January 1, 1900

by Adam Picinich

The fundamental role of directors and officers of condominium associations and homeowner’s associations is to manage the business of their respective associations. Namely, they establish the corporate policies, declare monetary distributions, and recommend fundamental corporate changes. In executing these roles, the directors and officers of condominium associations and homeowner’s associations must discharge certain fiduciary duties. Typically, fiduciary duties stem from the obligations owed as a result of the relationship between a trustee and the entity for which the trustee acts. As trustees, the directors and officers owe both the duty of care and the duty of loyalty to the association that they govern.

The Duty of Care

As a fiduciary of the corporation, a director or officer’s nonfeasance or malfeasance may give rise to liability. In a situation of nonfeasance, liability stems from a director or officer’s inaction that proximately caused a loss to the corporation. In the case of malfeasance, liability may arise when a director or officer acts in a fashion that causes harm to the corporation. However, in the case of malfeasance, a director or officer will not be held personally liable if he or she has satisfied the Business Judgment Rule. This rule creates a rebuttable presumption that the directors and officers were honest, reasonable, informed, and rational in reaching their decision to act. In order to overcome the Business Judgment Rule’s rebuttable presumption, an injured party must show fraud, illegality, conflict of interest, or lack of rational business purpose.

In Francis v. United Jersey Bank, the Court addressed the issue of whether a corporate director may be held personally liable for failing to prevent other directors (who were also officers and shareholders) from misappropriating corporate trust funds. There, the plaintiff trustees filed an action to recover the funds a corporation paid to its primary shareholder’s estate and family members that were the directors and officers of the corporation. The New Jersey Supreme Court applied a negligence standard to the defendant director, finding that the defendant director breached her duty of care due to her nonfeasance.

The Supreme Court held that, as a general rule, corporate directors must "acquire at least a rudimentary understanding of the corporation" by apprising themselves of the "fundamentals of the business in which the corporation is engaged." Accordingly, a director or officer’s duty of care must be discharged in good faith and with a degree of diligence, care and skill that an ordinarily prudent person in the like position would exercise in similar circumstances. Furthermore, to facilitate proper participation in the overall management of the corporation, directors and officers are charged with a continuing duty to keep themselves reasonably informed of the business affairs of the corporation; they may not "bury their head in the sand" with respect to corporate misconduct and then maintain that they did not have a "duty to look." As noted by the Supreme Court in Francis, the "sentinel asleep at his post contributes nothing to the enterprise he is charged to protect." Thus, to avoid personal liability as fiduciaries of the condo- minium/homeowner’s association, directors and officers must educate themselves as to the basic workings of the corporation in which they govern as the duty of care requires a director and/or officer to be reasonably informed of the workings of the corporation. Furthermore, to protect against personal liability, directors and officers must make honest, reasonable, and informed decisions to act on the corporation’s behalf to ensure that such decisions are protected by the Business Judgment Rule.

Duty of Loyalty

The second duty required of a director or officer is the duty of loyalty, which requires the placement of the corporation’s interests above their personal financial interests. More specifically, directors and officers are obligated to act in good faith and with the conscientiousness, fairness, and honesty that the law requires of fiduciaries. They are not permitted to use their position of trust and confidence to further their private interests. The public policy underlying the duty of loyalty demands the utmost observance of the duty to protect the interests of the corporation and to refrain from engaging in any transactions that would cause injury to the corporation or that would deprive it of profit or advantage which his skill and ability might properly bring to the corporation. A breach of the duty of loyalty may arise when a director or officer engages in self-dealing transactions or misappropriates a corporate opportunity. Given the conflict of interest involved in a breach of the duty of loyalty, a director or officer cannot invoke the Business Judgment Rule in defense of a claim for personal liability. Thus, an aggrieved party does not have to overcome the presumption that the director or officer’s actions were honest, reasonable, informed, and rational.

The administration and interpretation of the fiduciary duties imposed upon the directors and officers of Condominium or Homeowner’s Associations may be difficult to comprehend without the guidance of knowledgeable legal counsel. Hill Wallack’s Community Association Law Practice Group is legally experienced and knowledgeable in representing Boards of Directors and Trustees and is readily available to provide guidance in the interpretation and execution their official duties.

Adam S. Picinich is an associate of Hill Wallack where he is a member of the Litigation Division and Trial & Insurance Practice Group.