Volunteer Defined
California's Corporation Code § 5239(b) defines “Volunteer” to mean the rendering of services without compensation. “Compensation” means remuneration, whether by way of salary, fee, or other consideration, for services rendered. However, the payment of per diem, mileage, or other reimbursement expenses to a director or executive officer does not affect that person’s status as a volunteer within the meaning of this section. Payment of per diem, mileage, or other reimbursement expenses to a director or executive officer does not affect that person's status as a volunteer. (Corp. Code § 7231.5(b); Civ. Code § 5800(b)) For example, if a director buys light bulbs for the common areas using his own money, the association can reimburse him without impacting his volunteer status. Directors should ALWAYS produce a receipt for any items they seek reimbursement for.
The board members of a homeowners association are seldom professional managers, are very often uncompensated and most often are neighbors. Undoubtedly, the specter of personal liability would serve to greatly discourage active and meaningful participation by those most capable of shaping and directing homeowner activities. (Jaffe v. Huxley Architecture (1988) 200 Cal.App.3d 1188, 1193)
[T]he services of directors and officers of nonprofit corporations who serve without compensation are critical to the efficient conduct and management of the public service and charitable affairs of the people of California ... It is the public policy of this state to provide incentive and protection to the individuals who perform these important functions. (Corp. Code § 5047.5(a))
Business Judgment Rule
Even though officers and directors are deemed fiduciaries, boards are not required to make the "right" decision. Rather, they must make what they believe to be the best decision for the corporation with the available information. The Business Judgment Rule (Corp. Code § 7231) protects directors from personal liability if they make decisions that result in damage or loss to others, provided their decisions were made:
- Good Faith. In good faith (The business judgment rule immunizes directors from good faith mistakes in judgment. Barnes v. State Farm Mut. Auto. Ins. Co., (1993) 16 Cal.App.4th 365, 378); To rebut good faith, plaintiff must point to specific evidence establishing a director's conscious doing of a wrong because of a dishonest purpose or moral obliquity, furtive design or ill will. Pugh v. See's Candies, Inc. (1988) 203 Cal.App.3d 743, 763-764)
- Best Interests. In a manner that the directors believe to be in the best interests of the corporation, and
- Reasonable Inquiry. With such care, including reasonable inquiry, as an ordinarily prudent person in a like position would use under similar circumstances. (Before making decisions, boards may rely on the advice of persons they believe to be reliable and competent in the matters being presented. (Corp. Code § 7231(b)) The phrase "in a like position" means the court will look at industry standards for volunteer homeowner association directors rather than paid professional directors. Professional directors are held to a higher standard. (See Parth Statement of Decision in the remanded case) "Permitting directors to remain ignorant and to rely on their uninformed beliefs to obtain summary judgment would gut the reasonable diligence element of the rule and, quite possibly, incentivize directors to remain ignorant." (Palm Springs Villas II HOA v. Parth (2016) 248 Cal.App.4th 268)
The BJR creates 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. (Ritter & Ritter v. The Churchill (2008) 166 Cal.App.4th 103, 123) Corporate directors are presumed to have acted in good faith, on an informed basis, and in the honest belief that the action taken was in the best interest of the corporation. (Katz v. Chevron Corp. (1994) 22 Cal.App.4th 1352, 1366)
- For the business judgment rule to apply, boards must actually make a decision. Inaction is not protected. (In re Walt Disney Co. Derivative Litig (Del Ch 2005) 907 A.2d 693) Weighing the facts and making a conscious decision to take no action is protected. A decision to refrain from action is different from inaction. An association is not shielded from liability if directors ignore problems. (Affan v. Portofino Cove)
- Boards can weigh the gravity of a rules violation and the likely outcome of litigation, and make a good-faith determination not to litigate a particular violation, and their decision is protected. (Beehan v. Lido Isle)
- A director acting with a material conflict of interest is not protected from personal liability by the business judgment rule. (Coley v. Eskaton)
- [T]he business judgment rule protects well-meaning directors who are misinformed, misguided, and honestly mistaken. [Directors are] protected by the business judgment rule unless they knew their acts were illegal or they “knowingly committed acts outside the scope of their authority.” (Biren v. Equality Emergency Medical Group, Inc. (2002) 102 Cal.App.4th 125, 137)
- [T]he presumption created by the business judgment rule can be rebutted only by affirmative allegations of facts which, if proven, would establish fraud, bad faith, overreaching, or an unreasonable failure to investigate material facts. (Lauckhart v. El Macero Homeowners Assn. (2023) 92 Cal.App.5th 889, 906)
Davis-Stirling Insurance Protections
Protecting Directors from Personal Liability. As provided for in Civil Code § 5800(a), a volunteer officer or director who owns no more than two separate residential interests (Civ. Code § 5800(e)) 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:
- The act or omission was performed within the scope of the officer's or director's association duties.
- The act or omission was performed in good faith.
- The act or omission was not willful, wanton, or grossly negligent.
- 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 Directors & Officers Insurance 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.
Protecting Owners from Personal Liability. Civil Code § 5805 protects owners from individual liability provided their association maintains at least minimum levels of insurance as follows: $2 million for associations with 100 or fewer separate interests, and $3 million for associations with more than 100 separate interests. The protection applies to both incorporated and unincorporated associations. For more information, see Commercial General Liability Insurance.
Governing Document Protections
Most, but not all, association CC&Rs and bylaws contain hold harmless and indemnity provisions protecting directors and officers from liability for negligent acts and omissions while in office. If the language is missing, it can be added when governing documents are amended. An association has the right to defend itself and its directors.
Indemnity Protections
The Corporations Code provides that “A corporation shall have power to indemnify any person who was or is a party or is threatened to be made a party to any proceeding.” (Corp. Code § 7237(b)) “Proceeding” means any threatened, pending, or completed action or proceeding, whether civil, criminal, administrative, or investigative. (Corp. Code § 7237(a)) In addition to the right to defend itself, an association owes a duty of indemnification to its directors to the extent a complaint arises out of actions undertaken on behalf of the association (Fidelity Mortgage Trustee Serv., Inc. v. Ridgegate E. Homeowners Ass’n (1994) 27 Cal.App.4th 503, 525)
501(c)4 Corporations
Some homeowner associations qualify as a 501(c)(4) social welfare organization because they benefit the entire community, not just their members. As such, their board members have additional liability protection under section 425.15 of the Code of Civil Procedure. This particular statute establishes a procedure for filing a claim against their directors. Before a cause of action against a board member can proceed, a plaintiff must first submit a verified petition with supporting affidavits that establish the underlying facts supporting the claims against a director. The director responds with his/her own evidence. If a court determines that the evidence supports a claim against the director, the case can proceed. If the judge is not convinced, the case cannot proceed. This prevents frivolous lawsuits against directors.
Case Law Liability Protections
An officer or director will not be liable for torts in which he does not personally participate, of which he does not know, or to which he has not consented. While the corporation itself may be liable for such acts, the individual officer or director will be immune unless he authorizes, directs, or in some meaningful sense actively participates in the wrongful conduct. To maintain a tort claim against a director in his or her personal capacity, a plaintiff must first show that the director specifically authorized, directed, or participated in allegedly tortious conduct, or that, although they specifically knew or reasonably should have known that some hazardous condition or activity under their control could injure the plaintiff, they negligently failed to take or order appropriate action to avoid the harm. The plaintiff must also allege and prove that an ordinarily prudent person, knowing what the director knew at that time, would not have acted similarly under the circumstances. (Frances T. v. Village Green Owners Ass’n (1986) 42 Cal. 3d 490, 503-04, 508-09)
A mistake of judgment by a board of directors does not justify taking control of corporate affairs from the board and placing them with the stockholders. The board of directors may make both correct and incorrect decisions, so long as it remains faithful to the corporation and exercises its best business judgment. (Behan v. Lido Isle Community Ass'n (1977) 70 Cal.App.3d 858, 866)
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/she might otherwise enjoy in separate, privately owned property. (Nahrstedt v. Lakeside Village (1994) 8 Cal.4th 361, 374)
Elements of the Business Judgment Rule. California also has a statutory business judgment rule. Corporation Code § 7231(a) provides that a director must 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 that 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. The rule provides further that 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(a))
Presumption. The business judgment rule presumes 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 rule does not create a presumption that applies when a court is evaluating the committee's independence or whether the committee acted in good faith in the first instance. (Ritter & Ritter v. The Churchill Condo. Ass'n (2008) 166 Cal.App.4th 103, 122-123)
[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 (2016) 248 Cal.App.4th 268)
[N]either a court nor minority shareholders can substitute their business judgment for that of a corporation where its board of directors has acted in good faith and with a view to the best interests of the corporation and all its shareholders. The power to manage the affairs of a corporation is vested in the board of directors. Where a board of directors, in refusing to commence an action to redress an alleged wrong against a corporation, acts in good faith within the scope of its discretionary power and reasonably believes its refusal to commence the action is good business judgment in the best interest of the corporation, a stockholder is not authorized to interfere with such discretion by commencing the action. Every presumption is in favor of the good faith of the directors. Interference with such discretion is not warranted in doubtful cases. (internal cites and quotation marks deleted; Behan v. Lido Isle Community Ass'n (1977) 70 Cal.App.3d 858, 865)
[T]he business judgment rule may protect a director who acts in a mistaken but good faith belief on behalf of the corporation without obtaining required shareholder approval." ... "[T]he [business judgment] rule . . . protect[s] well-meaning directors who are misinformed, misguided, and honestly mistaken." (Biren v. Equality Emergency Medical Group, Inc. (2002) 102 Cal.App.4th 125, 131-132, 137)
Judicial Deference
There is a related rule called the "Business Judgment Doctrine" or "Judicial Deference," under which courts defer to a board's business decisions even if a reasonable person could have acted differently. Absent an abuse of discretion by directors, courts will respect a board's decision.
Volunteer Protection Act of 1997
The Center for Community Economic Development analyzed the Federal Volunteer Protection Act of 1997 and compared its protections against those provided by California laws. The article found that "In some cases, the federal law slightly expands the protections available in California to volunteer directors and officers of nonprofit corporations, tax-exempt under Internal Revenue Code Section 501(c)(3). In other cases, California law provides broader protection. However, the insurance requirements of California law serve to defeat much of the protections available under both federal and California law."
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