The Business Judgment Rule provides protections from liability to board
members who are acting in the best interest of the association. To maintain
the protections offered by the Business Judgment Rule board members must
act in good faith, with due diligence, and after reasonable investigation.
Most, if not all associations, which are represented by legal counsel,
have been informed by counsel of this rule of law. It can be a powerful
protection. To meet the requirements of the Business Judgment Rule, board
members need to receive multiple bids on large projects, keep informed
on association finances, understand the governing documents, and discuss
issues with the appropriate professionals before taking action on behalf
of the association.
The typical example of the application of the Business Judgment Rule is
Lamden v. La Jolla Shores Clubdominium Homeowners Association. In this case, a board decided to spot treat termites rather than fumigate. The decision was made after consulting with an exterminator and weighing
other issues and concerns related to the association and homeowners. The association ultimately decided not to fumigate after considering “concerns
about the cost of fumigation, logistical problems with temporarily relocating
residents, concern that fumigation residue could affect residents'
health and safety, awareness that upcoming walkway renovations would include
replacement of damaged areas, pet moving expenses, anticipated breakage
by the termite company, lost rental income and the likelihood that termite
infestation would recur even if primary treatment were utilized.”
When a homeowner later sued, the court found the board was protected by
the Business Judgment Rule as the board acted in good faith, after reasonable
investigation, and in a manner it believed to be in the best interest
of its members and the association. Additionally, it was within the board’s authority to make such repairs
and determine the manner in which the repairs would be made.
When, however, does the Rule not apply?
Palm Springs Villas II Homeowners Association, Inc. v. Parth provides one example. In this case, the board president, over a series
of years, entered a roofing repair contract with one company while paying
another (much more than the project was worth), signed promissory notes
secured by association assets without member approval, entered a contract
for landscaping with a term of 5 years, hired new management and entered
an agreement with a security company without proper board action.
The court found there were facts indicating that the president should not
be protected by the Business Judgment Rule. The president did not obtain multiple bids for the roofing contract and
the board paid a different company for roofing work, which was, furthermore,
defective. She signed loans securing association assets without making an effort
to inquire as to her authority to do so. She was ignorant of the CC&Rs and remained ignorant while taking action
outside of her authority. She completed no reasonable investigation before
Failing to understand or seek counsel to understand the governing documents
and failing to make reasonable inquiry may be enough to remove the protections
of the Business Judgment Rule.
It is important for boards to understand their governing documents. When
the board has a question about the governing documents it should reach
out to legal counsel and ask for a legal opinion. When there is a maintenance
project—whether landscaping, roofing, walkways, etc.—the board
should reach out to the proper professional for the project and obtain
multiple bids before proceeding with any action. Taking these steps will
properly inform the board as to what needs to be done to make the necessary
repairs and the expected costs for such repairs. The board can then make
an informed decision that it feels addresses the issue in the best interest
of the members and association. Following the proper procedures and taking
the right precautions may protect the board in the future.
Lamden v. La Jolla Shores Clubdominium Homeowners Association (1999) 21 Cal.4th 1999, *254.
Palm Springs Villas II Homeowners Association, Inc. v. Parth (2016) 2016 WL 3437593, *2-4.