This week Jim Slaughter, Attorney, Black, Slaughter & Black wrote an excellent article on Board of Directors for HOA’s duties, standard of conduct, and the Liability. This is a great article for new and long standing board members of HOA’s.
Congratulations! You’ve just been elected to your HOA/condo association board of directors. Your new position shows your fellow members respect you and trust your judgment. By the way, did anyone describe your duties or mention that you could be financially responsible for actions?
Almost without exception North Carolina community associations are incorporated nonprofit corporations. While that’s different than for-profit corporations (and governed by different statutes), the directors of both have similar duties. Directors of community association must:
- follow state laws pertaining to HOAs or condominiums
- enforce the association’s governing documents, including any declaration, articles of incorporation, and bylaws
- protect and preserve the assets of the association
- collect monies owed the association, including owner assessments
FYI, for associations that have a professional community manager, there is a separation between “governing” and “managing” the association. In those associations that have them, the community manager is responsible for managing many of the day-to-day needs of the association, subject to direction from the Board.
DIRECTOR STANDARDS OF CONDUCT
Boards of directors must have the authority and discretion to manage the organization successfully. At the same time, however, wrongdoing by directors must be prevented. As a result, a balance must be made between a board of director’s protection and its accountability.
The NC Nonprofit Corporation Act (“Nonprofit Act”) give guidance on the duties and liabilities of directors. Specifically, directors must discharge their duties:
- in good faith;
- with the care an ordinarily prudent person in a like position would exercise under similar circumstances; and
- in a manner the director reasonably believes to be in the best interests of the corporation.
Although these standards are somewhat vague, they can be generally described as directors having a duty of “good faith” and a duty of “due care.” (The NC Planned Community Act specifically notes that directors must “discharge their duties in good faith” and “according to the standards for offices of a nonprofit corporation.”)
A primary duty of directors is good faith. Directors must perform their duties honestly, conscientiously, and fairly. Associations must be managed in the best interests of the association as a whole and not for the benefit of any specific group or individual. Even in associations where directors are elected by phase or by sub-association, once elected their duty and responsibility is to the community as a whole.
An important element of good faith is loyalty to the association. Directors are prohibited from using the office for personal gain to the detriment of the association or its members. Issues of loyalty sometimes arise when a director serves on the board of a master association as well as a sub-association, as it can be difficult to wear two hats. Another aspect of loyalty is confidentiality. Board members should keep in confidence information obtained through board service that is privileged or private as to the association’s business or its members.
While it not illegal for a director to do business with an association, we generally recommend against it. Both the NC Planned Community Act and Condominium Act state as follows:
[N]o financial payments, including payments made in the form of goods and services, may be made to any officer or member of the association’s executive board or to a business, business associate, or relative of an officer or member of the executive board, except as expressly provided for in the bylaws or in payments for services or expenses paid on behalf of the association which are approved in advance by the executive board.
Even following these provisions, a director should not be involved in business transactions with the association unless the director “reasonably believes [them] to be in the best interests of the corporation.” And transactions with a director must also be approved by a majority vote of disinterested directors following the steps outlined in the “director conflict of interest” provisions of the Nonprofit Act. Given all these provisions, it’s usually best for a director not to do business with the association.
A term often association with directors is “fiduciary.” While the word is likely thrown around too often in associations, the principle is accurate. A fiduciary is someone who supervises or manages assets or property for others and is held to a higher standard (think trust officer at a bank). Whenever directors of an association are sued, a common legal claim is “breach of fiduciary duty.” This cause of action is often alleged when the claim is that developer-appointed directors looked after the developer’s interests rather than the association’s interests as a whole.
While the duty of good faith prohibits misconduct, the duty of due care imposes an obligation to direct and supervise the corporation’s business. The specific language from the Nonprofit Act is that directors must conduct themselves “with the care an ordinarily prudent person in a like position would exercise under similar circumstances.”
At a minimum, directors must ensure that the association is operated according to state law and the provisions of any governing documents, including the declaration, articles of incorporation, and bylaws. Directors also have a “duty of reasonable inquiry” to inform themselves as to the association’s condition and the conduct of its affairs. A director can’t claim that lack of information about mismanagement or fraud when reasonable attention would have revealed the misconduct. This principle has been used to hold directors liable when they delegated management functions to other individuals or committees. While directors can delegate the authority to act, they cannot delegate oversight responsibility for actions or inactions.
The duty of due care could place an overwhelming burden on directors, in that it obligates the board to what they know as well as to what they ought to know. Since association board members are part-time volunteers, directors seldom have the ability to research every issue individually. As a result, the Nonprofit Act allows directors to rely upon the advice of others under certain circumstances. A director can rely upon information, opinions, reports, or statements, including financial statements and financial data, if prepared or presented by any of the following:
- Officers or employees whom the director reasonably believes to be reliable and competent in the matters presented
- Outside advisers such as legal counsel, accountants, insurance agents, and others as to matters the director reasonably believes to be within their professional or expert competence
- A committee of which the director is not a member if the director reasonably believes the committee merits confidence.
There is no right of reliance if the director has actual knowledge of information that makes reliance unwarranted.
When directors make decisions in good faith and with due care, they are usually protected from claims that they should be held personally responsible for mistakes. The idea that management should be protected from unfair reviews of their mistakes in retrospect is known as the “Business Judgment Rule.” According to this Rule, a court will generally not invalidate or hold directors liable for a business judgment
- made by disinterested directors
- within the scope of their authority
- in good faith
- with reasonable care and
- not for their own self-interests.
Even if held individually liable for an act, a director may have a right to indemnification (i.e., compensation for losses) from the association. The Nonprofit Act has provisions that may require indemnification to a director who is successful in the defense of a proceeding to which he was made a party because of being a director. In other instances, a corporation may, but is not required to, indemnify a director. The association’s legal documents should be examined to determine under what circumstances a right to indemnification may exist. And, just as importantly (and the subject of other blogs), directors should make certain the association maintains proper and adequate insurance, including Directors & Officers (D&O) coverage and fidelity/crime insurance.
Finally, a director should never sit idly by while action is taken at a board meeting that violates the director’s duties. That’s because a director who is present at a board meeting is usually deemed to have assented to any action from which the director does not clearly and promptly dissent or abstain. As a result, the director could be responsible for such actions, even if they did not agree with them. Directors who believe an action at a meeting is a breach of their standards of conduct should express their opposition, preferably to be included in the minutes.
Service as an association director can be rewarding and significant, both for the individual and the association. However, all directors or those seeking office should be aware of the duties and responsibilities that come with the office.
Because board duties can vary by state, type of community association, and the language of the governing documents, any specific questions should be directed to a North Carolina or South Carolina licensed attorney at Black, Slaughter & Black, PA.