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.
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.