Preventing a Mutiny

Boards sometimes think the business judgment rule is a safety bubble, that pretty much anything they do is protected. But it’s not fail-safe, and there are nuances they need to be aware of.

Exceptions to the rule. The business judgment rule states that courts cannot overrule board policy no matter how strongly a judge may disagree with it as long as it 1) is consistent with the governing documents, 2) complies with the law, 3) furthers a legitimate corporate purpose and 4) doesn’t violate the board’s fiduciary duty. That’s an easy test to pass. But there is a fifth area where boards have to tread carefully — making a decision so unpopular that owners rise up and revolt.  

Cautionary tale. I worked on a case in Suffolk County where a homeowners association board passed a rule banning the use of pickup trucks anywhere on the community property on the grounds that they were downscale and contrary to the upscale image it was trying to promote. The owners sued, but the court upheld the policy on the grounds of the business judgment rule. The judge, who was opposed to the policy, noted that the owners had political remedies, and they picked up on the hint. They staged a proxy fight at the next annual meeting, threw out the entire board and voted in a new one that repealed the ban. 

Letter of the law. You could look at the board’s ban as classist and discriminatory. But as long as actions taken by a board steer clear of the 19 protected categories — and classism isn’t one of them — the discrimination is not illegal. So the court’s ruling wasn’t surprising. Still, boards need to think hard before making decisions that may fall within the exceptions protected by the business judgment rule but are way out of line from the pulse of their community. That kind of mistake could boomerang and come back to bite you — with very severe consequences.