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." 

RECUSAL

"Recusal" or to "recuse" oneself means to remove oneself from participation in a decision where you have a conflict of interest.

No member should vote on a question in which he has a direct personal or pecuniary interest not common to other members of the organization. For example, if a motion proposes that the organization enter into a contract with a commercial firm of which a member of the organization is an officer and from which contract he would derive personal pecuniary profit, the member should abstain from voting on the motion. RONR (12th ed.) 45:4.

Recusal normally occurs when a director has a conflict of interest or prejudice concerning a particular matter. A conflict of interest is any situation in which financial or other personal considerations may unduly influence the director's judgment. This includes matters such as a disciplinary action against the director for violating the CC&Rs or voting on a potential contract with a company owned by a close relative of the director.

Leave the Room During Recusal. In each case, the director has a personal interest in the outcome of the vote--an interest not shared by other directors. In such instances, the interested director should leave the meeting room so the remaining directors can freely discuss and vote on the issue. (California's Fair Political Practices Act, Calif. Code of Reg. § 18702.5.) Once the vote is taken, the recused director may return to the meeting.

If the interested director were to stay in the meeting, his presence could inhibit the board's discussion and influence the vote. To avoid liability, a conflicted director must remove himself from the process of conferring and voting on matters in which he has a personal interest.

the disqualified member's mere presence, or knowledge thereafter, might also subtly influence the decisions of other council members who must maintain an ongoing relationship with him. ... The attorney, as well as the other council members, might not feel as free to disclose everything necessary when a "biased" public official were present. The council members and attorney might feel similarly inhibited where they are aware that a "biased" council member can later obtain a tape recording of the attorney-council discussion. The town might thus be denied effective assistance of counsel. (Hamilton v. Los Gatos.)

Interested Director Refuses to Leave the Room. If the interested director does not leave voluntarily, the board can ask him to leave. If he refuses to leave, the board can adjourn the meeting to another location where they can hold the discussion and vote without interference by the interested director. Under those circumstances, the board might also consider a vote of censure against the director for his refusal to recuse himself.

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.

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