Many co-op and condo boards sleep well at night because of the business judgment rule, which can shield boards from second-guessing and legal challenges. But those protections have their limits.
The business judgment rule essentially says that so long as the board is acting for the purposes of the cooperative or the condominium as a whole, within the scope of its authority and in good faith, the courts will uphold a board’s decision. The types of cases where the business judgment rule does not protect a board’s actions are where boards or individual board members are accused of discriminatory conduct or acting outside of their authority because they are not following the requirements of a co-op’s proprietary lease or a condominium’s bylaws.
You’re involved in an interesting case at a Sunset Park condo that’s now winding its way through the courts. Can you tell us about that?
That’s One Sunset Park, where the unit-owners have brought a lawsuit against the condo board, claiming that it acted outside the scope of its authority by failing to obtain sufficient insurance to protect the building. The building was destroyed by fire. The unit-owners and their counsel reviewed the governing documents and found that the bylaws required the board to obtain insurance equal to at least 80% of the replacement value of the building. Professionals were called in to calculate the projected new construction costs to rebuild the property, and that was in the ballpark of $25 million. OK, 80% of that is $20 million, and the board had only procured insurance in the amount of $13.7 million, leaving a shortfall of over $6 million. The board is being sued for breach of contract because it failed to follow the condo’s organizing documents, and the business judgment rule should not protect it.
The condo board is claiming that the amount of insurance was adequate for the building at the time of construction, but board members obviously didn’t factor in the added costs over the years of maintaining the building. Is that part of the problem here?
Every time a board buys insurance for a building, it has to look at the building’s value at the time. Insurance is generally purchased annually, sometimes for three-year periods, and the board should be working together with its insurance brokers and with appraisers so that it acquires insurance that meets the minimum criteria set forth in the bylaws. That’s an area where the board here may have misstepped.
Are there any other notable cases where the business judgment rule did not protect the board?
Well, I think one of the leading cases is Fletcher v. Dakota Inc., where Fletcher, a board member who was African American, had differences of opinion from time to time with other members of the board. When he tried to buy an apartment that was next to his, the board rejected his application. He claimed that the board members’ rejection was based on their antipathy to him and that they discriminated against him as an African American. He sued the board, which tried to defend itself by saying the decision was made in the interests of all of the shareholders. But the court said that once discrimination is alleged, it would not allow the business judgment rule to be a protective device. The court avoided looking into the facts and determining whether there was in fact discrimination. So that’s a very telling case.
Does a simple allegation of discrimination automatically mean that plaintiffs will prevail?
Unfortunately, an allegation that is supported by some facts and not just a bold conclusory statement of discrimination would be sufficient to get a board outside of the protections of the business judgment rule. The board probably could have protected itself by approving the application, because if you look at all the history of the disputes that Fletcher had with other board members, there were enough facts to support a discrimination claim to allow the case to go forward.
What’s the takeaway?
Boards have to know what their documents require. I recommend boards consult with their counsel when they’re going to be making decisions. That way they can be assured that upon review the decision will be found to be in the best interests of the co-op or condo, that it’s made within their authority, that it’s done in good faith and that there’s no discrimination or singling out of an individual for adverse consequences compared to others in the building.
WHO’S SUING WHOM
Business Judgment Rule Protects Individual Board Members Who Called Special Meeting
Two sets of bylaws were recorded for a condominium. Although the bylaws required maintenance to be assessed based on the percentage of ownership of the common interest, there was a discrepancy in the bylaws that affected one of the owners. The board refunded the amount in question, which was $2,867.76, and also called a special meeting to resolve the discrepancy. Eighty-two percent of the unit-owners approved. The affected owner was displeased and commenced an action. The individual board members moved to dismiss the complaint on the grounds that they were protected by the business judgment rule. The motion was granted.
72 Poplar Townhouse LLC v. Bd. of Managers of 72 Poplar St. Condo
March 1, 2021