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BUSINESS JUDGMENT RULE

I.  Corporations Code. Even though officers and directors are deemed fiduciaries, boards are not required to make the "right" decision. Corporations Code §7231(a) protects directors from personal liability if they make 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.

II.  Davis-Stirling Act. As provided for in Civil Code §5800(a), a volunteer officer or director is not personally liable in excess of the association's insurance for bodily injury, emotional distress, wrongful death, or property damage or loss as a result of the tortious act or omission of the officer or director if all of the following criteria are met:

  1. The act or omission was performed within the scope of the officer's or director's association duties.

  2. The act or omission was performed in good faith.

  3. The act or omission was not willful, wanton, or grossly negligent.

  4. The association maintained and had in effect at the time the act or omission occurred and at the time a claim is made one or more policies of insurance which shall include coverage for (A) general liability of the association and (B) individual liability of officers and directors of the association for negligent acts or omissions in that capacity; provided, that both types of coverage are in the following minimum amount:

  • At least $500,000 if the association consists of 100 or fewer separate interests;

  • At least $1,000,000 if the association consists of more than 100 separate interests.

III.  Case Law. California Business Judgment Rule:

Generally, courts will uphold decisions made by the governing board of an owners association so long as they represent good faith efforts to further the purposes of the common interest development, are consistent with the development's governing documents, and comply with public policy. Thus, subordination of individual property rights to the collective judgment of the owners association together with restrictions on the use of real property comprise the chief attributes of owning property in a common interest development.… Inherent in the condominium concept is the principle that to promote the health, happiness, and peace of mind of the majority of the unit owners since they are living in such close proximity and using facilities in common, each unit owner must give up a certain degree of freedom of choice which he [or she] might otherwise enjoy in separate, privately owned property. (Nahrstedt v. Lakeside Village.)

California also has a statutory business judgment rule. Corporation Code Section 7231, subdivision (a) provides, in relevant part, " [a] director shall perform the duties of a director . . . in good faith, in a manner such director believes to be in the best interests of the corporation and with such care . . . as an ordinarily, prudent person in a like position would use under similar circumstances." Subdivision (b) provides that the director is entitled to rely on information, opinions, and reports presented by certain specified persons. Finally, subdivision (c) provides, in relevant part, "[a] person who performs the duties of a director in accordance with subdivisions (a) and (b) shall have no liability based upon any alleged failure to discharge the person's obligations as a director . . . ." (Italics added.) The rule provides further: "no cause of action for damages shall arise against, any volunteer director . . . based upon any alleged failure to discharge the person's duties as a director" of a nonprofit organization if that person: (1) performs the duties of office in good faith; (2) performs the duties of office in a manner believed to be in the best interests of the corporation; and (3) performs the duties of office with such care, including reasonable inquiry, as an ordinary prudent person in a like position would use under similar circumstances." (Corp. Code § 7231.5, subd. (a).) The business judgment rule "sets up a presumption that directors' decisions are based on sound business judgment. This presumption can be rebutted only by a factual showing of fraud, bad faith or gross overreaching." The business judgment rules does not create a presumption which applies when a court is evaluating the independence of the committee or whether the committee acted in good faith in the first instance. (internal cites removed; Ritter & Ritter v. Churchill.)

[I]n Lamden, ample evidence demonstrated the association board engaged in the sort of reasoned decisionmaking that merits judicial deference... [p]roof . . . that the investigation has been so restricted in scope, so shallow in execution, or otherwise so pro forma or halfhearted as to constitute a pretext or sham, consistent with the principles underlying the application of the business judgment doctrine, would raise questions of good faith or conceivably fraud which would never be shielded by that doctrine.'”].) (Palm Springs Villas II v. Parth.)

Judicial Deference. There is a related rule call the "Business Judgment Doctrine" or "Judicial Deference" where courts defer to business decisions of a board even if a reasonable person would have acted differently.

ASSISTANCE: Associations needing legal assistance can contact us. To stay current with issues affecting community associations, subscribe to the Davis-Stirling Newsletter.

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