The Director’s Duty of Loyalty Is Important but Often Misunderstood

Published on: January 28, 2006

The Pledge of Allegiance (to the United States flag) remains a morning ritual for students in many classrooms throughout the country. While there is no comparable public oath recited by the volunteers elected to the boards of their homeowner associations, association directors do make a formal, if silent, promise to execute their responsibilities in good faith and to act in the best interests of the communities they serve.

Unlike the pledge of allegiance, which often has little significance to the students who mumble its words, the directors’ pledge — known broadly as their “fiduciary duty”— is a legal concept as well as a personal commitment. It defines standards of behavior and creates potential legal liability for directors who fail to meet those standards.

Fiduciary duty actually encompasses two separate obligations:

  • A duty of care, requiring directors to exercise good judgment and make sound business decisions on the community’s behalf; and
  • A duty of loyalty, requiring directors to act in good faith, putting the association’s interests ahead of their own.

Of the two, the duty of loyalty is probably the most often understood, because the obligations it imposes are not always entirely clear.

No Special Treatment

The obligation to act in the best interests of the association certainly seems straightforward enough, and sometimes it is. Directors would clearly violate their duty of loyalty if they used the community’s funds to finance personal expenditures —purchasing furniture, equipment, or services for their own homes, for example. Directors also would violate this duty if they approved association-financed repairs, such as exterior painting, for their own homes, while deferring that work on other buildings in the community, or if they regularly violated rules the board enforced strictly against other owners. The duty of loyalty prevents directors from approving or allowing special treatment for themselves and requires them always to put the association’s interests first.

Following that dictate, it would seem that a board member who has lost his /her job should vote to approve a special assessment needed to fund the replacement or repair of a leaking roof, even though that director will be hard-pressed to pay the bill. But not necessarily. What if this director votes against the special assessment because he/she knows it would create a financial hardship for many other residents and wants to encourage the board to consider other alternatives, such as obtaining a bank loan to finance the repair? The director is arguably acting in the interests of other owners as well as his or her own.

Respecting the Process

On the other hand, a director who votes to approve an owner’s request to install a swing set (in violation of the community’s architectural standards) because the director plans to seek a similar waiver, would be promoting a personal rather than a community interest. If the director knows that other owners have children and are likely to want similar equipment, the vote might be cast in a more positive light, but not quite positive enough. The duty of loyalty also includes a commitment to enforce the association’s rules. In important respects, the duty of loyalty is about respecting the governing process. The director in this example should use the political process to revise the rules instead of voting to waive them on an ad hoc basis.

Inherent in the director’s duty of loyalty is an obligation not to benefit at the association’s expense. This does not mean directors may not benefit at all from their decisions, however; directors will necessarily enjoy the same benefits as other owners and should share the same obligations. But they should not use their position to obtain benefits that are denied to other owners or that impose additional burdens (financial or otherwise) on them.

Steering contracts for construction work to a company a director owns or in which the director (or members of the director’s family) have a financial interest would seem on its face to violate the director’s duty of loyalty to the association. But what if the director’s company offers the best deal for the community — quality work at a discounted price? Must the association reject the contract or the director refrain from bidding on it, simply because the director would benefit from the arrangement?

Conflicts of Interest

Common sense and the law suggest otherwise. The duty of loyalty requires directors to minimize conflicts of interest and to disclose them, but not necessarily to avoid them. In this example, as long as the director discloses his interest in the construction company and the other directors conclude that the contract is in the community’s best interest, then the director with the conflict and the other board members have fulfilled their duty of loyalty and their fiduciary duty to the community. They have made, or attempted to make, a sound business decision based on their assessment of what is best for the community. The community and the director who owns the construction company will both benefit from the decision, but the director will not benefit at the community’s expense.

Usually, the duty of loyalty requires directors to separate their interests from the community’s, but sometimes the problem is determining where the association’s interests lie. California lawmakers, who don’t much trust homeowners associations, recently amended a state law establishing the right of owners to inspect association books and records, by detailing more than 20 specific types of documents owners are allowed to see. If I’m on the board of a California association, am I disloyal if I interpret this law restrictively because of the cost to the association of locating and retrieving the voluminous records owners might now demand to see? Or am I disloyal if, by restricting access, I invite law suits the association will have to defend?

I don’t know the answer, but I suspect the issue will arise soon for many California boards. The best advice for directors is to develop a clear policy, document the reasons for it, and make sure you can demonstrate that whatever policy you adopt was motivated by an effort to protect the association’s interests, as the board defined them.

A Duty for Owners?

Some industry observers have suggested that the obligation to put the association’s interests first should apply to all members of a common interest ownership community and not just to members of the board — a nice idea in theory, but impractical, and faintly horrifying, in practice. Consider the prospect of Owner ‘A’ suing Owner ‘B’ for failing to consider the “common” interest, by voting against a policy supported by Owner A. Now consider the likelihood that Owners C through Z will file similar suits against each other on every other disputed vote in the community.

Owners can vote as they please for any reason – because they dislike their neighbors, because they like children or don’t like them, because they are concerned about the community’s interests, or because they are concerned only about their own. The directors responsible for governing the association must adopt a broader view, encompassing the needs of the entire community and the collective interests of its residents.

This does not mean that directors are required to embrace a kind of communal group-think and abandon ideas of their own. Disgruntled owners often criticize board members for having an “agenda,” as if an agenda is somehow synonymous with self-interest or self-dealing. In fact, most owners who volunteer to serve on the board do so because they have in mind policies they want to support, oppose, or amend.

All things considered, it is probably better for owners to have some idea of what they want to accomplish on the board than not. There is nothing wrong with a board member having an “agenda” as long as it is an agenda for supporting the community collectively and not for profiting the board member individually. Besides, the agendas owners have in mind when they run for the board often change dramatically or disappear entirely after they are elected, when they begin to view their association from a director’s perspective, and against the backdrop of the duty of loyalty that directors pledge