Applying the Business Judgment Rule Individual Tort Liability for Co-op & Condo Boards

Applying the Business Judgment Rule

 Recently, the Appellate Division First Department, in Fletcher v. Dakota, Inc.,  involving a shareholder in The Dakota, a historic luxury co-op on the Upper  West Side, held that the business judgment rule does not protect individual  condo and co-op board members from personal tort liability where a board acting  in its corporate capacity has acted in bad faith, but where it is not alleged  that defendant board members have committed a tort independent of the tort  committed by the board itself.  

 Following the Business Judgment Rule

 The Business Judgment Rule, a court-created rule that pre-dates cooperative  corporations themselves, is a common-law doctrine by which courts exercise  restraint and defer to good faith decisions made by boards of directors in  business settings. The origin of the Business Judgment Rule derives from  Section 717 of the Business Corporation Law (BCL), which states that “a director shall perform his duties as a director… in good faith and with that degree of care which an ordinarily prudent person  in a like position would use under similar circumstances.”  

 As the Court explained, “although participation in a breach of contract will typically not give rise to  individual director liability, the participation of an individual director in a  corporation’s tort is sufficient to give rise to individual liability.” In so deciding, the First Department expressly overruled its prior decision in  Pelton v. 77 Park Ave. Condominium, which had held to the contrary. The Court  said it wanted to “clear up an element of possible confusion in this area of law that may arise out  of [the Pelton decision].”  

 In doing so, the First Department brought its interpretation of the business  judgment rule, as applied to condo and co-op boards, into alignment with its  rulings in cases involving business corporations. The Court noted that “it has long been held by this Court that ‘a corporate officer who participates in the commission of a tort may be held  individually liable, . . . regardless of whether the corporate veil is pierced,” that “[i]n actions for fraud, corporate officers and directors may be held  individually liable if they participated in or had knowledge of the fraud, even  if they did not stand to gain personally,” and that “officers, directors and agents of a corporation are jointly and severally liable  for torts committed on behalf of a corporation and the fact that they also  acted on behalf of the corporation does not relieve them from personal  liability.”  

 Equal Treatment of All

 Interestingly, in Stalker v. Stewart Tenants Corp., a decision rendered just  three months before Fletcher, a separate First Department panel held that the  plaintiffs’ complaint stated causes of action for housing discrimination against the  corporate defendant, but that the individual board members who had approved the  discriminatory acts of the corporation were not themselves subject to personal  liability. The Stalker Court stated: “Although allegations of unequal treatment of shareholders may be sufficient to  overcome the protection afforded directors under the business judgment rule  [for purposes of “board” liability], individual directors may not be subject to liability absent  allegations that they committed separate tortious acts.” Interestingly, since this decision was from a completely different group of  Appellate Division judges, this decision could have an effect on how much  credence the Fletcher decision receives.  

 If this decision fails to be spurned by the Court of Appeals and its progeny of  cases protecting board members by applying the business judgment rule, the  decision will necessarily impact condo and co-op board membership in three  ways: first, it will have a chilling effect on the willingness of qualified  persons to volunteer to sit on these boards without compensation; second, it  will permit individual board members to be personally liable for torts  committed in their official capacity even though they believe they acted in  good faith within the limits of their board authority; and, as discussed below,  board members will have to serve at risk of incurring the costs to defend  themselves, from charges of unlawful discriminatory acts or other bad faith  conduct, without the protection of insurance.  

 Discriminatory Actions?

 The plaintiff in Fletcher, an African-American resident shareholder of The  Dakota co-op in Manhattan, had applied for board approval to purchase an  apartment adjacent to one he owns for the purpose of combining the two  apartments. The board refused to approve the purchase, and the plaintiff  alleged that, in refusing its approval, The Dakota and two of its directors had  discriminated against him on the basis of race. The defendant directors  contended that the discrimination claims should be dismissed against them  because the complaint failed to allege that they had engaged in any acts  separate and distinct from actions they took as board members. In response, the  Court stated that “there is no principle of corporate law that director liability arises only where  the director commits a tort independent of the tort committed by the  corporation itself.”  

 Although the Fletcher Court intended to address the confusion it perceived in  condo/co-op law, the decision raises new questions concerning the scope of  board insurance coverage. Will carriers provide insurance protection to  individual board members accused of wrongdoing when acting as “the board,” and will condo and co-op apartment owners readily volunteer to sit on boards  whereby they will not only have increased exposure to potential personal tort  liability, but whereby they may also incur personal responsibility for the  legal costs of defending “board” action they honestly believed was rendered honestly and in good faith? Only  time will tell.      

 Adam Leitman Bailey is the founding partner of Adam Leitman Bailey, P.C. John M.  Desiderio, the chair of the firm’s Real Estate Litigation Group and Colin E. Kaufman, another firm partner,  contributed to this article.


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