Overview of Fiduciary Obligations of Board Members
Much of the law surrounding fiduciary obligations of board members has been in place for decades. And a lot of it is common sense. However, it is a topic worth revisiting periodically—both as a refresher for returning board members and as a guide for new members.
Serving on a cooperative or condominium board is fundamentally different from other board service. Board members literally live with those who elected them—they see each other in the elevators, or even when they throw out their garbage. The balance between neighbor and elected official is something each board, and each board member, has to navigate. And what works for one building, and for one member, may be different from what works for others. But no matter the building, general principles of board service should be kept in mind.
It was slightly more than 30 years ago that the Court of Appeals addressed cooperative and condominium living: “… the cooperative or condominium association is a quasi-government—‘a little democratic sub society of necessity’… owners consent to be governed, in certain respects, by the decisions of a board. Like a municipal government, such governing boards are responsible for running the day-to-day affairs of the cooperative and to that end, often have broad powers in areas that range from financial decisionmaking to promulgating regulations regarding pets and parking spaces *** [P]urchase of a cooperative apartment represents a voluntary choice to cede certain of the privileges of single ownership to a governing body, often made up of fellow tenants who volunteer their time, without compensation. The board, in return, takes on the burden of managing the property for the benefit of the proprietary lessees.” Levandusky v. One Fifth Ave. Apartment, 75 N.Y.2d 530, 536-37 (1990).
The corporation (and condominium) itself owes no fiduciary obligation to its shareholders. Peacock v. Herald Sq. Loft, 67 A.D.3d 442, 443 (1st Dept. 2009); Hirschhorn v. Bd. of Managers of 169 Hudson Street Condominium, No. 650717/18, 2019 WL 295238. This concept, perhaps counterintuitive, stems from general corporate principles which have been in place for more than 100 years. Kavanaugh v. Kavanaugh Knitting Co., 226 N.Y. 185 (1919).
It is the board members who owe their fiduciary obligations—they are, in effect, the trustees of the interests of the apartment owners. A fiduciary is, indeed, one who handles money or property for the benefit of another. This relationship necessitates a “high degree of good faith” on the part of board members, who must perform their duties “in good faith and with that degree of care which an ordinary prudent person in a like position would use under similar circumstances.” Bd. of Managers of Fairways at N. Hills Condominium v. Fairway at N. Hills, 193 A.D.2d 322, 325 (2d Dept. 1993); Business Corporation Law §717.
Board members are expected to participate. They cannot repeatedly fail to attend meetings and are presumed to know those affairs of the building which they can learn by the exercise of reasonable care and diligence. This does not mean that a board member needs to know the governing documents chapter and verse, but they should have a general familiarity—enough to know whether to inquire when an issue is raised. From a practical standpoint, board members should review their management reports, which often provide a comprehensive look at what is going on in the building.
Board members can (and should) delegate, and they can and should rely on information, reports and opinions of their professionals, their employees and any committees. No board member is expected to know, for example, the inner workings of the building’s physical plant, or the specifics of the building’s insurance policies. But board members are expected to listen to what the building’s professionals have to say and to ask questions until they are satisfied that the building and apartment owners are well-served. The law recognizes that the input or advice may be wrong. Board members, however, will still be protected provided they reasonably relied on the other person.
The business judgment rule is an important tool for boards and board members. It, too, has been around for more than 100 years as a general corporate principle and it was Levandusky which made it squarely applicable to cooperative and condominium boards. In its simplest terms, courts will defer to the decision of a board if the action was “taken in good faith and in the exercise of honest judgment in the lawful and legitimate furtherance of corporate purposes.” Courts shouldn’t have to decide what is right or wrong for a particular building or its owners—that is the job of the board. It is board members, and not the court, who “possess experience of the peculiar needs of their building and its residents.”
There are two important components of the business judgment rule. First, it is the challenging apartment owner who has the burden to demonstrate that the board’s action did not meet the three-part standard above. Further, business judgment rule protection can be in place even if the board’s decision is wrong: “So long as the corporation’s directors have not breached their fiduciary obligation to the corporation, ‘the exercise of [their powers] for the common and general interests of the corporation may not be questioned, although the results show that what they did was unwise or inexpedient.’” Levandusky (quoting Pollitz v. Wabash R.R. Co., 207 N.Y. 113).
Yet, it is important to remember that the business judgment rule is not a get out of jail free card. There are exceptions. If there is a contractual obligation, boards cannot “override” that contract under the guise of the business judgment rule. Whalen v. 50 Sutton Place South Owners, 276 A.D.2d 356 (1st Dept. 2000). This includes the governing documents, license agreements and alteration agreements, among others.
Sometimes governing documents have provisions which say a board must be “reasonable.” You see this most often in the promulgation of “reasonable” house rules, or when apartment owner alterations must be approved by the board, with approval “not to be unreasonably withheld.” Where a “reasonableness” standard is imposed, the board and its members must act for the “welfare” of the cooperative or condominium. Rosenthal v. One Hudson Park, 269 A.D.2d 144 (1st Dept. 2000). This essentially shifts the burden so that that the board, and not the apartment owner, must demonstrate the reasonableness of the decision.
Finally, boards cannot adopt policies under the banner of the business judgment rule if they violate public policy, or law. A board could not require a shareholder to settle outstanding litigation with the cooperative as a condition of sale, Chemical Bank v. 635 Park Ave., 155 Misc.2d 433 (Sup. Ct. N.Y. Co. 1992), nor could a board argue that, in its business judgment, it would not fund construction of a ramp needed for a disabled resident to be able to access the building. United Veterans Mutual Housing No. 2 v. NYC Commission on Human Rights, March 2, 1992, New York Law Journal, 35:3 aff’d 207 A.D.2d 551 (2d Dept. 1994).
Anyone who works in this field of law is familiar with these issues, which are a mere starting point. But it is important to remember that board members may not be aware, or may want a reminder of their responsibilities.
Reprinted with permission from the Sept. 23, 2021 issue of New York Law Journal. © 2021 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.