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.