East Bay Panel Update - Director Liability

You are here

Two weeks ago, we met with a great group of ECHO members at our East Bay Resource Panel. We were gathered to talk about the recent Parth case and how it affects the personal liability of HOA directors. Ann Marquis-Fisher, chair of the Panel and president of her HOA, invited attorney Mark Wleklinski to speak about the case, and David Stompe to discuss the insurance implications.

Here’s a not-so-brief summary of what we learned (it’s long because it’s important!):

Why You Need to Know Your Documents

Erna Parth was a director on the board of Palm Springs Villas II HOA. Her HOA sued her for decisions that she made while on the board, saying that she had breached her fiduciary duty. Ms. Parth, however, claimed that she should be immune from liability because of the “business judgement rule” and “judicial deference.” Also, the association’s governing documents contained language protecting director decisions.

Both the Business Judgment Rule and the principle of Judicial Deference help to protect board members from personal liability, even when they make bad decisions. So what happened here?

To understand, you need to know something about both terms.

Business Judgment and Judicial Deference

Business Judgement Rule. This rule says that Directors are not personally liable for decisions that result in damage or loss to others, provided their decisions were made in good faith, in a manner which the directors believe to be in the best interests of the corporation, and with such care, including reasonable inquiry, as an ordinarily prudent person in a like position would use under similar circumstances.

In other words, you can’t be personally sued if you put your community first, did your homework, and used common sense.

Judicial Deference. Also called the “business judgment doctrine,” this principle means the courts will defer to business decisions of a board even if a reasonable person would have acted differently. The courts will also assume that directors’ decision are based on sound business judgment. In both circumstances, the suing owner must prove that an association’s decisions do not deserve this deference.

In other words: The courts are going to assume that the association made a reasonable choice, unless the homeowner can prove a specific set of facts.

The Parth Case

But back to Erna Parth. Ms. Parth, claiming to operate with the authority of the board, made a string of questionable decisions. Here are a few:

  • Roofing repairs. Without consulting the board, Ms. Parth hired an unlicensed contractor to make roofing repairs. The board ultimately hired the roofer, but did not see many of the checks (signed only by Ms. Parth) paid to the roofer. The work was later determined to be both overpriced and deficient.
  • Repaving projects and loans. In order to fund a paving project, Ms. Parth signed for loans totaling more than $1.5 million without the approval of the membership as required by the governing documents.
  • Landscaping. Ms. Parth and other board members approved a 5-year landscaping contract in violation of their governing documents.
  • Termination of management. In spite the board’s decision to table the discussion of terminating their management company, Ms. Parth hired a new management company.
  • Security contract. Ms. Parth entered into a security contract on behalf of the association but without approval from the board. The board’s refusal to ratify or pay for this contract ultimately lead to a lawsuit from the security company.

You can visit this site to read the complete details of this case, Palm Springs Villa II HOA vs. Erna Parth.

What Went Wrong?

If bad decisions are protected by law, why weren’t these decisions protected? The court held that:

When courts say that they will not interfere in matters of business judgment, it is presupposed that judgment—reasonable diligence—has in fact been exercised. A director cannot close his eyes to what is going on about him in the conduct of the business of the corporation and have it said that he is exercising business judgment.

In other words, a director must be “reasonably diligent” before the court will apply the business judgment rule or judicial deference. The court also held that language in the governing documents protecting board decisions is subject to the same limits.

Limits on Board Protections

We’re going to assume that ECHO Members are not like Erna Parth. But what does this case mean for you? It means that a board member must show the court that they deserve the protections of the “Business Judgment Rule” and “Judicial Deference.”

You cannot assume that you are protected.

Here are two areas where you need to be particularly careful:

You must know your governing documents. Decisions of the board, even spectacularly bad ones, are usually protected by the Business Judgment Rule. But if those decisions violate the governing documents, the Rule may not apply.

You must investigate and decide. If the board doesn’t investigate a problem, use qualified experts, and fails to make a repair decision, their inaction does not receive judicial deference. In other words, only an investigation and decision qualifies for judicial deference, even if the decision is to do nothing.

A Note about Insurance

Most associations carry Directors & Officers insurance to provide protection against losses (including attorneys’ fees) that result from wrongdoing or negligence. David Stompe highlighted three important points:

  • Always tender to insurance. Insurance companies often deny claims that are not submitted in a timely fashion. If know about a potential claim, it’s important to submit it to insurance promptly.
  • Check your coverage. This may seem obvious, but coverage should be extensive, and should include claims for libel or slander (or other defamation), discrimination, and attorneys’ fees.
  • Check your exclusions. Avoid policies that contain an “insured vs. insured” exclusion.

If you are an ECHO member living in the East Bay and would like to attend these round-table discussions, please check the schedule in the ECHO Journal or online. We’d love to have you! Have a question about our Regional Panels? You can reach us here.

 

Blog Category: 

Comments

Thank you for the update and case break down. This case should be a major eye opener to the board of directors. In my experience, it will not. I have served on the board and notice the majority of directors have no interest learning or educating themselves on laws, bylaws, and cc&r. Operating strictly on their management's company opinion. I have witnessed a management company act as a dual agent, representing their vendor and the board.  There was a contract with the vendor which called for the vendor to have insurance before starting work. The management company allowed the vendor to start working without the needed insurance and without informing the board. Once discovered the management said the vendor can't obtain insurance due to being a sole proprietor and the state of California doesn't call for it. Only one board spoke up and objected the remaining four sat quietly.  It's sad the lack of education kept them from knowing the liabilities they were exposed to.  Management company still employed so it the vendor.

Hi Maurice,   I was able to get on the board, and educated myself, read everything, and when I provided my input, I was alienated as being a know-it-all, the two other board members were offended.  The two board members allowed and depended on the CAM to make all the decisions and pay herself any invoice.  The condition of the community is horrific, as well as financially.  The managment company continues to  profit and the HOA suffers.  The two other board members don't see the problem or even try to resolve the issues  we are experiencing.  As a board member I have been harassed, I recently received 5 violation letters and centured in meetings.    With the CAM's advice, they made themselves president and treasure without a vote.  As the Director at Large, I have no voice, CAM refuses to respond to me and the place get worse and wrose.   9 trees are dead as they have not dealt with deferred maintenance, a balcony was hit badly damaged by a tree and needs repair, (very unsafe)  but the CAM is planning  to get postings  up to tow away vehicles.  It just doesn't make sense.....
 

What is next?  ADR request submitted 24 days.  Near 30 days and I have no response.  What can I do?

Hi, Diania, I feel your frustration. You joined your Board to make a difference. If you are like me you idealized the Board becoming better with good leadership. I'm personally at my wit ends. It seems we are out here without any help. As an individual aka homeowner, it's hard to get an attorney to take your case. I found attorneys lines up when the Association needs help.  Go, figure.  I paid out my pocket for this site in search of answers and guidance, so far to no avail. I was told attorneys, community managers, and board members reply to these blogs. I haven't found one worthy reply. Another dead end.  Diania, I wish you luck and hope you find help with your ADR sessions.  

tcoffin's picture

Hi Maurice - without a doubt, it's tough to be an owner if your board isn't committed to transparency or to the law. While we don't have the staff to provide answers to detailed questions through our blog, I hope that you will consider coming to an event (like the one mentioned in this blog) or to any of our seminars. They are nearly all free to our members, and we invite owners, attorneys, managers, and other experts. Our resource Panels meet bi-monthly throughout the Bay Area (from Aptos through Santa Rosa).

Please don't give up! We are working on more information for HOA boards and owners all the time. And while we can't force any board or owner to do the right thing, we can at least help them understand what the law says, or what best practices dictate.