|No man is allowed to be a judge in his own cause because his interest would certainly bias his judgment and, not improbably, corrupt his integrity. -James Madison (4th US President, Federalist Paper #10.)
Interested Director. 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 of influencing his/her vote as a board member. Decisions that are influenced by personal interests rather than the interests of the association 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:
(1) Disciplinary action against them.
(2) An assessment for damage to the common areas.
(3) A request for a payment plan for overdue assessments.
(4) A decision whether to foreclose on a lien on their property.
(5) Review of a proposed physical change to their separate interest.
(6) A grant of exclusive use common area to the director or committee member.
Business Judgment Rule. When a director acts in his/her own personal 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.)
Example. A board member votes to award a roofing contract to a company owned by the director or the director's spouse, brother, son, granddaughter, etc. The award of the contract results in a personal benefit to the director. Such contracts are voidable.
Contracts with Directors. As provided for in Corporations Code § 310, contracts between an association and a director, or between the association and any other entity in which a director has a material financial interest, are either void or voidable unless:
1. The material facts as to the transaction and the director's interest are fully disclosed or known to the membership and such contract or transaction is approved by the members, with the interested director abstaining from voting, or
2. The material facts as to the transaction and the director's interest are fully disclosed or known to the board or committee, and the board or committee authorizes, approves, or ratifies the contract or transaction in good faith by a vote sufficient without counting the vote of the interested director or directors and the contract or transaction is just and reasonable as to the corporation at the time it is authorized, approved or ratified.
Not a Conflict. 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.
Avoid Liability. Potential liability can be avoided if:
1. Full Disclosure. The interested director fully discloses the conflict.
2. 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.
3. Just & Reasonable. Even if the director makes full disclosure and avoids influencing the vote, the transaction must be fair and reasonable as to the association at the time it is authorized, approved or ratified. (Corp. Code § 310; Corp. Code § 5233; Corp. Code § 7233; .)
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.
Recusal. Interested directors may be counted in determining the presence of a quorum at a meeting of the board or a committee thereof which 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 members of the board. (Robert's Rules, 11th ed., p. 407.)
...no 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.)
Burden Shifts. If the interested director makes full disclosures and recuses himself and if a disinterested majority of directors approves the proposal of the interested director, the burden of proof falls 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.
1. 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.
2. 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.
Manager. As with board members, managing agents must also disclose conflicts of interest. See Manager Conflicts of Interest.
Treasurer. See Treasurer 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.