The Fiduciary Duties of HOA Board Members
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Overview
For those of us living in a community under the jurisdiction of a homeowner’s association, it might sometimes feel like the arrangement is mostly comprised of obligations assigned to the homeowner.
However, even if an association is permitted to dictate where one may park her car or what color one may paint her house, this relationship between homeowner and association entails duties from each party. As a dues-paying member of an association, a homeowner is entitled to certain rights.
This article will help elucidate what the law requires of an HOA board concerning its obligations toward homeowners. There are three broad categories of fiduciary duties of association Boards that we will discuss:
The duty of care,
the duty of reasonable inquiry, and
the duty of good faith.
With each topic, we will first explain general concepts then delve into examples for clarification. These rights for homeowners derive from old English common law (meaning that this law has grown over time through court decisions), but today almost every state has codified these rights into state statutes.
The following rights could be enforced through case precedents or state statutes, depending on the fact pattern. Our readers can access their state statutes here.
General Fiduciary Duties of HOA Board Members and Their Origin
First, it would be helpful to do a quick refresher on the legal definition of “fiduciary duty.” Black’s Law Dictionary defines fiduciary duty as “when one party must act for another. [Said party is] entrusted with the care of property or funds.”
Note the important helping verb above, must. When someone is assigned a fiduciary duty, whether by law or assigned by contract, this person must act in the best financial interest of another.
Often, lay folks will interpret this as a simple requirement of the fiduciary as just needing to treat another’s financial interests as she would treat her own. This is incorrect. If a person is assigned a fiduciary role, she is required to treat the assets/monies with the customary due care that another reasonable fiduciary would practice in her place.
Say, for example, our fiduciary spends her own money wildly and irresponsibly. As a fiduciary, she would not be permitted to spend another’s assets with such a patent disregard for the reasonable due care necessary; it is not a defense that she is treating the asset as if it was her own. The amount of reasonable care required by a fiduciary is based on an objective, customary standard.
The fiduciary duties an association board owes to its members might not be that intuitive—let us dig a little deeper. First, from where does this fiduciary duty from the Board to its members arise? In most jurisdictions, homeowners’ associations are considered non-profit corporations as they are most often created by filing incorporation documentation in the state of jurisdiction.
Each state requires the members of corporate boards to act in the best interest of the corporation with a fiduciary duty to do so. This obligation applies to HOA boards, even if volunteers staff it. As fees-paying members of a homeowners’ association, homeowners are entitled to these fiduciary protections. We will now look at the first category of fiduciary responsibility, the duty of care.
Duty of Care
Board members are required to exercise what is called a “duty of care” concerning their responsibilities. Two of the most common ways that there is a fiduciary breach of the duty of care is for the lack of enforcement of governing documents and the lack of what is called “sound business judgment” in making reasonable inquiries before investing community funds in a project. Each of these will be addressed in turn.
As we hinted in the introduction, often, community associations have a reputation for being overly aggressive in enforcing community rules. However, there is a good reason for this kind of diligence; the board members are required by law—as fiduciaries of the community association—to enforce all covenants, rules, guidelines, bylaws (and the like).
If the board members are not enforcing the rules to the letter, the association would be liable for breaching its duty of care to its community members.
Say, for example, some younger homeowners run for the Board and win seats. These younger folks find the prescribed community rule on loud music after 10 p.m. to be invasive, and they decide that the formal procedures to amend the rule are too arduous. Choosing not to enforce this community guideline would be violating their duty of care to the other residents that purchased/rented the property with the expectation that their nights would be noise-free.
It is not often that folks speak of wanting tighter enforcement of rules but think of the opposite, where these same rules applied only to people acting in good faith. Especially after spending a pretty penny to acquire a prime real estate in a private community, it is nice to know there is legal recourse to have community the guidelines enforced.
This duty of care can get particularly messy if the Board has a duty to bring legal action against a homeowner for not abiding by certain community rules (perhaps like an egregious, ongoing violation of a sound regulation). The personal feelings of the Board (either for or against the perpetrator) must be ignored because, as fiduciaries of the community, the Board needs to take the necessary actions to protect the community as a whole, no matter how personally unpleasant that action is.
We can extend this scenario to see how a situation could put a board member in a legal pickle if he or she is not careful. Let us continue the scenario where the Board brought legal action against the noisy neighbor, but there was dissension on the Board, and a split vote approved the decision to take legal action.
Even if the objecting board members have a valid reason for opposition to the suit, these dissenting Board members have a legal obligation to continue to represent the best fiduciary interests of the community only.
Within the duty of care comes the duty of confidentiality: any discussion with the association’s legal counsel must remain confidential, even if a couple of board members feel the noisy homeowner is getting a raw deal. Discussing the case with the noisy homeowner would be a breach of the Board members’ fiduciary duty and could have significant legal consequences.
What is required of due care is dependent on the jurisdiction. California is a more extreme example, (see the California appellate case Ravens Cove Townhomes, Inc. v. Knuppe Development Co. (1981)). The California Courts have construed their fiduciary statues to say that the duty of care requires a Board to establish and maintain an adequate reserve fund for the association to maintain the property.
The Board was found to have breached its fiduciary duty by not doing so. The proactive requirements of a Board to abide by its fiduciary duty will depend upon what state homeowners live in and its developed law on the subject.
The Duty of Reasonable Inquiry and Sound Business Judgment
The second common breach of the duty of care by an association fiduciary is for the lack of a reasonable inquiry in a financial investment of common funds. This breach of duty is different from fraudulent self-dealing, which we will address next.
This element of the duty of care requires the Board to exercise a reasonable amount of prudence in making decisions. However, one must keep in mind that what is considered prudent to one person may not be considered so to others.
One can envision a scenario where homeowners take advantage of the broad term like prudence to use legal actions to prevent nearly any action being taken by a Board. Luckily, most states (Florida, Colorado, and Georgia are three examples) have statutes that limit the liability for Boards in scenarios where “sound business judgment” was executed.
The sound business judgment is an objective standard, like the general fiduciary responsibilities discussed above. Meaning that a court will see the proper amount of due care exercised by a board if a reasonable person would have taken the same actions before deciding on behalf of the homeowner’s association.
Not all business decisions are successful—what matters here is the process. So long as the process applied is one that a reasonable person would have used, then courts will not wade into the details of association business matters.
However, this is not as simple as it sounds. The State of Washington has an excellent example of how this seemingly simple requirement can go wrong for a Board in a hurry.
In the case Riss v. Angel (1997), the Riss family purchased a lot in a residential Seattle subdivision, subject to an HOA jurisdiction, with the intention of replacing the current residence with a new, one-story home. The Board rejected the Riss’ plans citing a restrictive covenant permitting them to reject plans if they are not in “harmony with other dwellings.”
The Washington Supreme Court held that the Board violated its duty of care by exercising due diligence in rejecting the Riss’ plans. In its holding against the community association, the Court finds the Board never reasonably assessed the proposal.
Instead, the homeowners were presented with a misleading photo montage about the impact of plaintiffs’ plans. There was no evidence the Board visited the site, much less with an eye to neighbors’ views or privacy. There was no evidence in the record that the Board made any objective comparisons with existing homes to compare size and height. However, those were significant reasons for rejecting the proposed plans.
The association in question in the Riss case ended up paying the Riss family more than $200,000 after attorney’s fees. It is expected in most jurisdictions that sound business judgment includes consultation with experts for decisions that involve specialized knowledge.
The Riss Court noted that an architect was consulted “only after the decision was made.” A reasonable inquiry may sound simple but will require effort on behalf of the Board to meet the duty of care standard.
If a homeowner makes a reasonable request, an association may not dismiss it out-of-hand without diligently considering the proposal.
Next, we will consider another general fiduciary duty assigned to HOA Boards, the duty of good faith.
Duty of Good Faith (Duty of Loyalty)
Related to the duty of due care is the legal obligation that Board members act in good faith while acting as fiduciaries for their communities. Board members need to be very careful when it comes to what is called “self-dealing,” which simply means making a decision on behalf of the community that benefits the specific voting Board member.
Self-dealing does not just apply to the obvious scenario where a Board member solicits a contractor that she has a financial stake in to do work for the community. A Board member can violate the duty of good faith by just not disclosing a financial tie to a contractor, even if the contract is reasonably prudent.
In Florida, the disclosure of conflict is all that is required—after such a disclosure, self-profiting deals are permitted. Remember, though, the rules for self-dealing are state-specific.
Self-dealing does not need to profit the Board members necessarily. If, for example, the Board held up the sale of a condominium unit to a buyer until the new buyer would pay an extra fee that would be held by the HOA treasury, this, too, is considered self-dealing.
Although from a cursory examination, it looks as if the Board is improving the finances of the association by acquiring more money for the treasury, this arbitrary action is not in good faith. The courts will not permit it.
Lastly, as discussed in the article “HOA Violations: The Homeowner’s Right To A Fair HOA Due Process,” Board members may not use their authority to settle personal vendettas against disliked community members. The duty of good faith requires the Board to settle matters on the merits without regard to the personal feelings of the fiduciaries involved.
Within the duty of good faith, it is assumed that the Board members must treat all community members equally, not to do so is a breach of the required duty. This duty applies to any Board decision: smaller issues like painting and parking to much larger ones like construction requests and property assignments.
Prudent Boards will have express, written procedures to address requests (and hopefully abide by the procedures) so that even the appearance of impropriety is avoided. If a pending matter before the Board implicates a business or personal relationship, it is most prudent for the affected Board member to not participate in the given decision.
Different procedures for different folks will undoubtedly lead to suspicions of unfair dealings, and if not adequately addressed, could lead to a suit for a breach of fiduciary duty.
We hope that with our discussion today, homeowners have a firmer idea of the fiduciary duties owed to the community by a homeowners’ association and the types of scenarios that one may bring legal action against a Board, if necessary. Thanks for reading.