This blog is the third in a series of posts discussing an individual’s potential liability for the collective decisions made by their board. Be sure to read our previous posts online here.
New Jersey courts that have considered the application of the business judgment rule have concluded that the scope of judicial review of condominium association decisions is limited to a two-pronged test: (1) whether an association’s action was authorized by statute or its own bylaws and, if so, (2) whether the action was fraudulent, self-dealing or unconscionable. Thanasoulis, supra, 110 N.J. at 655; see also Chin v. Coventry Square Condo, 270 N.J. Super. 323, 328-29, (App. Div. 1994); Siller, supra, 93 N.J. at 382; Papalexiou v. Tower West Condo, 167 N.J. Super. 516, 527 (Ch. Div. 1979).
In Thanasoulis, the New Jersey Supreme Court considered whether a rule adopted by the board of directors of a condominium association increasing the parking fee for tenants of nonresidents owners but not for those of resident owners constituted a breach of the board’s fiduciary duty to the nonresident owners. In a 4-3 decision, the Supreme Court determined that the association was without requisite authority to enact the revised parking fee schedule in such a discriminatory manner, and thus failed to meet even the first prong of the test. The majority held that the association’s regulation was not authorized by either the Condominium Act or the condominium’s master deed. The Court noted that by substituting itself as the lessor of the unit owner’s parking space and thereby severing the owner’s right to the parking space, the association had, in effect, confiscated for its own use the value of the unit owner’s parking space. The Court reject the argument that the regulation was a security measure aimed at the prevention of subletting parking spaces to people not residing in the building since the same end could have been accomplished through other means.
Perhaps the clearest explication of the business judgment rule is contained in Papalexiou v. Tower West Condominium, in which individual unit owners challenged the authority of the board to levy a special emergency assessment upon the membership. In upholding the assessment, the court said:
[Papalexiou, supra, 167 N.J. Super. at 527 (citations omitted) (emphasis added).]
The refusal to enforce arbitrary and capricious rules promulgated by governing boards of condominiums is simply an application of the “business judgment” rule. This rule requires the presence of fraud or lack of good faith in the conduct of a corporation’s internal affairs before the decisions of a board of directors can be questioned. If the corporate directors’ conduct is authorized, a showing must be made of fraud, self-dealing or unconscionable conduct to justify judicial review . . . Although directors of a corporation have a fiduciary relationship to the shareholders, they are not expected to be incapable of error. 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.
Accordingly, to hold a Board member personally liable, a plaintiff must establish evidence that illustrates self-dealing or a lack of good-faith in carrying out the duties of the Board.
Nevertheless, the business-judgment rule does not apply to shield board members where the action of the association is in violation of the Condominium Act, the association’s master deed, or its by-laws. Micheve, L.L.C. v. Wyndham Place at Freehold Condo. Ass’n, 381 N.J. Super. 148, 154 (App. Div. 2005), certif. denied, 186 N.J. 256 (2006). Likewise, where the Board acts without authority derived from its governing documents or statute, it is similarly unprotected by the business judgment rule. See Verna v. Links at Valleybrook Neighborhood Ass’n, 371 N.J. Super. 77, 93 (App. Div. 2004) (Only when a board’s actions are authorized and of the type that justify application of the “business judgment” rule, will a court refrain from second-guessing its actions).
Generally, enforcing rules and other constituent document provisions, such as the duty to collect assessments, is an area of special sensitivity for board members and associations, which may be attacked for breach of fiduciary duty for failure of such enforcement as well as for discriminatory enforcement. In Glen v. June, 344 N.J. Super. 371 (App. Div. 2001), the court found that an association had breached its fiduciary duty by depriving an owner of the use of his driveway, a limited common element, and a garage, which was apparently part of his unit. The court concluded that an award of damages would be appropriate for the breach of fiduciary duty. The court also found that an attempt to humiliate the owner by piling snow in his driveway was a breach of fiduciary duty, although it offered no remedy for that incident.
Necessarily, self-dealing must be avoided, corporate opportunity enhanced, and facts which have a bearing on association concerns must be honestly and fully disclosed. The issue of self-dealing was considered in Owners of the Manor Homes of Whittingham v. Whittingham Homeowners Ass’n, Inc., 367 N.J. Super. 314, 323 (App. Div. 2004). There, the allegation was that the Board members breached their fiduciary duties by changing the method of calculating maintenance assessments (i.e. by re-measuring the units) several years after the condominium had been in operation. As a result, the monthly assessments for certain types of residences increased while it decreased for others. Plaintiffs alleged self-dealing, but that was rejected by the court because there was no evidence that the Association or Board benefited by the remeasuring. Moreover, there was an independent business reason for doing the remeasurement, i.e. the source of the developer measurements were unclear and contradicted by architectural drawings. Accordingly, in order for a breach of fiduciary duty claim to pass muster, a plaintiff must come forward with evidence that the Board or an individual Board member received some type of direct benefit from an authorized act of the Board.
Nonetheless, breach of fiduciary duty to “maintain, repair and replace” common area of the condominium could cause a trustee to be liable for the cost of returning the condominium to the position that it would have been in had such maintenance been undertaken. See Berish v. Bornstein, 770 N.E.2d 961 (Mass. 2002), remanded to 21 Mass. L. Rptr. 530 (Mass. Super. 2006) (trustee was also the developer). Notably, however, our research produced no published New Jersey case that considered this issue.
An association’s fiduciary duty will in certain circumstances include the duty to warn owners of a known dangerous condition. See Siddons v. Cook, 382 N.J. Super. 1, 10-11 (App. Div. 2005), where the association knew that faulty dishwasher hoses had flooded several condos but did not notify the unit owners. The court examined the nature of the risk, the interests a notification would protect, and the ease with which the association could notify the owners, in holding that the association breached its duty to warn the unit owners.
Additionally, a director’s breach of fiduciary duty owed to unit owners may expose the director to liability for punitive damages. For instance, in Scott v. Williams, 607 S.W.2d 267 (Tex. Ct. App. 1980), unit owners brought suit against the directors of the association alleging that the directors had controlled the condominium for the their own personal gain and had mismanaged its affairs and misapplied its funds. The trial court enjoined the directors from controlling the affairs of the condominium to maximize their profits, awarded damages for the directors’ failure to repair the common elements of the condominium, and awarded punitive damages. The Texas Appellate Court affirmed the grant of an injunction but reversed and remanded for a new trial that part of the award dealing with damages. The appellate court reversed the damage award on the sole ground that the plaintiffs had no standing to sue on behalf of other unit owners who may have been damaged by the directors’ conduct and who were not joined as plaintiffs in the suit. At no point in its opinion did the Scott court indicate that the punitive damage awards were improper. Even if the Association has obtained directors and officers insurance, policies of this nature do not cover intentional acts.