Fiduciary Duty What Boards & Residents Should Know

Fiduciary Duty

 Being elected to the board of directors of a co-op or condo comes with a great  deal of power, and with that power also comes a great deal of responsibility. Whether they serve a co-op or condo community, board members, in their position  of power, have a responsibility to govern and make decisions on behalf of that  community—often referred to as the board's “fiduciary duty.” Decisions made on behalf of their fellow residents must be made in good faith,  with the best interests of the community firmly in mind, and violating this  duty can lead to legal consequences for boards and individual board members who  stray.  

 Fiduciary Duty in a Nutshell

 The fiduciary duty in the co-op and condo board context arises out of the  special relationship that exists between directors of co-op and condo boards  and the shareholders and unit owners who place their trust in these directors.  A fiduciary relationship can be formed in other types of relationships such as  attorney/client, broker/client, or even clergyman/congregation member.  

 The fiduciary duty is similar to the duties described in New York’s Business Corporation Law (BCL) section 717, which states that directors of a  corporation must perform their duties "in good faith and with that degree of  care which an ordinary prudent person in a like position would use under  similar circumstances."  

 “A fiduciary duty arises when one person places his trust in another person and  as a result of that act of faith, another person gains a position of power and  influence such that he is in the position to hurt the person who places faith  in him,” says attorney Bruce Cholst, a partner with the Manhattan-based law firm of  Rosen Livingston & Cholst LLP. “At that point, he has a special legal obligation, which would not otherwise have  existed but for the fiduciary duty, to refrain from doing anything that  violates his fiduciary’s interest.”  

 As defined by the New York courts long ago in 1928, the conduct of a board  member (a fiduciary) is held to a high moral standard: “something stricter than the morals of the marketplace. Not honesty alone but the  punctilio of an honor the most sensitive is then the standard of behavior...”  

 In more practical terms, “The simplest definition of a fiduciary is one that holds property for another,” explains Steven Wagner, a partner at Manhattan-based Wagner Davis P.C. And,  Wagner continues, “as such that person has an obligation that is greater than just the common  market to do whatever they wish, but they have an obligation to act in good  faith, with undivided loyalty, and in accordance with the obligations and  limitations set forth in the governing documents of their co-op and generally  with the law.”  

 The concept is the same for both co-op and condo boards: A fiduciary, in the  context of condominium management, is "one who transacts business, or who  handles money or property, which is not his [or her] own or for his [or her]  own benefit, but for the benefit of another person, as to whom he [or she]  stands in a relation implying and necessitating great confidence and trust on  the one part and a high degree of good faith on the other part." (Board of Mgrs. of Fairways at N. Hills Condominium v Fairway at N. Hills).

 Thus, the fiduciary duty in the co-op and condo board context illustrates the  special responsibility that board members have, given their position of  influence over the property and lives of the shareholders and unit owners. The  act of faith shareholders and unit owners place in board members is represented  by their votes and proxies for board members at the annual meeting, explains  Cholst. With that act of faith, shareholders and unit owners trust that board  members will look after their best interests and refrain from abusing their  power.  

 Breaching Your Fiduciary Duty

 So what exactly does it look like when a board member breaches their fiduciary  duty? A great majority of the time, the business judgment rule protects most board  action taken in good faith. “So long as the board acts for the purposes of the cooperative, within the scope  of its authority and in good faith, courts will not substitute their judgment  for the board's,” explains the New York court in the seminal case of Levandusky v. One Fifth Ave. Apt. Corp.“Stated somewhat differently, unless a resident challenging the board's action is  able to demonstrate a breach of this duty, judicial review is not available.”  

 That said, according to Cholst, real-life breaches of fiduciary duty really just  boil down to abuses of power. From his practice, he has seen that potential  breaches of fiduciary duty fall into three categories: self-dealing, exercising  of personal vendettas, and selective enforcement of policy.  

 Self-dealing.Self-dealing occurs when board members obtain a personal advantage from their  position on the board, and take an opportunity, no matter how big or small,  that should have lawfully been available to the shareholders or unit owners of  the co-op or condo. “The failure of a board member to subordinate his personal interests to those of  the association or its constituent shareholders and unit owners is called  self-dealing,” explains Cholst.  

 The most obvious case of self-dealing is when a board member steals money from  the co-op or condo’s reserve fund. However, self-dealing is often more subtle than outright theft.  Stephen M. Lasser, a partner at the Manhattan law firm Barton LLP, has  encountered “outgoing board members who have sold their apartments and excused themselves  from paying a flip-tax or a board member attempting to purchase a foreclosed  apartment at a discounted price at auction, thereby depriving his or her co-op  or condo of the opportunity to purchase the apartment and make a profit.”  

 Similarly, “The case of Bernheim v. 136 East 64th Street Corporation presents a classic example of alleged self-dealing among board members,” says Cholst. “In this instance, several co-op board members were accused of conspiring to  obtain the rejection of a proposed sale so they could acquire the unit for  themselves at a below market price and flip it for a profit.”  

 Wagner has seen cases like Bernheim in his own law practice. He also provides an example of self-dealing on a smaller scale: “A board tried to negotiate with a television station in connection with allowing  them to use some of the building’s property for photographing an event. Each one of the board members got a  beautiful leather jacket with the logo of the television show.” This seemingly small benefit these board members took illustrates how easy it  can be for board members to fall into temptation and abuse their power. Nevertheless, this type of activity constitutes self-dealing, and thus is a  breach of fiduciary duty.  

 Personal vendettas.Another abuse of power and breach of fiduciary duty can occur when an individual  board member treats a shareholder or unit owner unfairly just because the board  member has a personal issue with that person. “Board members have a lot of power to make life miserable for those people, and  when they use it, that too is a form of self-dealing, certainly an abuse of  power, and breach of fiduciary duty,” explains Cholst. Cholst provides the example from his practice of a board member and head of the  alterations committee, who was in an ongoing feud with his neighbor over loud  parties the neighbor had and his refusal to quiet down. That neighbor submitted a request to do an alteration for his apartment, and the  board member persuaded his colleagues to reject the alteration. Since there was  no legitimate reason for the decision other than to indulge the board member’s gripe against his neighbor, the situation illustrates an abuse of power and  breach of fiduciary duty.  

 Selective enforcement.The third kind of breach occurs when a board member plays favorites in enforcing  building rules and regulations. “As a result of having to act in good faith and in a way that’s consistent with those to whom I owe a fiduciary duty as a board member,” says Cholst, “I can’t favor one board member at the expense of another board member. I have to treat  everyone equally.” For example, “if I have a friend who wants to put an enclosure on his terrace, I can’t say ‘yes’ to him and then ‘no’ to somebody else who wants to put the exact same kind of enclosure on the  terrace. I have to enforce the rules consistently and avoid what legally is  called ‘selective enforcement.’ ” Another example of selective enforcement is if the building has a no pet  policy, but a board member looks the other way when a dog comes into the  building belonging to a friend.  

 Consequences

 If a board member is found to have breached his or her fiduciary duty, the  consequences can be severe. “First, the offending board member will be held personally liable in money  damages for all pecuniary losses sustained as a result of his or her  misconduct. Such judgments (and the attendant legal fees) are rarely, if ever,  covered by directors and officer's liability insurance,” explains Cholst. Cholst further explains that “courts are not shy about assessing punitive damages against those board members  who breach this most exacting of moral obligations.” These severe consequences can be avoided if board members educate themselves on  their special responsibilities as fiduciaries and take all necessary  precautions.  

 How Board Members Can Protect Themselves

 The last thing most volunteer board members want to become involved with is a  lawsuit claiming they have breached their fiduciary duty. “Board members are not expected to be experts on all business matters they are  involved with,” says Lasser. “They can discharge their fiduciary duties if they act in good faith and rely on  information, opinions, reports and financial data presented by their  accountants and attorneys.”  

 An example of self-dealing that can be easily avoided is in the context of  interested directors. If a board is selecting to hire a professional such as a  lawyer, accountant, or managing agent or company that offers services such as  security, telecommunications, or interior design, and a board member has an  interest in one of these companies, special precautions must be taken in order  to avoid a breach of fiduciary duty. Section 713 of New York’s Business Corporation Law outlines the situations in which boards can enter  into contracts with companies that directors have a substantial financial  interest in.  

 “An interested director is a director or board member who enters into a  transaction with his or her co-op or condo or who has a personal financial  interest in a transaction involving his or her co-op or condo,” says Lasser. “An interested co-op director or condo board member should always disclose his or  her interest in a transaction to his or her fellow board members. Failure to do  so, may allow the co-op or condo to void the transaction if the interest is  discovered later.”  

 Wagner explains: “Let’s say for example, you sell a product, floor wax, that’s the best product in the world, does that mean that the co-op can’t purchase the floor wax just because you’re on the board? No. As long as you disclose that you are the seller of floor  wax, and that it’s a good product, it’s fairly priced, and you exclude yourself from consideration of whether to buy  the floor wax, then the fact that the board purchases the floor wax does not  mean that you have violated your fiduciary duty.”  

 “Assuming an interested board member discloses his or her interest in a  transaction to his or her fellow board members, the interested director should  recuse himself or herself from any vote to authorize such transaction,” says Lasser. “The voting board members should then vote, keeping in mind their fiduciary duty,  which requires that they act for the benefit of their shareholders or unit  owners and not the personal interest of one of their fellow board members.”  

 Another action boards should take is to be careful about enforcing their rules  consistently, says Cholst.  

 When There’s An Abuse of Power

 If the above examples sound all too familiar, what can you do? Aside from  immediately seeking legal counsel, there are some steps board members,  shareholders, and unit owners can take. In order to do your research, check the  bylaws to find out what remedies you may have. Obtaining copies of the minutes  of board meetings may be helpful in finding information on the board’s conduct. If a resident finds facts (actions made in bad faith) that they  believe are sufficient to constitute a breach of fiduciary duty, he or she can  put the board on notice of the alleged breach, and request that the particular  decision not be enforced. If the board is unresponsive to these requests, the  resident should consult a lawyer to explore the possibility of obtaining a  court-ordered injunction, to prevent the questionable rule from being enforced  or the transaction from happening.      

 Elizabeth I. Robbins, Esq. is an attorney admitted in New York and a freelance  writer for The Cooperator.

 

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