The first question that Board members usually ask is – what is fiduciary duty?
The Merriam-Webster Dictionary defines fiduciary duty as follows:
“A duty obligating a fiduciary (as an agent or trustee) to act with loyalty and honesty and in a manner consistent with the best interests of the beneficiary of the fiduciary relationship (as a principal or trust beneficiary).”
There are various duties associated with fiduciary duty, and depending on the jurisdiction these duties may include:
Duty of Care;
Duty of Loyalty;
Duty of Confidentiality;
Duty to Act Within Scope of Authority;
Duty of Good Faith;
Duty of Prudence; and
Duty of Disclosure.
How does fiduciary duty apply to community associations?
In the context of a community association, a fiduciary duty entails the duty that a Board of Directors (and/or a member thereof) owes the Association (which is typically a non-profit corporation). The Board has a fiduciary duty to act in the best interests of the Association with every decision that it makes.
What standard of review do the courts utilize as it relates to fiduciary duty?
Courts in most jurisdictions utilize some form of the “business judgment rule” (BJR) as it relates to fiduciary duty issues. Under the BJR, board members must make decisions within the scope of their given authority, in good faith, using ordinary care and in the best interest of the Association.
Under the BJR, courts do not substitute their judgment for that of the board of directors and will not interfere with the internal management of the Association unless the acts complained of constitute fraud, bad faith or gross mismanagement, or are unlawful. Kelso Woods v. Swanson, 692 A.2d 1132 (Pa. Cmwlth. 1997), Mulrine v. Pocono Highland Community Association, 616 A.2d 188 (Pa. Cmwlth. 1992).
In order to establish a cause of action for breach of fiduciary duty against an association for actions taken by its board members under the BJR, the party complaining must allege facts which would establish that the actions of the board members were unauthorized, or that the actions had been taken fraudulently, in bad faith, or constituted self-dealing. Lyman v. Boonin, 635 A.2d 1029 (Pa. 1993).
In Pennsylvania, the Non-Profit Corporation Law of 1988, 15 Pa.C.S. § 5101 et seq. (NPCL), addresses the standard of care related to board members of non-profit corporations, which include Associations:
§ 5712. Standard of care and justifiable reliance.
(a) Directors. — A director of a nonprofit corporation shall stand in a fiduciary relation to the corporation and shall perform his duties as a director, including his duties as a member of any committee of the board upon which he may serve, in good faith, in a manner he reasonably believes to be in the best interests of the corporation and with such care, including reasonable inquiry, skill and diligence, as a person of ordinary prudence would use under similar circumstances. In performing his duties, a director shall be entitled to rely in good faith on information, opinions, reports or statements, including financial statements and other financial data, in each case prepared or presented by any of the following:
One or more officers or employees of the corporation whom the director reasonably believes to be reliable and competent in the matters presented.
Counsel, public accountants or other persons as to matters which the director reasonably believes to be within the professional or expert competence of such person.
A committee of the board upon which he does not serve, duly designated in accordance with law, as to matters within its designated authority, which committee the director reasonably believes to merit confidence.
(b) Effect of actual knowledge.–A director shall not be considered to be acting in good faith if he has knowledge concerning the matter in question that would cause his reliance to be unwarranted.
(c) Officers.–Except as otherwise provided in the bylaws, an officer shall perform his duties as an officer in good faith, in a manner he reasonably believes to be in the best interests of the corporation and with such care, including reasonable inquiry, skill and diligence, as a person of ordinary prudence would use under similar circumstances. A person who so performs his duties shall not be liable by reason of having been an officer of the corporation.
15 Pa.C.S. § 5712.
The NPCL also speaks to the personal liability of directors:
§ 5713. Personal liability of directors.
General rule.–If a bylaw adopted by the members of a nonprofit corporation so provides, a director shall not be personally liable, as such, for monetary damages for any action taken unless:
The director has breached or failed to perform the duties of his office under this subchapter; and
The breach or failure to perform constitutes self-dealing, willful misconduct or recklessness.
Common Interest Community Statutes — In Pennsylvania, pursuant to both the Uniform Condominium Act, 68 Pa. C.S. § 3101 et seq. and the Uniform Planned Community Act, 68 Pa.C.S. § 5101 et seq., board members stand in a fiduciary relation to the association and shall perform their duties, including duties as members of any committee of the board upon which they may serve, in good faith in a manner they reasonably believe to be in the best interests of the association. See 68 Pa.C.S. § 3303(a) and § 5303(a). Under the Pennsylvania Uniform Acts, Judicial review of board decisions is available even when a condominium or HOA was organized prior to the adoption of the Uniform Condominium Act, 68 Pa. C.S. § 3101 et seq. and/or the Uniform Planned Community Act, 68 Pa.C.S. § 5101 et seq.
Finally, a large percentage of community association Bylaws also speak to board members’ responsibilities and duties, and what standard is utilized to determine if a board member has acted appropriately. To wit, many Bylaws provide for indemnification for actions filed against the board and/or its members and specify when indemnity would apply given how a board member is to act on behalf the association (and at times, Bylaws will specify what actions would lead to no indemnification occurring, i.e., self-dealing, failure to act in the best interest of the association, etc.).
Insurance and claims.
Obtaining appropriate insurance to cover potential breach of fiduciary duty claims is critical for every association. Associations should work with insurance professionals that specialize in association matters in order to ensure that the association is receiving the best possible insurance product and coverage available.
As it relates to fiduciary duty claims, these claims can be brought under many legal theories (and for which it appears that the list of such potential legal theories is constantly growing), including:
Use of association property;
Buying/selling property;
Expenditure of association funds;
Hiring/firing;
Vendor and bidding issues;
Staff issues;
Election issues;
Member issues;
Collections disputes;
Operation of the association;
Self-dealing;
“Out of Control” board or board member(s) and Declaratory action(s) to remove;
Maintenance issues;
Design/Architectural issues;
Defamation;
Premises liability issues for an alleged failure to maintain;
Discrimination;
Failure to hold Annual Meeting;
Business decisions – insurance, reserve issues, FHA mortgage approvals; and
Enforcement of covenants/selective enforcement.
Fiduciary duty claims should be submitted to the association’s carrier for review under the association’s Officers (D&O) Liability Coverage. The D&O coverage part is generally drafted to include a myriad of potential claims, coverage for many of which may include a “wrongful act”. Board members must be considered an “insured” under the policy and required that the “insured” be acting in the scope of their capacity as a board member. There are also exclusions, defense cost issues and other issues pertinent to insurance that must be reviewed. The moral of the story is that D&O policies vary tremendously, so it is crucial that the association review their specific policy with its insurance professional in order to clearly understand their policy terms, conditions and exclusions.
Defense of fiduciary duty claims.
Typically, the threshold issue with the defense of breach of fiduciary duty claims is whether the BJR applies. The BJR is applied, in some form, whether through common law or statute, in the vast majority of jurisdictions. Standing to sue will be analyzed, as will the duties owed (i.e., is the duty owed to the association or is it also owed to individual members/owners?), conflicts/potential conflicts of interest, privilege and immunities and other issues like offers of judgment should be considered.
Claims, threats and suits should be submitted to the association’s D&O carrier so the carrier can make a coverage determination. It is important to notify the carrier as soon as possible so a defense can be provided, if applicable. Carriers will often open a file to “monitor” a fiduciary duty claim in the event the claim escalates and so defense to the claim may be provided to the association by the carrier.
Best practices.
How can associations attempt to avoid claims based upon an alleged breach of fiduciary duty? In a nutshell, board members should: (a) act within the scope of their given authority; (b) act in good faith; (c) use ordinary care; (d) act in the best interest of the association; (e) act reasonably with respect to enforcement of covenants and rules and regulations; and (f) act reasonably when making management and business decisions. Of course, each situation a board will face may be different, but at the day, acting reasonably will go a long way to overcome an allegation of a breach of fiduciary duty.
– Edward Hoffman, Jr., Esq., CCAL
* A version of this Blog post was drafted by Edward Hoffman, Jr., Esq., CCAL and originally included in his portion of the written materials for his presentation at CAI’s 2018 Community Association Law Seminar in Palm Springs, CA.
Time flies. Since about 2010, I have been counseling community associations on risks involving potential breaches of personal information and the fact that Pennsylvania has a specific statute related to such breaches, literally called the “Breach of Personal Information Notification Act” (“BPINA”). BPINA was recently amended and signed into law by Governor Wolf on November 3, 2022 (and effective in 180 days).
As a general BPINA primer, community associations qualify as “businesses” under BPINA and are covered “entities” which do business in the Commonwealth of Pennsylvania. BPINA defines “Personal information” as follows:
(1) An individual’s first name or first initial and last name in combination with and linked to any one or more of the following data elements when the data elements are not encrypted or redacted:
(i) Social Security number.
(ii) Driver’s license number or a State identification card number issued in lieu of a driver’s license.
(iii) Financial account number, credit or debit card number, in combination with any required security code, access code or password that would permit access to an individual’s financial account.
(iv) Medical information. (Added as amended on 11/3/22)
(v) Health insurance information. (Added as amended on 11/3/22)
(vi) A user name or e-mail address, in combination with a password or security question and answer that would permit access to an online account. (Added as amended on 11/3/22)
Most community associations do not keep social security numbers, medical information and/or health insurance information (and likely should not be if they are), but many have access to and keep records of driver’s licenses, financial accounts and credit/debit cards. Many also have portals which contain a user name or e-mail address, in combination with a password or security question and answer that would permit access to an online account (usually an association account of some kind). (Note: the last section re: email addresses and login information was added as amended on 11/3/22 so community associations should use due diligence to protect the information and comply with BPINA as amended, even if they were properly handling records of driver’s licenses, financial accounts and credit/debit cards prior to the recent BPINA amendments).
Hopefully any and all of this personal information is being properly handled and kept (maintained) offsite on properly encrypted systems run by third-party providers and/or contactors to attempt to offset and/or limit liability (I note that managing agents also keep this information as well, and there should be similar considerations/protections for maintaining such data).
BPINA has always required notification of the breach of the security of the system, but the November 3, 2022 BPINA amendments added additional notification requirements, including the following new Section 3(a.3):
(a.3) Electronic notification.–In the case of a breach of the security of the system involving personal information for a user name or e-mail address in combination with a password or security question and answer that would permit access to an online account, the entity, to the extent that it has sufficient contact information for the person, may comply with this section by providing the breach of the security of the system notification in electronic or other form that directs the person whose personal information has been materially compromised by the breach of the security of the system to promptly change the person’s password and security question or answer, as applicable or to take other steps appropriate to protect the online account with the entity and other online accounts for which the person whose personal information has been materially compromised by the breach of the security of the system uses the same user name or e-mail address and password or security question or answer.
Accordingly, community associations should be aware of not just the general (preexisting) notification requirements pertinent to a breach of personal information, but associations should also understand how to handle notification involving the breach of the security of the system involving personal information for a user name or e-mail address in combination with a password or security question and answer that would permit access to an online account in accord with BPINA as amended.
Finally, this post was not intended to serve as a discussion of how to properly handle a breach of personal information nor was it intended to be an exhaustive review of BPINA in general and/or as amended; rather, the intent was to notify our community association clients and industry colleagues of changes in the law, so proper due diligence can be undertaken. For some reason lawyers [still] love to use a dead language – Latin – to make their points. Our question is therefore: parati estis? … or, are you ready?
To get ready, we recommend that community associations review BPINA as amended, which can be found here, discuss with their counsel, managing agents, any service providers that handle personal information (especially association software providers), and confirm proper insurance coverage with association insurance professionals. As it relates to insurance, community associations should obtain adequate cyber-liability insurance to offset risk and cover a breach incident (it is noted that the cost of proper notification is tremendous, especially if the breach involves notification to over 1,000 persons at one time (because all consumer credit reporting agencies must also be notified)).
I know, I know… nobody – and I mean – nobody, wants to hear, read, speak or even think about the COVID-19 pandemic now. I get it, we’ve had enough. As a community association attorney and litigator, I’ve certainly dealt with my share of issues related to COVID-19 – virtually anything and everything that could have happened in the communities that my firm represents did happen from March of 2020 until about now. This sadly includes the loss of multiple people in associations that our firm represents.
But what if I were to tell you that community associations actually learned some good things as a direct result of the pandemic? It’s not as crazy as it sounds – let me explain by way of a good old-fashioned Letterman-esque “top-ten” list (of course sans Paul Schaffer and the World’s Most Dangerous Band’s/the CBS Orchestra’s musical interludes). Queue the drum roll please:
Number 10: Community associations can survive a pandemic.
In fact, community associations did survive the pandemic. This is due to the resilience and determination of community association Board Members, Community Managers, vendors, contractors, advisers and community residents. We are in a much different place now than where we were last year at this time, and while much of this is due to the reduction of COVID-19 infection rates, the unwavering efforts of community association leaders must also be acknowledged. Difficult decisions had to be made in every community at the outset of the pandemic and throughout its pendency – whether it was how to handle the economic impact of resident unemployment and the potential non-payment of association assessments/dues, the closure of community facilities such as pools, gyms and recreation areas, the issue of if, when and how to have the required Board and/or Committee meetings and/or association owners’ meetings, whether or not to allow guests onto the property, or looking out for the physical, mental and emotional well-being of residents who were home and literally “in” the community probably more than they ever have been since purchasing their units. Community associations around the country deserve a round of applause.
Number 9: For the most part, community association residents do the right thing when asked.
After the pandemic started, community association leaders were put in a position to act quickly and ask residents to do things they never had to do before, including wearing masks around the community, maintain a “social distance” from one another, not use facilities and amenities that had to be shut down and participate in meetings virtually rather than in-person. Using the communities that my firm represents as a statistical sample, I believe that the vast majority of community association residents were not only cooperative (with rare exception(s), of course), but many of the residents went above and beyond in many different ways. Community association residents will do the right thing when asked, which is a wonderful thing.
Number 8: Even when faced with an emergency situation like a pandemic, most community association residents still pay their assessments/dues on time, or make arrangements to pay.
We learned that despite the impact of the pandemic, the overall delinquency rate in most community associations did not increase substantially. Of course, community association leaders had no way to predict if this, or the opposite, would end up being the outcome.
What we did know is that, not too long after the pandemic started, some community association residents were laid off or even let go from their jobs, and unemployment compensation payments were not immediately sent to these residents. The worst-case scenario would have been that a majority of residents could not pay their community association assessments/dues, which would lead to the community association not being able to pay its staff and/or its vendors for all of the required services that are provided to the residents. Fortunately, this did not happen. In the communities that my firm represents, we actually saw residents reaching out to the Board to make arrangements to pay their assessments, and Boards worked with residents as needed – often times allowing residents to enter into payment plans and not charging late fees and/or interest on any delinquency that started after March or April of 2020.
It therefore appears that while the pandemic had a massive financial impact on the global economy, the overall financial impact of COVID-19 on community associations was not as drastic, at least to date. Let’s hope it stays that way, especially as we move from the dark into the light.
Number 7: Community association leaders were diligent in their efforts to protect residents.
During the pandemic, community association leaders increased their due diligence efforts to a level commensurate with the problem at hand. Rather than ignoring issues or letting the chips fall where they may, Board members and Community Managers engaged in unparalleled levels of communication with all of their trusted vendors and advisers, myself included. The daily Zoom meetings, conference calls and chains of emails resulted in proper due diligence by community leaders on issues related to the pandemic and served to protect the health and safety of residents. We learned that community association leaders decided to tackle, rather than retreat from, the pandemic in order to protect their residents.
Number 6: Common Interest Community statutes need to be updated to allow for electronic voting, the use of electronic proxies and to allow for electronic Board and owners meetings in community associations.
While some state legislatures have already updated their statutes to allow for the use of modern technology for community association voting, proxies and meetings, and these issues were in the process of being legislatively discussed in some jurisdictions, there was no plan to update the statutes in many others. However, as a direct result of the pandemic, we learned that community association leaders and residents want to utilize modern technology for these essential issues and functions in community associations. When there was suddenly no other choice available due to the inability to have in-person meetings, community associations turned to technology to continue to operate, albeit on an emergency basis.
Absent the enactment of statutory amendments to allow for the permanent use of modern technology which would generally apply to all community associations, the only choice most community associations whose documents are silent on the issue(s) would have would be to seek to amend the governing documents, by way of unit owner vote, to specifically allow the community association to use modern technology for voting, proxies and meetings. The pandemic taught us that the use of modern technology is good for community associations and statutory updates around the country are the preferred path.
The Community Associations Institute has a federal Legislative Action Committee and various state Legislative Action Committees (including the PA-LAC in my home state of Pennsylvania) that are diligently working on these issues for the benefit of community associations nationwide. Information can be found at: https://www.caionline.org/Advocacy/LAC/Pages/default.aspx.
Number 5: Community association residents learned what really matters.
The pandemic served to “reset” our expectations in virtually every aspect of our lives. Lest we forget, not too long ago, there were toilet paper and paper towel shortages, hand sanitizer was selling for $15 a bottle if it was available, Lysol wipes were harder to find than a unicorn covered in diamonds and grocery stores were rationing items like chicken breast to one pack per customer. All of this led to a decrease in demands, complaints and communications from unit owners about things like the grass being ¼ inch too high in the back of their unit or that the guy across the street owns a car that has a registration that expired a month ago. In other words, when residents focused on what was actually important, they stopped focusing on things that, while they might have merit, didn’t matter in the grand scheme of things.
Number 4: Community association education is important.
During the pandemic, those of us in the industry who focus on community association education, including the Community Associations Institute, worked tirelessly to ensure that community association Boards and Community Managers would continue to have access to quality educational content. The end result was shifting the educational seminars from in-person to virtual events. Community association leaders apparently agreed that quality educational content was needed during the pandemic, as the overall attendance for the virtual seminars vastly exceeded the turnout of prior, similar in-person events.
While the content of the majority of the virtual educational seminars during the pandemic pertained to pandemic-related issues and solutions, it served a valuable purpose. Community association leaders were hungry for information and cogent guidance on important issues and the pandemic was not a reason to stop educating those in our industry. Rather, it was time for us to amp up our efforts because community association education is important.
Number 3: Community association residents like attending electronic meetings more than they like attending in-person meetings.
Let’s not sugarcoat it. The pandemic literally forced us to meet with one another virtually instead of in-person. What community association leaders quickly learned was that these virtual meetings led to a better turnout, whether it was for Board meetings or unit owners meetings, and the virtual meetings were generally more efficient to run and took less time to complete.
Community associations want to continue to utilize electronic meetings, and this makes complete sense. As discussed in Number 6, above, the solution for community associations in many jurisdictions lies in updating statutory language to allow for the use of modern technology. If you live in a community association in a state that currently does not allow for electronic meetings, you should contact your state legislators’ offices and make them aware of the issue.
Number 2: “Community” matters.
The pandemic, by its nature, forcibly changed our notion of what “community” really is, and in thinking about all of this in retrospect, it appears that we took “community” for granted prior to the pandemic. Community association leaders learned that “community” matters, so we must focus on building (or rebuilding) “community” moving forward.
The good news is, it looks like we have a jump start on this because during the pandemic, residents turned their attention to assisting other residents in the community with things they could not handle or do on their own due to the pandemic, which actually served to foster an actual sense of “community”. If we continue to serve our neighbors this way, the “community” will be amazing.
And, the Number 1 GOOD thing that community associations learned from the COVID-19 pandemic:Have empathy towards your fellow human.
During the pandemic, we experienced and witnessed an abundance of personal pain, loss and struggle in our homes, families and communities. Community associations were certainly not immune from this – on a personal level, some of my clients unexpectedly and suddenly lost dedicated Board members to COVID-19, which had substantial impact(s) in these communities. Add the emotional, physical and mental stress of the pandemic to all of this and the end result is that community association residents (our fellow humans) deserve some empathy when we are dealing with them.
When speaking to my community association clients about these issues, I advise that they should govern with empathy and utilize emotional intelligence, in addition to good faith and due diligence, when making decisions. “Don’t leave empathy at the door when making important decisions” is something I said a lot to them over the last couple years. Many community association leaders also began to think this way, and I hope it continues well after the COVID-19 pandemic is nothing but a distant memory.
– Edward Hoffman, Jr., Esq., CCAL
* Content in this Blog post is also contained in an abbreviated/edited article by Edward Hoffman, Jr., Esq., CCAL, published in the March/April 2022 issue of CAI’s Common Ground magazine, entitled “The Bright Side”.
Welcome to Episode 2 of Association Nation, where Ed Hoffman will take you through a slideshow presentation on delinquency issues in Pennsylvania Community Associations. We hope you learn something of value today.
