The Business Judgment Rule is Touched by an Angel

Published on: January 17, 2001

Over the years, the business judgment rule has protected the actions of community association board members. Although various states have given the business judgment rule different standards towards its application, in essence the business judgment rule requires that in the absence of fraud or lack of good faith in a conduct of a community association’s internal affairs, the courts will not second guess the decisions of a board. Obviously, fraud, self-dealing or unconsciousable conduct will justify judicial review. Certain courts through time have inserted a test of reasonableness as well starting as early as 1975 with the Florida decision in Hidden Harbour Estates v. Norman where the court upheld a rule prohibiting the use of alcoholic beverages in the clubhouse and adjacent areas. The court reasoned that the facilities involved were common to all unit owners and thus necessitated their relinquishing a certain degree of freedom of choice which they might otherwise enjoy with separate, privately owned property. This result was necessary to promote the health, happiness and peace of mind to the majority of the unit owners and therefore, the court held that any rule which the association adopted had to have some relation to these objectives. Since the rule under consideration met these goals, the rule was upheld as being reasonable. In 1994, the California Supreme Court in Nahrstedt v. Lakeside Village Condominium Association, Inc. upheld a restriction against keeping cats, dogs and other animals in the condominium. The owner asserted that the restriction was unreasonable as applied to her case because she kept her three cats indoors and her cats were noiseless and created no nuisance. In applying Civil Code §1354, the Supreme Court of California stated that the test of reasonableness was not whether the restriction was reasonable in the particular circumstances, but whether the restriction as applied to the condominium in general is reasonable. Since a pet restriction in general was deemed to be reasonable, the Supreme Court of California upheld the restriction. The court stated that it had no ability to question the wisdom of the restriction and must enforce the restriction unless the challenger can show that the restriction is unreasonable because it is arbitrary, violates a fundamental public policy, or imposes burdens on the use of the affected property that substantially outweigh the restriction’s benefits.

However, the Supreme Court of Washington in the decision, dated April 10, 1997, in the case of Riss v. Angel may have established a standard of review which, if adopted by other jurisdictions, could change forever the landscape of the business judgment rule. In Riss v. Angel lot owners brought action against the board and homeowners challenging rejection of the lot owner’s plan to build a new dwelling despite the fact that the board and the homeowners had the ability under the covenants, conditions and restrictions to approve the architectural standards for new homes in the community. In this case, the board in a decision ratified by the requisite percentage of other homeowners rejected the lot owner’s building program pursuant to its right to consent to construction covenants. The court found that the decision of the board was unreasonable and arbitrary, as the proposed structure complied with the covenant requirements for minimum size and setoff of the maximum roof height, the homeowner’s association did not make any objective comparisons for existing homes comparing size and height, and the association board presented inaccurate and misleading information to homeowners regarding the structure prior to obtaining the vote. Although the court determined that under the business judgment rule the court should not substitute its judgment for that of the board, particularly where consent to the construction covenant forms its decision based upon standard such as aesthetics in a neighborhood, that in this case the decision of the Board of the unit owners ratifying the decision were unreasonable and, therefore, the decision would not be protected by the business judgment rule.

What is striking in this decision is that the damages incurred by the lot owner, which amounted to approximately $200,000.00, were found to be the joint and several liability of the board and those members of the homeowner’s association who participated in or ratified the unreasonable and arbitrary decision to reject the plan. The court found that under agency law, the board was in effect acting as the agents of the homeowners and, therefore, not only was the potential for board liability but each unit owner who ratified the rejection was also personally liable.

The ramifications of the decision of the Supreme Court of Washington are somewhat startling since it appears to be the first time that the highest court of any state has found that not only could there be personal liability of the board members for acting unreasonable but that those voting in favor of the decision of the board would also be personally liable. Philosophically, the discouragement of owner participation in a community association’s decisions is a dangerous one at best when obtaining quorums or even getting volunteer board members to run for community association boards has become increasingly difficult over the years. In addition, it would appear that unit owners and community associations must rely to a great degree upon the research done by its duly elected volunteer board and the property manager and other professionals. It would seem that at least in Washington, one would be reluctant as a unit owner subsequent to this decision to participate in the process at all since it appears that the court was punishing those who participated in the process and rewarding those who did not participate at all in the operation of the association. In the meantime, the best hope for all is that the remainder of the states continue to use the standards they developed for enforcement of the business judgment rule and that these states do not expand the unenforceability of same to the extent that not only may a court determine that a board is personally liable because it acted unreasonably but that the unit owners who participate in the process bear the same level of personal liability. If the standards annunciated by the Supreme Court of Washington are followed by other jurisdictions, the owners of community association units and future owners will be hampered dramatically by the outcome in this case.