DIRECTOR CONFLICTS OF INTEREST

  Conflicts of Interest

Interested Director Defined

An "interested director" is one who has an interest in the outcome of a board decision because he/she receives a personal benefit from the decision that is different from the benefit conferred on other members of the association. This creates a conflict of interest for the director, which has the potential to influence his/her vote as a board member. Decisions influenced by personal interests rather than the association's interests can lead to a breach of the director's fiduciary duties. The Davis-Stirling Act clearly defines actions the Legislature considers conflicts of interest. As provided for in Civil Code § 5350(b), a director or member of a committee may not vote on any of the following matters:

• Disciplinary action against them.
• An assessment for damage to the common areas.
• A request for a payment plan for overdue assessments.
• A decision on whether to foreclose on a lien on their property.
• Review of a proposed physical change to their separate interest.
• A grant of exclusive use common area to the director or committee member. 

Lose Protections. When a director acts in his/her interests instead of the association's, the director loses the protections of the Business Judgment Rule: "An exception to the presumption afforded by the business judgment rule ... is that it does not shield actions taken without reasonable inquiry, with improper motives, or as a result of a conflict of interest." (Berg & Berg Enterprises, LLC v. Boyle (2009) 178 Cal.App.4th 1020, 1045-1046.) Regardless of whether he has a material financial interest, a director “may not make decisions for the association that benefit their own interests at the expense of the association and its members.” Raven's Cove Townhomes, Inc. v. Knuppe Development Co. (1981) 114 Cal.App.3d 783. A director who breaches the basic fiduciary duties are liable to the Association. (Id.) Where a director finds himself in a position to vote on a matter in which he has a personal interest, he should be recused.

Full Disclosure

An example of a conflict of interest is a potential contract between an association and a director or between the association and any other entity in which a director has a material financial interest. When a director has a conflict of interest, potential liability can be avoided if:

• Full Disclosure. The interested director fully discloses the conflict.
• No Influence on Vote. The interested director leaves the room so the remaining directors can discuss the issue fully and freely and vote without the interested director.
• Just & Reasonable. Even if the director makes full disclosure and avoids influencing the vote, the transaction must be fair and reasonable to the association at the time it is authorized, approved, or ratified. (Corp. Code § 310; Corp. Code § 5233; Corp. Code § 7233.)

Burden Shifts. If the interested director makes full disclosures and recuses him/herself, and if a disinterested majority of directors approves the proposal of the interested director, the burden of proof shifts to the person challenging the transaction. (Harvey v. The Landing HOA.)

Problems. Even when a director recuses himself, associations should avoid contracting with companies where a director has a financial interest. Such arrangements are fraught with peril both politically and legally.

• Political Problems. At election time, owners may accuse the board member of reaping secret profits, taking advantage of his or her position on the board, doing shoddy work, etc., and demand his/her ouster.
• Legal Problems. If the work by the interested director's company is defective, the board faces the unpleasant prospect of making legal demands on a fellow board member. At the same time, they face political problems with the membership for having given the fellow director the contract in the first place.

Interested Director & Quorum

Interested directors may be counted in determining the presence of a quorum at a board or committee meeting that authorizes, approves, or ratifies a contract or transaction. (Corp. Code § 7234.) However, directors must recuse themselves from discussion and voting on issues in which they have a direct personal or pecuniary interest not common to other board members. RONR (12th ed.) 45:4.

[N]o person can, at one and the same time, faithfully serve two masters representing diverse or inconsistent interests with respect to the service to be performed. The principle has always been one of the essential attributes of every rational system of positive law, even reaching to private contractual transactions, whereby there are created between individuals trust or fiduciary relations. (Stockton Plumbing & Supply Co. v. Wheeler (1924) 68 Cal. App. 592, 601-2.)

Adversarial Director - Legal Advice

A director who is adversarial to the board and likely to bring litigation against the association is not entitled to receive legal advice from the association’s counsel or attend executive session meetings where the matter is discussed. Although there is no California statute or case directly on point, the issue was decided in a 2015 case by the Washington Court of Appeals. The Court decided that an adversarial director likely to sue the association was required to recuse himself from meetings where the board would discuss potential litigation involving the director. (Hartstene Pointe Maintenance Association v. Diehl, No. 45739-3-II (Wash. June 23, 2015).) Case law from another state is not binding in California, but the principles described in the case would likely produce the same result in a California court. This same principle applies to directors who breach confidential information or waive attorney-client privilege.

Not a Conflict of Interest

Oftentimes board members vote on matters that result in a benefit to them that is not a conflict of interest because the matter also benefits the membership as a whole. For example, if a board member votes to add security patrols to the development, there is no conflict of interest since the benefit he receives from the patrol is the same benefit received by all members of the association. RONR (12th ed.) 47:10. Directors are allowed to vote for themselves for an office. RONR (12th ed.) 45:5. A director subject to a censure is not required to recuse him/herself from the discussion or vote. See "Censuring Directors." 

Miscellaneous
 

• Managers. As with board members, managing agents must also disclose conflicts of interest. See Manager Conflicts of Interest.
• Ethics Policy: To avoid problems, boards should adopt and carefully follow an ethics policy.

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