Fiduciary Duty of Board of Directors
Q. I have heard that homeowner association board members have a “fiduciary duty”. What exactly is it? Is it spelled out in the law? What sort of actions would violate that duty?
A. A fiduciary duty arises out of a relationship in which one person or entity is entrusted to make decisions for, and control the interests of, another person or persons. For example, the common estate planning device of a trust sometimes provides for a qualified individual or bank to be the trustee and control the funds within the trust. In such a relationship the trustee would be a fiduciary and have fiduciary duties to the beneficiaries of the trust. Boards of directors owe a fiduciary duty to the association’s members. Most jurisdictions have either enacted statutes or have specific case law that establishes directors of nonprofit and non-stock corporations as fiduciaries. In Virginia, there is a statute on this topic in the Virginia Nonstock Corporation Act. Many associations are incorporated as non-stock corporations.
There are two aspects of fiduciary duty. The first relates to a director’s responsibility to perform his duties in good faith, in a manner each director believes to be in the best interest of the association, and with such care, including reasonable inquiry, as a prudent person in a like position would ordinarily use under similar circumstances. This standard of care has been adopted in most jurisdictions and is often cited as the “prudent person standard” or the “business judgment rule.” Directors will not be liable for mere mistakes in judgment so long as they act in good faith and have a rational and informed basis for their decision.
The second aspect relates to a director’s duty of undivided loyalty to the association and its membership. This higher standard of performance is breached when a director acts in his or her own interest or with a conflicting interest. An example would be the failure of a board to initiate assessment collection actions against their units where a delinquency occurred. Not only must directors perform their duties in good faith and in the association’s best interest, but they also must exercise undivided loyalty and honesty and avoid any conflict of interest or self dealing.
A director can comply with the standard of due care by following the business judgment rule requirements. Courts will not second-guess a director’s decision that is made with reasonable diligence and is believed to be in the association’s best interest. The business judgment rule requires directors to:
· Be informed about the association’s business at all times.
· Attend and participate in all meetings.
· Register a dissent in the minutes and, in appropriate cases, explain that dissent when a director disagrees with an action being taken.
· Remain knowledgeable about the declaration, bylaws, rules and other documents essential to the association’s operation.
In most jurisdictions, a director is entitled to rely on the information, opinions, reports, statements, financial data and recommendations prepared or presented by the following qualified individuals:
· Association officers or employees
· Legal counsel, independent accountants, or other competent professionals
· A committee of the board on which the director does not serve
As to the avoidance of conflicts of interest, failure to meet the standard of undivided loyalty and honesty could expose the director to liability for a breach of fiduciary duty. When faced with a decision involving a potential conflict of interest, the director should disclose the conflict of interest in writing and abstain from voting on the issue.
Some ways directors expose themselves to liability for a breach of fiduciary duty are as follows:
· Failure to secure adequate insurance
· Failure to enforce governing documents
· Conflicts of interest and self dealing
· Failure to file a lawsuit before the statute of limitations ends
· Failure to supervise employees properly
· Failure to use due care in hiring responsible personnel
· Failure to maintain the common area
· Failure to provide adequate safety measures for common-area facilities.
Fortunately, Virginia statutes protect volunteer directors from personal liability for their improper actions as directors, unless they engage in a knowing violation of the criminal law or willful misconduct; however, the board members can be sued and the Association could be required to pay a claim. Therefore, it is advisable for the association to carry directors and officers liability insurance. Some homeowner association and condominium documents require that it be obtained.
Hopefully these guidelines will help prevent any breaches of fiduciary duty by your board of directors.