Adams Stirling PLC

DUE DILIGENCE (Duty to Investigate)

"Due diligence" or the duty to investigate is one of the fiduciary duties of directors. Association boards of directors must make reasonable inquiry of rules violations, maintenance issues, reserve components, association finances, etc. before making decisions. This does not mean they must personally inspect water leaks or personally talk to vendors--they can rely on managing agents, committees or others to gather information for their review and discussion.

A director cannot close his eyes to what is going on about him in the conduct of the business of the corporation and have it said that he is exercising business judgment. (Burt v. Irvine Co.)

We hold that where 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.)

[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.)

The term "under similar circumstances" requires a court to consider the nature and extent of a director's alleged oversight or mistake in judgment in the context of such factors as the size, complexity and location of activities involved, and to limit the critical assessment of a director's performance to the time of the action or non-action and thereby avoid the harsher judgments which can be made with the benefit of hindsight (Gaillard v. Natomas Co. (1989) 208 Cal.App.3d. 1250, 1265.)

Competent Advice. Boards may rely on the advice of persons they believe to be reliable and competent in the matters being presented. (Corp. Code §7231(b).) This means boards can rely on CPAs for financial and tax issues, attorneys for legal issues, etc. Good faith reliance on advice of counsel provides a defense even if that counsel's advice later proves to be legally unsound (Melorich Builders, Inc. v. Superior Court (1984) 160 Cal.App.3d 931, 936-37.) Following is a list of some of the advisors boards commonly rely on:

  • Accountants
  • Attorneys
  • Bankers
  • Consultants (elevators, roofing, architects, engineers, etc.)
  • Insurance brokers/agents
  • Managers
  • Reserve specialists
  • Vendors (landscapers, roofers, plumbers, electricians, etc.)

Recommendation. Boards should adopt an Ethics Policy for directors to follow.

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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