J and N Realty Blog posts about General Topics. Homeowners Association Management services to HOAs in and around Los Angeles.

Fiduciary Duty

 

What Does it Mean to be a Fiduciary?

In simplest terms, to be a fiduciary to another person or party is to be in a position of trust. For example, a patient trusts her doctor to make the correct diagnosis.  A parishioner trusts his priest to keep his confessions confidential.  Moreover, if you are our client we hope you will trust us, as your lawyers, to give you the correct advice!

How does being a fiduciary play into the setting of a community association? Again, a fiduciary relationship exists where people place a special trust in someone.  In the association context, this means that if you are elected to the board of directors, the homeowners have placed their trust in you to preserve and protect the association’s assets, maintain the association’s property, enforce the association’s covenants, and, in general, to promote the interests of the common interest community.

If you are a member of the board of directors, then you owe a fiduciary duty to the association.  On the whole, your fiduciary obligation encompasses the following four duties, each of which is discussed below:

  1. Duty of Care
  2. Duty of Loyalty
  3. Duty of Obedience
  4. Duty of Confidentiality

Duty of Care

The duty of care requires a board member to make decisions: (i) in good faith, (ii) in the best interests of the association and (iii) prudently. The foregoing standard is what courts will review when determining if a board member(s) acted appropriately when a decision is challenged.  Directors are recognized as having the same duties as those of a business operation, so they must give the business of the association the same degree of care and diligence that prudent persons would exercise in their own affairs in similar circumstances.  So, what does this mean?

First, to act in good faith means, quite simply, act with honesty, fairness and good intentions.  When taking action, do not act with deception; do not act maliciously; do not act with ill will.  Sounds easy enough, but sometimes this can be one of the most difficult rules to follow.  As a board member have you ever been faced with a person who repeatedly interrupts you during meetings, constantly challenges your decisions and seems to look for ways to personally attack you?  Then, suddenly, that same person asks you to approve his or her fence request. Moreover, you find yourself looking for a way to deny it?  That, my friends, is acting in bad faith. Always remember that as a board member you must look at every decision objectively, and act with honesty and fairness.

Second, to act in the best interest of the Association means to set aside your self-interest.  Even if you may be a homeowner, while on the board you must remove your homeowner hat and put on your board member hat. If moving forward with a particular action would be in the best interest of the association, you must cast your vote in favor of that action, even though it may not align with your own personal interests.

That being said, it is not uncommon for a board decision to also support your own individual interest as a homeowner. That does not mean the decision is incorrect or inappropriate; it just means your own self-interest is in line with that of the association.  However, as a director, your decisions will be scrutinized, and if there is any appearance of preferential board treatment, the decision may be challenged. Do what’s necessary to avoid the perception that your action is solely in your best interest. Make sure you document how you made your decision objectively and without preference.

Moreover, remember, your decision must be in the best interest of the association; not the best interest of another board member, not the best interest of the kindest person on the block; not the best interest of the most energetic and dynamic faction of the community.  Any of the foregoing categories of people have the potential to sway, intentionally or unintentionally, a director’s decision because of who they are as individuals, and because of a director’s natural inclination to help the nicest group or the one in the most need.  Do not review a proposal based on which homeowners will benefit from the decision. Review a proposal based on whether it benefits the association and is in the association’s best interest.

Third and lastly, make sure your decision is prudent.  This means to ask many questions so you can make an informed decision.  Read, be familiar with, and follow your governing documents and applicable law. Make sure you attend board meetings.  Review your board packet thoroughly before the meeting, so you can be ready to ask questions at the meeting. Study and understand your financial statements, so you know where the money is going. Hire qualified professionals and vendors.  In short, when making any decision, board members need to be sure they exercise sound judgment.

Making an informed and sound decision is particularly critical if the decision has a significant impact on the association and its members.  If, for example, your decision has a substantial financial impact on the homeowners, such as levying a special assessment or obtaining a loan, then make sure you do your due diligence.  Review your governing documents and determine whether you have authority to levy the special assessment. Ask your managing agent for assistance in reviewing the operating and reserve accounts and in understanding the present financial state of the association. Ask your attorney for a legal opinion on whether owner approval is necessary for obtaining a loan and pledging the income of the association as security.

Moreover, paper trail, paper trail, paper trail.  Make sure the association’s files contain documentation establishing that the board’s decision was made in good faith, prudently and in the best interest of the association.  You can document your decision-making process through minutes, committee reports, opinion letters, memos and other such records.

Duty of Loyalty

The duty of loyalty requires a director to be loyal to the corporate entity of the association.  Again, you need to set aside your self-interest to act in the best interest of the association.  The duty of loyalty primarily relates to conflicts of interest.

A conflict of interest exists whenever any contract, transaction or other action taken by or on behalf of the association would financially benefit: (1) a director or (2) a party related to a director.  A “party related to a director” means:

(i)  a parent, grandparent, spouse, child, or sibling of the director;
(ii)  the spouse or descendant of the director’s sibling;
(iii)  an estate or trust in which the director or party related to the director has a beneficial interest; or
(iv)  an entity in which a director is a director or officer or has a financial interest.

A common example is if a director owns a landscaping company and wants to enter into a contract with the association to provide landscaping services.  This potential contract would provide a financial benefit to the director.  Thus, a direct conflict of interest exists.  Alternatively, if the landscaping company was owned by the director’s sister, a similar but indirect conflict of interest arises.  The existence of this conflict does not make the contract illegal or inappropriate in itself.  It is the way the director proceeds concerning the conflict that determines the correctness of the transaction.

Colorado law requires the director to disclose the facts of the conflict to the remaining directors before the board takes action on the proposed transaction.  The transaction is enforceable if a majority of the disinterested directors, even if less than a quorum, in good faith, approves the transaction.  Moreover, although not legally required, the director may consider it prudent to be absent from that part of the meeting during which the matter will be discussed, except when her or his information may be needed.

Note that even though the law does not require the director with the conflict to recuse him or herself from the discussion or vote, the board may adopt a conflict of interest policy which requires such recusal.  Colorado law requires the board to adopt a policy which:

(i)     defines or describes the circumstances under which a conflict of interest exists;
(ii)    sets forth procedures to follow when a conflict of interest exists, including how, and to whom, the conflict of interest must be disclosed and whether a director must recuse himself or herself from discussing or voting on the issue; and
(iii)    provides for a period of review of the conflict of interest policies, procedures, and rules and regulations.

So, if the policy requires the director to refrain from participating in the discussion and from voting, the director must follow the policy.  The minutes should then reflect his or her absence from discussion and abstention from any vote relating to the subject of the conflict.

Duty of Obedience

The duty of obedience is an easy one: obey the governing documents and obey the laws.  Directors owe a duty to the association to perform their duties in accordance with the authority granted to them by statute and in their governing documents (i.e., the declaration, bylaws, articles of incorporation, and any rules, regulations, and policies adopted by the board).  If directors exceed this authority, and damage results, the directors may be personally liable for their unauthorized actions.

However, your obedience is only as good as the rules you follow.  If your governing documents are outdated, then you could be following illegal provisions.  Make sure to review your governing documents with your attorney, and revise or rewrite them to bring them into compliance with current applicable law.

Duty of Confidentiality

Board members will have access to private and confidential information that must remain confidential.  A director should not individually disclose information about the association’s activities unless they are already known by the members or are part of the association’s records.  In the normal course of business, a director should treat all matters involving the association as confidential until there has been general disclosure, such as at a board meeting (outside of executive session) or an owners meeting, or unless the information is part of the records available to members for inspection (i.e., minutes, resolutions, etc.) or common knowledge. This presumption of confidential treatment should apply to all current information about legitimate board or association activities.

To be effective, a community association needs a strong board of directors that comprehends its role entirely and pursues it effectively. Moreover, to be an effective board member, you must fully understand your fiduciary duties and responsibilities as outlined above.

How to Determine Responsibility in HOAs

This is one of the most frequently asked questions involving community associations. It can come up at 2 a.m. after a dishwasher flood has damaged four units; when a homeowners association is re-roofing a building and wants to demolish people’s decks to gain roof access; when an owner’s uninsured contractor makes a hole in a pipe and causes a flood; or when mold is found as a result of leaks in common areas and owners’ failure to ventilate units properly.

The question has no easy answers and usually generates heated emotions. Here are some general principles that may help you sort out the answer.

What Do the Governing Documents Provide?

The first place to look is in the HOA’s Declaration of Covenants, Conditions, and Restrictions (CC&Rs). The most helpful provisions will usually be the following:

Definitions – Is the area in question common area, exclusive use common area or a separate interest? (In a condominium, the separate interest is a unit. In a planned unit development, it is the lot and the residence.)

Division of Property – This section often explains who owns and maintains various areas of the development.

Powers and Duties of the Association – See what the CC&Rs say about the HOA’s maintenance responsibilities.

Owner Maintenance Responsibilities – See what it says about the owner’s maintenance responsibilities.

Reviewing these provisions will answer a high percentage of questions about who must pay for various items. If your CC&Rs are unclear about specific areas, this should be addressed when you revise your governing documents. The attorneys who prepare the revisions usually don’t know nearly as much about your building as you do; so be sure to bring any ambiguities about this subject to the attention of the attorneys who are preparing the revisions.

Try Looking at Civil Code Section 4775

After you have looked at your governing documents, the next step is to check Civil Code Section 4775. That code section is part of the Davis-Stirling Act, and it currently states:

Unless otherwise provided in the declaration of a common interest development, the association is responsible for repairing, replacing, or maintaining the common area, other than exclusive use common area, and the owner of each separate interest is responsible for maintaining that separate interest and any exclusive use common area appurtenant to the separate interest.

This is one of the few provisions of the Davis-Stirling Act that does not prevail over contradictory provisions of the CC&Rs. However, if the CC&Rs do not “otherwise provide,” then Civil Code Section 4775 controls, except as discussed later in this article.

A bill was signed by Governor Brown in September of 2014 that will significantly alter Civil Code Section 4775. While the new law will not go into effect until January 1, 2017, it is important that your HOA be aware of the coming changes to prepare their CC&Rs to accommodate the law. Look to ECHO to provide tools and material to best help your HOA through the process.

Read more about the changes to Civil Code Section 4775 

How to Determine Common Areas and Exclusive Use Common Areas

How do you figure out what is a common area, what is exclusive use common area and what is a separate interest? First, look at your documents. If that does not help, review Civil Code Sections 4075-4190.

Civil Code Section 4185 provides that a separate interest in a condominium is a unit as described with detailed boundaries in the condominium plan (Civil Code Section 4125). In a planned unit development, a separate interest means “a separately owned lot, parcel, area or space.”

Civil Code Section 4185 goes on to say, “Unless the declaration or condominium plan, if any exists, otherwise provides, if walls, floors or ceilings are designated as boundaries of a separate interest, the interior surfaces of the perimeter walls, floors, ceilings, windows, doors, and outlets located within the separate interest are part of the separate interest and any other portions of the walls, floors, or ceilings are part of the common area.”

Thus the surfaces of walls, floors, etc., are separate interest but, unless the documents say something else, the sheetrock, subfloor, etc., are common areas.

Learn more about designating maintenance responsibility for condominiums and planned unit developments

Another very helpful provision is found in Civil Code Section 4145, which defines exclusive use common area as follows: “A portion of the common areas designated by the declaration for the exclusive use of one or more, but fewer than all, of the owners of the separate interests and which is or will be appurtenant to the separate interest or interests. Unless the declaration otherwise provides, any shutters, awnings, window boxes, doorsteps, stoops, porches, balconies, patios, exterior doors, door frames, and hardware incident thereto, screens and windows or other fixtures designed to serve a single separate interest, but located outside the boundaries of the separate interest, are exclusive use common areas allocated exclusively to that separate interest” (emphasis added).

The bottom line is that unless the CC&Rs say something else, the owners are responsible for maintaining the exclusive use common area and unless the CC&Rs say something different, the items listed in  Civil Code Section 4145 are all exclusive use common areas.

Damage Caused by an Individual

The above principles are modified by the common law of negligence and, sometimes, by other CC&R provisions. Under the common law, everyone has a “duty” to act reasonably to avoid foreseeable risk of harm to other people. The failure to do this is negligence. If someone’s negligence causes property damage, wrongful death, bodily injury, etc., the negligent person is responsible for the consequences.

Thus, even though the separate interest is usually supposed to be maintained by an owner, the rule is usually different if the homeowners association was supposed to maintain the roof, a common area, but did so negligently; and, as a result, the roof leaked and damaged the separate interest. In that case, it is up to the HOA to fix the damage to the owner’s separate interest and personal property.

This rule does not always help, however. What if an owner’s dishwasher leaks and causes a flood? Can you prove the owner was negligent? Alternatively, did the dishwasher leak all of a sudden, with no warning, in which case maybe the owner was not negligent, after all? Fortunately, such damage is often covered by insurance!

Insurance Considerations for HOAs

The CC&Rs usually require a community association to purchase insurance for the common areas. The community association will purchase “property insurance,” which covers the common areas if they are damaged by an insured peril, such as a fire or windstorm. The HOA will also purchase liability insurance, which will cover damage caused by the homeowners association’s negligence. Many times, damage to the common area will be covered by one or both of these policies. Most policies define common area in the same way it is defined in the CC&Rs. However, HOAs should have a written policy, or a CC&R provision, setting forth who pays the deductible in various circumstances. Usually, if the HOA was negligent, or if no one was negligent, the association pays the deductible. If the damage originated in an owner’s unit, then often, the owner is asked to pay the deductible, whether or not the owner was negligent.

Insurance does not cover all possible damage, however. What happens if an owner does not have liability insurance; he hires an uninsured contractor to do work in his unit; the contractor whacks a common area water pipe and causes a flood, and the flood damages the separate interests? The homeowners association’s property policy will not cover the separate interests. The HOA’s liability policy will not cover it either—the association did nothing negligent! The owner who hired the contractor is liable, but if the damage is hundreds of thousands of dollars—which can happen, neither he nor the uninsured contractor can afford to pay. Sometimes the individuals whose separate interests are damaged are underinsured. This can result in owners, who are innocent victims being displaced for months, having all their property destroyed, with no good source of obtaining payment! For this reason, although it is hard to enforce, many homeowners associations amend their CC&Rs to require all owners to purchase liability insurance! Others at least strongly “urge” owners to do so.

Damage Done for the Good of the Community

Sometimes CC&Rs do not address the issues that are presented when a community association must destroy or damage individually owned property for the common good. For example, perhaps there are exclusive use decks that prevent the HOA from accessing the roof membrane. When it is time to re-roof the building, the association has to demolish the decks. Who pays?

The HOA may take the position that, because the CC&Rs and Civil Code Section 4775 says that the owner of the separate interest must maintain the exclusive use common area decks, the owner must pay.

The owner will say there was nothing wrong with the deck; it had to be demolished to re-roof the building, and the cost is part of the association’s cost of maintaining common area.

Many courts have made analogies between homeowners associations and mini-governments. Under this analysis, we can conclude that the association, in demolishing the decks, is doing something like what a government does when it takes privately owned property for a public purpose. The homeowners association, like the government, must compensate the property owner for the taking. However, if the deck was nearly worn out, the association should pay only for the deck’s remaining useful life, not for a brand-new deck.

Changing the CC&Rs to Reallocate Maintenance Responsibility

Sometimes, HOAs change the allocation of responsibilities by amending the CC&Rs. This may or may not be a good idea.

Sometimes, the original CC&Rs required owners to maintain particular components. If some owners do not do this in a timely manner, it can damage other people’s property values. Sometimes, the HOA can achieve economies of scale by replacing all decks at the same time; it would cost a lot more if each owner replaced only one deck. It may be particularly appropriate for an association to assume maintenance responsibilities when it is impractical for individual owners to maintain a component. How reasonable is it to expect individual owners to maintain, repair and replace windows on a multi-story building? Each owner has to scaffold the building to replace one window! That makes no sense. If an association is going to assume maintenance of components, be sure to reserve for the new component.

When an area is inaccessible, it is often easier to have the owner maintain it. However, sometimes, associations with financial problems trying to solve them by shifting responsibility for components to individuals. This is not always wise; it can lower property values because not all owners have pride of ownership, and fixing each component individually loses all ability to get economies of scale.

Summary

Sometimes, figuring out who pays for what in a community association is a big headache, and the answer makes everyone unhappy. The best ways to avoid these problems are the following:

  1. Amend your CC&Rs to make the solutions to these problems as clear as possible.
  2. Require or encourage each owner to obtain his own liability insurance and adequate levels of property insurance.
  3. Adopt clear policies about who pays the insurance deductible.
  4. Act fairly and use common sense.

These steps will help you cope with these thorny issues.

 

Pool Sign Rules

The California Code of Regulations was recently supplemented with new Building Code Requirements for mandatory new pool signs, one of which requires adult supervision of children and contradicts advice under Federal discrimination requirements.

California Code of Regulations, Chapter 31B apply when “construction, installation, alteration, addition, relocation, replacement or use of any public swimming pool.” The Chapter specifically sites “auto and trailer park[s]” and “mobile home park[s]” as examples of public swimming pools.

The supplement release date was September 12, 2012 and it has been advised that industry members consider the new rules as effective now. Local counties will oversee and enforce these regulations.

The new sign regulations under the Building Code, CHAPTER 31B, SECTION 3101B, et seq. require the following:

3120B.3 No diving sign. Signs shall be posted in conspicuous places and shall state, “NO DIVING” at pools with a maximum water depth of 6 feet or less.

3120B.4 No lifeguard sign. Where no lifeguard service is provided, a warning sign shall be posted stating, “WARNING: NO LIFEGUARD ON DUTY.” The sign also shall state in letters at least 1 inch (25 mm) high, “Children under the age of 14 shall not use the pool without a parent or adult guardian in attendance.” (this language is prohibited by U.S. v. Plaza and considered discrimination against families with children)

3120B.5 Artificial respiration and CPR sign. An illustrated diagram with text at least 1/4 inch (6 mm) high of artificial respiration and CPR procedures shall be posted.

3120B.6 Emergency sign. The emergency telephone number 911, the number of the nearest emergency services and the name and street address of the pool facility shall be posted.

3120B.7 Warning sign for a spa pool. A warning sign for spa pools shall be posted stating, “CAUTION” and shall include the following language in letters at least 1 inch (25 mm) high:

  1. Elderly persons, pregnant women, infants and those with health conditions requiring medical care should consult with a physician before entering the spa.
  2. Unsupervised use by children under the age of 14 is prohibited.
  3. Hot water immersion while under the influence of alcohol, narcotics, drugs or medicines may lead to serious consequences and is not recommended.
  4. Do not use alone.
  5. Long exposure may result in hyperthermia, nausea, dizziness or fainting.

3120B.8 Emergency shut off. In letters, at least one inch (25 mm) high a sign shall be posted at the spa emergency shut off switch stating “EMERGENCY SHUT OFF SWITCH.”

3120B.9 No use after dark. Where pools were constructed for which lighting was not required, a sign shall be posted at each pool entrance on the outside of the gate(s) stating, “NO USE OF POOL ALLOWED AFTER DARK.”

3120B.10 Keep closed. A sign shall be posted on the exterior side of gates and doors leading into the pool enclosure area stating, “KEEP CLOSED.”

3120B.11 Diarrhea. A sign in letters at least 1 inch (25 mm) high and in a language or diagram that is clearly stated shall be posted at the entrance area of a public pool which states that persons having currently active diarrhea or who have had active diarrhea within the previous 14 days shall not be allowed to enter the pool water.