Every person elected to serve on a homeowners association board of directors should understand the basic obligations and potential liabilities of the position.
Newly elected members should educate themselves about HOA board member responsibilities and obligations or risk legal exposure for both the HOA and individual directors.
Basic Fiduciary Obligations
Once elected to serve on a homeowners association board. a board director becomes a fiduciary. A fiduciary is a person legally entrusted with the care, protection and use of another’s interest.
HOA board duties and powers are dictated by the following:
Most of the responsibilities of a director of a homeowner’s association are set forth in the governing documents, and quite often more particularly in the declaration of covenants, conditions and restrictions. Some of the important obligations of a director include maintenance of the common area, entering into service contracts on behalf of the association, obtaining various forms of insurance, preparing annual budgets, establishing and maintaining reserve funds, collection of assessments, supervising contract services, enforcement of the governing documents and rules promulgated pursuant to those documents, architectural control, and the maintenance of association records. Certainly this list is not intended to be all inclusive; however, it does demonstrate that the obligations of a director are extensive and can often be complicated. (Learn more about HOA governing documents here)
In the context of a landlord-tenant relationship, the association and its board members have a slightly different relationship with the members of the association. In this context, the association and its board members must act in a non-negligent fashion so as to avoid any physical injury to its members or others who come onto the development.
Guiding Principles of the Fiduciary Relationship
Fiduciary obligations entail legal responsibilities outlined in California statutes and case laws. In January 1980, the California Corporations Code came into effect and established guiding principles for board directors of nonprofit corporations.
While these provisions directly apply to incorporated HOAs, courts have used the guiding principles in scrutinizing the actions of both incorporated and unincorporated homeowners association boards.
The Corporations Code for HOAs
Section 7210 of the Corporation Code states that while a board may delegate some of their authority, they cannot delegate their responsibility or their liability. And since certain powers cannot be delegated, the limits of the delegated and non-delegated powers should be clearly defined.
A second and perhaps one of the most important sections of the Code, and certainly one which each and every director should be thoroughly familiar with, is §7231, which the California Supreme Court in Frances T. v. Village Green Owners’ Association (1986):
Section 7231(a) is the guiding principle for a director in carrying out his or her obligations. First, it requires a director to act “in good faith”, which means that the action of each director must be genuinely directed towards those purposes set forth in the governing documents. There should be no ulterior reasons or motives. Secondly, each director must act in a manner that the director believes to be “in the best interest of the corporation.” Finally, and perhaps most importantly, a director must act with the care of an ordinary prudent person, including the duty of “reasonable inquiry.” This means that a director is obligated to investigate each and every situation sufficiently before acting, and once the director does act, he or she must do so in a non-negligent, prudent manner.
Section 7231(b) outlines the various types of information upon which a director is entitled to rely and which form at least a basis for a defense to a claim of breach of fiduciary duty. Obviously, the drafters of this section recognized that each director cannot be an expert in all aspects of a nonprofit corporation, particularly those areas which require substantial training, such as law, construction and accounting. This subsection further recognizes that each director cannot, in all probability, investigate each and every issue with the appropriate thoroughness to reach an independent judgment. It is certainly for that reason that the statute permits a director to rely upon other offices and employees of the corporation whom the director believes to be reliable and competent in the matters presented. Although subsection (b) permits a director to rely upon the information, opinions, reports and statements of others, it does not absolve him or her of the responsibility to make reasonable inquiry and to use reasonable care to assure that the information, reports, opinions and statements are being provided by individuals competent in the matters being provided.
Section 7231(c) makes it clear that if a director follows the principles of subsections (a) and (b), no liability shall attach based upon any alleged failure to discharge that person’s obligation as a director. This is so even if the ultimate action or decision of the director or the board of directors is incorrect. Stated simply, a director may be wrong in his or her ultimate decision, but that director is only liable if he or she has failed to follow the obligations and principles of subsections (a) and (b).
These two sections of the Code were, in effect, the basis for the landmark decision of Ravens Cove Townhomes, Inc. v. Knuppe Development Co. (1981) 114 Cal.App.3d 783, which involved a lawsuit against the initial developer-controlled board of directors for failure to establish and maintain adequate reserve funds. The court initially noted that directors of nonprofit corporations are, in fact, fiduciaries, and that they are held to a high standard of conduct, the breach of which may subject each or all of them to individual liability. Ultimately, the court concluded that the failure to maintain and establish adequate reserve funds in a homeowners association constituted a breach of the fiduciary duties to act in good faith and exercise the basic duties of good management, and held the directors individually liable. It is important to note that the court clearly indicated that such a breach may occur where a director, either because of the exercise or failure to exercise supervision, permits mismanagement or non-management of the association’s affairs to occur. In other words, a director is exposed to personal liability when that director manages the affairs of the association either negligently or not at all.
The principles first announced in the Ravens Cove case were later affirmed by the California Supreme Court in Frances T. v. Village Green Owners Association, supra, 42 Cal.3d 490, where the court acknowledged that the standard set forth in ‘7231 of the Code is the fiduciary standard for directors of incorporated homeowners associations (and by analogy, unincorporated homeowners associations). Thus, in California the standard relating to directors’ personal liability is defined by statute, ‘7231 of the Code.
Having reviewed the basic governing principles by which a director must carry out his or her fiduciary obligations, it is appropriate to consider some of the obligations of a director and how these principles might apply in certain situations. In undertaking these considerations, it is helpful to separate the various functions of a board of directors of a homeowners association into two general categories. The first category relates to those functions that are governmental in nature and usually relate to many of the relationships between the association and its members, the association and third parties.
Homeowner association documents generally contain a number of “use restrictions” that have as their primary purpose the maintenance of the property of the development and the harmony between the individual association members. Such documents often contain additional authority for the passage of rules and regulations that further promote the purposes of the association. The passage of such rules and regulations are generally the responsibility of the board of directors and the enforcement of both the rules and regulations, as well as the other use restrictions contained in the governing documents, usually rests with the association and thus, the board of directors. These functions are analogous to those exercised by governmental bodies; therefore, in addition to the general principles already discussed, additional principles apply.
The first principle is that where the board of directors adopts additional rules and regulations to further the purposes of the association, those rules and regulations must be rationally related to the protection, preservation or other proper operation of the property and the purposes of the association as set forth in its governing documents. In other words, the adoption of rules and regulations are limited to certain specified purposes in the governing documents, and rules and regulations that exceed that authority cannot legally be enforced. Where a board of directors attempts to enforce such invalid rules and regulations, they subject themselves and the association to potential liability.
The second principle is that where rules and regulations are to be adopted by the board of directors, those rules and regulations must be carefully drafted so as not to infringe upon other protected rights of the individuals involved. In other words, when a board of directors attempts to carry out their obligations by enacting rules and regulations that conflict with well recognized individual liberties, they have once again exposed themselves and their association to liability.
Finally, the third principle is that both rules and regulations that are adopted by the board of directors and the various use restrictions contained in the governing documents must be enforced in a fair and nondiscriminatory manner.
With all of these additional principles in mind as well as the general fiduciary principles discussed above, let us consider some examples and how these principles might apply.
Consider a homeowners association that has governing documents that permits owners to have pets in the development and further authorizes the board of directors to promulgate certain rules and regulations limiting or qualifying the presence of pets in the development. Since this use restriction on its face permits pets in the development, it would seem clear that should the board fail to pass any rules and regulations relating to pets, an owner would be permitted to bring virtually any pet into the development that was not otherwise illegal by local ordinance, statute or otherwise. Therefore, the board of directors first has an obligation to its members to establish rules and regulations relating to pets so as to clarify the conditions under which pets are to be permitted. Recognizing the requirement that directors act in good faith, the board of directors cannot use this process as a subterfuge to effectively and impermissibly limit or exclude pets. All limitations in any proposed rule must have a legitimate and compelling basis, and must be consistent with the intent of the provision in the declaration permitting pets in the development.
The next question in this example then becomes what types of rules and regulations would be appropriate. At this point, the directors have an obligation to make reasonable inquiry and perhaps even establish a committee upon which the directors can rely for such input. Once this information has been gathered, the directors are now at a point where they must adopt rules regulating pets. As indicated from the governmental principles discussed above, these rules must be specifically related to the preservation of the development and to the harmony of the individual owners, as well as to the intent of the drafters of the declaration to permit pets in the development. They must be reasonable in nature and must not violate the individual rights of the owners. Therefore, such rules may consist of limiting the number of pets, the types of pets, the size of pets, etc. as long as there are compelling and justifiable reasons. Further, such rules may require that all pets be maintained within the individual units and not be permitted to roam about the common area of the development. Such rules may further provide that any damage done by such pets will be the responsibility of the pet’s owner. Finally, in view of the fact that pets were permitted in the governing documents, it may well be appropriate to provide that owners who have pets, which would be in violation of the rules once they are adopted, would be permitted to retain those pets but not permitted to replace them, so long as the pets do not otherwise constitute a nuisance.
These considerations are obviously just an example of the considerations that should go into promulgating rules by the board of directors. As long as each aspect of the rules can be reasonably related to a valid purpose of the association, and is not discriminatory upon its face, the rules should withstand a challenge.
Obviously, if there are members of the board of directors who simply do not wish pets at all in the development, and are therefore using their position on the board not to pass reasonable rules, but to limit as narrowly as possible the presence of pets in the development, they should seriously question whether or not they are acting in good faith and in the best interest of the corporation.
Once the rules have been adopted, the next consideration is enforcement. Should the board undertake to enforce the rules against some, but not others, a clear case of discrimination will be demonstrated. For this reason, the board of directors should once again make reasonable inquiry to ascertain who is and who is not in violation of the rules. Once violators are identified, non-discriminatory, uniform enforcement should be undertaken by the board. Such enforcement should provide for reasonable notice and hearing to those who are allegedly in violation of the rules. This requirement is often referred to as “procedural due process.” It is based not only upon constitutional and case authority, but also upon provisions found within the Corporations Code §7341 and the Davis-Stirling Act, Civil Code §4820.
The above example relating to the promulgation and enforcement of pet restrictions is just one example of how the governmental principles as well as the more general principles of fiduciary responsibility might apply. Obviously, there are numerous other areas that could be considered. Such areas include rules and regulations relating to renters, children, architectural control, use of the common facilities, parking, etc. Whatever the particular area under consideration, it is clear that the director must act in good faith, in the best interest of the association and with reasonable care after having reasonably investigated the situation. Further, if rules and regulations are promulgated, they must relate to the purpose for which the association has been given authority, they must be non-discriminatory either on their face or in their enforcement. Equally clear is that the failure to observe these general principles not only constitutes a breach of the fiduciary obligation that each director owes to the association, but can also result in liability for individual board members who actively participated in the misconduct.
The business functions of a homeowners association are analogous to that of a private corporation for profit. The governing documents of a homeowners association make it clear that one of the primary responsibilities of the board of directors is to preserve the physical surroundings of the development. This will require contracting with various services to maintain the grounds and to perform maintenance and repair. A system for receiving assessments from owners and disbursing funds must be established. Financial management of the affairs of the association is extremely important and complete books and records must be maintained.
Recognizing these obligations and functions, let us consider how the general principles discussed above might apply. One of the primary functions of the directors is to maintain the physical surroundings of the development. Although this duty is frequently specified in a development’s CC&Rs, it is also a matter of statute. (See Civil Code §4775.) Thus, a director has an affirmative obligation to become aware of the physical condition of the development. This can be accomplished in a number of ways, e.g., periodically touring the development, reviewing reports from management and receiving communications from the membership. A director who does not undertake such reasonable inquiry is not fulfilling to his or her responsibility. Should that director then discover that certain aspects of the physical surroundings are in need of repair or additional maintenance, it then becomes his or her obligation to see that that repair or maintenance is performed. Often this requires the board to deal with outside contractors in which legal contracts are involved. In this situation, the director has an obligation to familiarize himself or herself with the contract and to obtain a basic understanding of it. If the director is unable to completely comprehend the document, he or she should consult others whom that director believes to have sufficient qualifications so as to obtain clarification.
Once the investigation of the issues and the proposed methods of addressing those issues have been adequately investigated, each directors must decide how best to proceed. The fiduciary standard requires this decision to be based upon what is in the best interest of the association. Thus, a director who vote for the least expensive approach or to defer any action based upon his or her personal concerns that as an owner he or she would have to pay an increased assessment is not acting in the best interest of the association if an uninterested person would have concluded that a more expensive approach is required.
Similarly, in the preparation of the homeowner association budget, each director has an obligation to understand the budget in detail. Each director should make reasonable inquiry to understand why certain figures have been allocated to various categories, why increases have incurred or are projected, and whether or not the amount of money allocated to each category appears to be adequate. If the directors need the assistance of experts, they have a clear obligation to seek their advice. And, again, if the analysis indicates an increase in assessments is in the best interest of the association, the directors must set aside their personal issues and vote for what is in the best interest of the association.
The Rule of Judicial Deference
In Lamden v. La Jolla Shores Clubdominium Homeowners Association (1999) 21 Cal. 4th 249, the California Supreme Court first announced the Arule of judicial deference as to the discretionary decisions of homeowner association boards. Simply stated, where a duly constituted 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, courts should defer to the board’s authority and presumed expertise. This rule in essence restates §7231 of the Code and indicates that the burden of demonstrating that a board has breached the standard of that section is on the party alleging such a breach and the courts will not second guess boards who adhere to the fiduciary standard.
This rule, which the court made applicable to both incorporated and unincorporated homeowners associations, was certainly good news for homeowners association boards. However, in essence it establishes how important it is that boards comply with the fiduciary standard set forth in §7231 of the Code. The rule of judicial deference will not apply if the fiduciary standard is breached. Thus, failure to act in good faith, failure to undertake a reasonable investigation, failure to act in the best interest of the association or failure to act as a reasonably prudent person under the same or similar circumstances renders the rule of judicial deference inapplicable.
Further, where the governing documents and/or the statutes require certain action and no discretion is involved, the rule of judicial difference is again inapplicable. (Ekstrom v. Marquesa at Monarch Beach Homeowners Association (2008) 168 Cal.App.4th 1111.)
Guiding Principles of the Landlord-Tenant Relationship
In 1986, the California Supreme Court in Frances T. v. Village Green Owners Association, supra, 42 Cal.3d 490, addressed the question of individual liability of a director of a homeowners association where a person, in this case a member of the association, was personally injured as a result of the actions or inactions of the association’s board. The court concluded that in such situations, the association relationship to third parties is like that between a landlord and tenant. As such, the association has a duty to carry out its functions in a non-negligent manner so as not to personally injure third parties, including members of the association. Importantly, the court further concluded that those individual members of the board who affirmatively participated in the action or inaction which resulted in the personal injury, they too could be held individually liable.
As an example as to how this ruling might apply, consider the situation where the board is informed that the jacuzzi in the development operates in such a way that a small child could be pulled to the bottom by the action of the jacuzzi pumps, with the potential result that the small child could be held under water and be injured or drown. Obviously, the potential for serious harm is great in this situation and requires the director to examine the situation without delay. If, upon examination, the director determines the report is accurate, he or she then has an obligation to take the necessary steps to rectify the situation. Such steps might include the enclosing of the jacuzzi area and/or requiring that no children under a certain age be permitted in or near the jacuzzi. The point is that a director who has been put on notice of a dangerous condition within the development has an affirmative obligation to investigate and to act without delay when appropriate, and failure to do so may result in not only liability for the association but also for the individual director.
An number of other examples come to mind. For example, adequate lighting in the development to avoid injuries at night, maintenance of landscaping such that safety warning and other signs are not obstructed, etc. Where personal safety of members and third parties who visit the development are in issue, ignorance is not bliss. The association and the individual board members have a duty as the landlord of the development to insure that all reasonable steps have been undertaken in an expeditious manner so as to make the development a safe environment for all. Further, this duty is non-discretionary and the rule of judicial difference does not apply. If an association is negligent in performing its duties and a third person in personally injured, that association and the members of the board who participated in or approved the negligent acts will be held accountable.
Once again, the examples discussed here are basically specific applications of the general principles discussed earlier. It is for this reason that each and every member of the board must understand the general principles so that each director can apply them in performing their duties.
Minimizing the Potential for Liability
Having briefly reviewed the basic obligations of a director of a homeowners association and the principles relating to the performance of those obligations, it is appropriate to consider some general procedures for fulfilling those obligations and thus minimizing the liability of both the association and the individual directors.
It goes without saying that one of the first actions a director should undertake after having been elected to the board is to become thoroughly familiar with the governing documents and all of the rules and regulations of the association. Further, a substantial body of laws has been enacted into statutes, primarily found in the Davis-Stirling Act (Civil Code §4000). These documents and statutes set forth, sometimes in general terms and sometimes specifically, the obligations of the board of directors and the limitations on their powers. Whenever a question arises as to either such obligations or such limitations, reference should always first be made to the governing documents and these statutes. Never guess! Further, when there is an inconsistency between your governing documents and the statutes, remember the statutes control.
It is also a very good idea for each new director to examine the minutes of the association for the previous years. This will enable that director to become familiar with many of the issues that have already been raised and how the previous boards have dealt with them. Such a review will also emphasize the importance of the maintenance of good minutes.
The Code requires that minutes of all board meetings be maintained. However, these minutes and all other records of the association will be of little value unless they are sufficiently detailed such that one can read them long after the meeting and still know what occurred at the meeting. Not only should the minutes be detailed, but when a vote is taken, the minutes should indicate how each individual director voted. Further, where there is reference to written reports and letters, those reports and letters should be attached to the minutes and made a permanent part of the record of the association.
Recognizing that the board ultimately has responsibility for the operation of the association, it should establish a strong committee system with written charters for each committee. Written reports from each committee should be required and when appropriate, sufficient authority should be delegated to a particular committee to permit them to fulfill their function.
In addition to committees, the board of directors should have professional personnel on retainer to assist them. Such professional personnel should include management companies, accountants, attorneys and technical experts. All too often, boards of directors wait until a problem occurs before they contact a professional for assistance. Many times, the problem could have been avoided, or at least minimized, had the board consulted with a professional at an earlier point in time. The Code permits the board to rely upon the information and opinions of professionals, and the directors should take full advantage of that.
The board should establish a system of communication between itself and the members of the association. If the members are adequately advised as to the various issues confronting the board on a regular basis, much more understanding, cooperation and participation from the members will result.
Most governing documents of homeowners associations permit directors to obtain errors and omission insurance and directors are foolish who do not obtain such insurance. While insurance does not relieve directors from their obligations, which have already been discussed, the coverage that is available is relatively inexpensive and does afford each director some degree of protection. As with other contracts, each member of the board should familiarize himself or herself with the contents of each and every insurance policy entered into by the association and particularly with those exclusions contained therein. Further, certain statutes limit the liability of directors only if adequate insurance is in place. (See, e.g., Civil Code §5800)
Individual directors should be acutely aware of the concept of conflicts of interest. Whenever such conflicts arise, those board members in conflict should refrain from voting on the particular issues involved. Those board members should disclose all such conflicts to the remaining members of the board.
Individual board members should make it a point to attend all meetings of the board. It is no defense to a claim of mismanagement or non-management that a director simply did not have enough time to devote to the meetings of the association. If a director does not have the time to comply fully with his or her obligations, then he or she should get off of the board without delay.
Board members should make every effort to educate themselves in all phases of their responsibilities. As indicated earlier, this begins by thoroughly familiarizing oneself with the governing documents of the association and the applicable statutes, and reading the minutes of previous meetings of the board of directors. But the education should not stop there. Numerous courses, seminars, periodicals, and books relating to the management of homeowners associations are available and directors should make a reasonable effort to obtain this information. Ignorance may sometimes be bliss, but it is definitely not a defense to an action for breaching the fiduciary obligation that each director has.
These suggestions are not intended to be all inclusive. However, if directors undertake a reasonable effort to follow these suggestions, they are well on their way to fulfilling their obligations and at the same time insulating themselves and their association from the potential liabilities that always exist. Perhaps the most important thing to remember as a director of a homeowners association is that it is very serious business and should not be taken lightly.
See also §7231.5 of the Code which restates that volunteer directors shall have no monetary liability if they comply with §7231.
Since the purpose of this example is to demonstrate the application of the fiduciary principle is a common process in a common interest development, such issues as the rules adoption procedure as set forth in Civil Code §4340, et seq. of the Davis-Stirling Act and the issues and unanswered questions of Civil Code §4715 relating to pets are not discussed here. However, with the adoption of Civil Code §5105, which requires all homeowners associations to adopt election rules, Civil Code §4715 is now applicable to all association, with the result that all associations must now permit at least one pet per separate unit, subject to reasonable rules and regulations.
John D. Garvic is the founding member of The Law Offices of John D. Garvic, a law firm in San Mateo, California, specializing in common interest developments since 1977. John is the chair of the ECHO Legislative Panel, and serves on the ECHO Board of Directors.