then ‘no’ to somebody else who wants to put the exact same kind of enclosure on the terrace. I have to enforce the rules consistently and avoid what legally is called “selective enforcement.’” Another example of selective enforcement is if the building has a no pet policy, but a board member looks the other way when a dog comes into the building belonging to a friend.
Failure to protect assets. Another area that board members and trustees can run into a potential breach of fiduciary duty is if they fail to have reserve studies performed. “Governing boards are charged with the responsibility of adopting and implementing a responsible association budget which covers not only operating expenses but expenses which are to be anticipated for future major replacements of the components which comprise the association's property (roofs, roadways, siding, etc.),” explains Giaimo.
“In order to quantify the expenses for those future major replacements, governing boards are responsible to periodically have an engineering evaluation performed in order to calculate the remaining useful life of those components and the cost to be incurred by the association in replacing those components. This is referred to as a ‘reserve study.’ The failure of an association's board to have those reserve studies periodically performed can be the basis for a claim of breach of fiduciary duties. The failure of the board to have reserve studies performed and periodically updated will result in the association having to levy an assessment to its members in order to fund major replacement projects.”
“Obviously, the existence of fiduciary duties upon a governing board and its members carries with it the potential for claims allegedly arising from breaches of those duties,” Giaimo says. “Trustees that serve on governing boards are to be held harmless and are to be indemnified by the association unless it has been determined that the actions of the board and/or trustee amounts to gross negligence or willful misconduct or that the trustee was involved in self-dealing.”
If a board member is found to have breached his or her fiduciary duty, the consequences can be severe. “First, the offending board member will be held personally liable in money damages for all pecuniary losses sustained as a result of his misconduct. Such judgments (and the attendant legal fees) are rarely, if ever, covered by directors and officer's liability insurance,” explains Cholst. Cholst further explains, “Courts are not shy about assessing punitive damages against those board members who breach this most exacting of moral obligations.”
These severe consequences can be avoided if board members educate themselves on their special responsibilities as fiduciaries and take all necessary precautions.
The last thing most volunteer board members want to become involved with is a lawsuit claiming they have breached their fiduciary duty. An example of self-dealing that can be easily avoided is in the context of interested directors. If a board is deciding to hire a professional such as a lawyer, accountant, or property manager or company that offers services such as security, telecommunications, or interior design, and a board member has an interest in one of these companies, special precautions must be taken in order to avoid a breach of fiduciary duty.
“On occasion a member of the governing board may have a conflict of interest with an issue being discussed or considered by the board,” explains Giaimo. He continues that board members or trustees “who believe they may have a conflict of interest should immediately disclose that conflict or potential conflict with their fellow board members. Whenever there is a conflict of interest or even the appearance of a conflict that member should remove him/herself from further discussions of the board and by all means not participate in the board’s decision. Many times and in an effort to educate a trustee as to his/her responsibilities to both the association and to the governing board, a board will request their legal counsel to prepare a "Trustee's Code of Conduct." A properly prepared Code of Conduct will address not only conflicts of interest, but the appearance of impropriety as well.”
Another action boards should take is to be careful about enforcing their rules consistently, says Cholst.
When There’s an Abuse of Power
If the above examples sound all too familiar, what can you do? Aside from immediately seeking legal counsel, there are some steps board members, shareholders, and unit owners can take. In order to do your research, check the bylaws to find out what remedies you may have. Obtaining copies of the minutes of board meetings may be helpful in finding information on the board’s conduct. If a resident finds facts (actions made in bad faith) that they believe are sufficient to constitute a breach of fiduciary duty, he or she can put the board on notice of the alleged breach, and request that the particular decision not be enforced. If the board is unresponsive to these requests, the resident should consult a lawyer to explore the possibility of obtaining a court-ordered injunction, to prevent the questionable rule from being enforced or transaction from happening.
“All governing boards and community association managers should be encouraged to seek counsel whenever a claim or threat of a claim has been received or is perceived. Governing boards and trustees that serve on those boards in discharging their duties are not to be held liable if, acting in good faith, they rely on the opinion of association counsel,” Giaimo says.
Being on one's board can be a tough job for a host of reasons—not least among which is the fact of fiduciary duty to the community at large. Knowing the breadth and depth of that duty and upholding it are two of the most important traits a board member can bring to the table.
Elizabeth I. Robbins, Esq. is a New York lawyer and legal writer for The New Jersey Cooperator.