Business Judgment Rule (BJR)

Although officers and directors are fiduciaries, boards are not required to make the “right” decision. Instead, they must make what they believe is the best decision for the corporation based on the information available. 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:

• 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. Directors must believe their decision is in the association's best interests.
   
• Reasonable Inquiry. Directors must make their decisions 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 corporation's best interest. (Katz v. Chevron Corp. (1994) 22 Cal.App.4th 1352, 1366)

• BJR protections apply to more than just maintenance and repair decisions. The deferential standard also extends broadly to general board and architectural decisions. The court said the business judgment rule, on which Lamden was modeled, creates a presumption that directors' decisions are made in good faith and are based on sound business judgment. (Eng v. Opperman)

• 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 consciously deciding 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, make a good-faith determination not to litigate a particular violation, and have that decision 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)

Judicial Deference Defined

Judicial Deference is the principle under which courts will defer to a board's business decisions even if a reasonable person would have acted differently.

The common law business judgment rule refers to a judicial policy of deference to the business judgment of corporate directors in the exercise of their broad discretion in making corporate decisions. . . . Under this rule, a director is not liable for a mistake in business judgment made in good faith and in what he or she believes to be the corporation's best interests, where no conflict of interest exists. (Gaillard v. Natomas Co. (1989) 208 Cal.App.3d 1250, 1263)

Case Law Regarding Judicial Deference

Courts have applied judicial deference in several cases involving community associations.

• The judicial deference rule applies to an association board’s discretionary decisions concerning the operation of the common interest development. (Eith v. Ketelhut (2018))
   
• Nothing in Lamden limits judicial deference to maintenance decisions. Deference applies to the board's authority to adopt rules and impose fees relating to short-term rentals. (Watts v. Oak Shores (2015))
   
• Judicial deference applies to decisions involving the board's authority to maintain, control, and manage the common areas, including its designated storage space within those areas. (Harvey v. Landing (2008))
   
• An association can select among means for remedying violations of the CC&Rs without resorting to expensive and time-consuming litigation, and the courts should defer to that discretion. (Haley v. Casa Del Rey (2007))
   
• An association has a corollary, fiduciary relationship with its members. Its actions must be undertaken in good faith, considering the best interests of the community association and its members and seeking professional advice where necessary (Berryman v. Merit (2007))
   
• Courts give deference to a board's decision denying an owner's application for a room addition on aesthetic grounds — its approval or rejection of a homeowner’s improvement plan. (Dolan-King v. Ranch Santa Fe (2000))
   
• As long as a homeowners’ association acts after reasonable investigation, in good faith, and in a manner the association reasonably believes is in the best interests of the association and its members, its decision will be upheld. (Lamden v. La Jolla Shores (1999))
   
• Generally, courts will uphold decisions made by the governing board of an owners' association as 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. (Nahrstedt v. Lakeside Village (1994))

Burden of Proof. The burden of proof is on an objecting homeowner to show that an association’s decision is arbitrary, imposes burdens on the use of lands it affects that substantially outweigh the restriction's benefits to the development's residents, or violates a fundamental public policy." (Nahrstedt, 8 Cal.4th at 361, 386; Cohen, 142 Cal.App.3d at 642, 651-654) In this regard, "courts do not conduct a case-by-case analysis of the restrictions to determine the effect on an individual homeowner; [instead they] consider the reasonableness of the restrictions by looking at the goals and concerns of the entire development." (Dolan-King, 81 Cal.App.4th at 965, 975)

Presumption Favors Decision. 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." (Eldridge v. Tymshare, Inc. (1986) 186 Cal.App.3d 767, 776)

[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.... Every presumption is in favor of the good faith of the directors. Interference with such discretion is not warranted in doubtful cases. (Beehan v. Lido Isle Community Assn (1977) 70 Cal.App.3d 858, 865)

A mistake of judgment by a board of directors does not justify taking control of corporate affairs from the board and placing it with the stockholders. The board of directors may make incorrect decisions, as well as correct ones, so long as it is faithful to the corporation and uses its best business judgment. (Beehan v. Lido Isle)

When Judicial Deference Does Not Apply

Judicial deference does not apply to all board decisions. The courts have published decisions outlining where the rule does not apply.

• Judicial deference does not apply to a board's improper construction of the governing documents. (Dover Village Assn. v. Jennison (2010) 191 Cal.App.4th 123, 130)
   
• Courts do not defer to a board’s interpretation of the CC&Rs. Courts, not the board, decide interpretation. (Eith v. Ketelhut (2018))
   
• Deference is limited where responsibility for repairs is unclear. (Dover Village v. Jennison (2010))
   
• Deference does not apply where a board fails to investigate and make a repair decision. (Affan v. Portofino Cove (2010))
   
• Deference does not apply where a board makes decisions contrary to the governing documents. (Ekstrom v. Marquesa (2008))
   
• It is limited when the board fails to enforce the governing documents. (Nahrstedt v. Lakeside Village (1994); Lamden v. La Jolla Shores (1999); Dolan-King v. Rancho Santa Fe (2000))
   
• Notwithstanding the deference to a director's business judgment, the rule does not immunize a director from liability in the case of his or her abdication of corporate responsibilities: ... 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 around him in the conduct of the corporation's business and have it said that he is exercising business judgment. Courts have properly decided to give directors a wide latitude in the management of the affairs of a corporation, provided always that judgment, and that means an honest, unbiased judgment, is reasonably exercised by them. (Burt v. Irvine Co. (1965) 237 Cal. App. 2d 828, 852-853)

Rules & Regulations. Although rules and regulations enacted by a homeowners’ association's board are not recorded, they are entitled to similar judicial deference. “[W]here a duly constituted community association board, upon reasonable investigation, in good faith and with regard for the best interests of the community association and its members, exercises discretion within the scope of its authority under relevant statutes, covenants, and restrictions to select among means for discharging an obligation to maintain and repair a development’s common areas, courts should defer to the board’s authority and presumed expertise.” (Lamden v. La Jolla Shores, (1999)  21 Cal.4th 249, 265)

Additional Liability Protections

For additional protections for HOA volunteers, see "Protecting Volunteers from Liability."

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