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JUDICIAL DEFERENCE RULE

Judicial Deference or "business judgment doctrine" is the principle where courts will defer to business decisions of a board 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 which is made in good faith and in what he or she believes to be the best interests of the corporation, where no conflict of interest exists. (Gaillard v. Natomas Co. (1989) 208 Cal.App.3d 1250, 1263)

Case Law. The issue of judicial reference has been applied in a number of cases involving community associations.

  • Boards are entitled to deference on whether operation of the vineyard violated the prohibition against commercial activity because it did not affect the community’s residential character. (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, i.e.,  its designation of storage space in a common area. (Harvey v. Landing (2008).)
  • An association has discretion to select among means for remedying violations of the CC&R’s 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, with regard for the best interests of the community association and its members, seeking professional advice where necessary. (Berryman v. Merit (2007).)
  • Deference was given 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).)
  • So long as a homeowners’ association acts upon reasonable investigation, in good faith, and in a manner the association reasonably believes to be 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 so 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 on the part of a board of directors does not justify taking the control of corporate affairs from the board of directors 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 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.

  • The rule of 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. Interpretation is a legal question to be decided by the courts, not the board. (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 where 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 about him in the conduct of the business of the corporation 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 the board of a homeowners’ association 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.)

Business Judgment Rule. A related doctrine is the Business Judgment Rule.

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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