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Condo/Co-op Help Line: Eroding of the Business Judgment Rule

Mann Report: Management - August 2016

By: Carol A. Sigmond

Over the years, members of boards of directors for condominiums and cooperative apartment buildings have come to believe that the business judgment rule articulated in Levandusky v. One Fifth Ave. Apt. Corp., 75 N.Y.2d 530, 540 (1990) provides what amounts to a safe harbor in decision making. That safe harbor is eroding. The business judgment rule will not protect board members who 1) violate the declaration and either the bylaws or the proprietary lease or 2) rely reflexively on passed practice.

The safe harbor granted by Levandusky is limited to board members who act in good faith and "exercise honest judgment in the lawful and legitimate furtherance of corporate purposes." Levandusky, 75 N.Y. 2d at 537-8. There was a caveat on this safe harbor: decisions made in an arbitrary fashion, for malicious reasons or based on favoritism or discrimination, would not be sustained under the business judgment rule. 40 West 67th St. v. Pullman, 100 N.Y.2d 147, 157 (2003). In Fletcher v. The Dakota, Inc., 99 A.D.3d 43 (1st Dept. 2012), the First Department made clear that the safe harbor of the business judgment rule would not protect directors who commit torts, such as engaging in racial bias.

The practical effects of these decisions are beginning to be felt. Many claims against board members have been dismissed over the years. But in Maxi Cohen v. CASSM Realty, et al., Index No. 105460/2011 (Supreme NY Cty, February 19, 2016) the trial court granted motions for summary judgment and partial summary judgment for breach of fiduciary duty against a cooperative board of managers for damages based on prolonged failure to repair a leaking roof and roof parapets as well as to remediate structurally unsound roof beams based on violations of the proprietary lease and bylaws. In Cohen, the responsible officers are not fully shielded in this matter, and face liability at trial for tort. In Kaplan v. Park South Tenants Corp., 20154 WL 1092445 (N.Y. Sup.), a board denied the right to install an air conditioning unit and relocate a telephone conduit in an owner's unit. There, the trial court granted the unit owner summary judgment, rejecting the old board standby "what if everybody wants to...." The trial court examined the record and found the board's examination of the facts and evidence to be wanting.

Both cases illustrate that boards of directors do not have the Godlike powers many have assumed. Boards and managing agents are bound by the organizing documents as well as by the specific facts and circumstances presented. In order to demonstrate sound decision making, board members actually need to review the facts and circumstances presented as well as any relevant documents. Decisions must reflect the exercise of judgment, nor a reflexive "no." The process of decision making should be carefully and accurately documented, so that later review will show a businesslike operation of the board.

That said, nothing will save a board or board members who engage in racial, religious, ethnic, or gender bias (to include bias based on orientation). Bias will be found to be an independent tort. Likewise, decisions based on retaliation, favoritism, hostility or jealousy will not be shielded.

Finally, decisions that directly contravene the governing documents also will not survive. Board members in that situation risk a finding that they have committed an independent tort, such as bias, in those situations.

Out of this grow bright-line rules: Bias, retaliation, friendship, favoritism, hostility or jealousy will not shield a decision from review. Decisions that violate the governing documents will not survive. Both of these situations may lead to liability for affected directors based on an independent tort. Decisions not based on a searching review of the documents, circumstances and facts are also at risk. Board membership is a privilege that entails duties and responsibilities to the building as a whole, not to some subset of the building or for the personal gratification of a board member. Board members would do well to remember that at all times.

This column presents a general discussion and is not intended to provide legal advice. You should consult your attorney for specific legal advice.

This article was originally published by Mann Report: Management. You can access the article on their website.