Collecting homeowners’ association fees from unit owners in foreclosure, fixing leaky roofs from hurricane damage, and hiring a new landscaper. These are just a few examples of the many decisions that a condominium association’s board of directors must consider on a regular basis. The condominium association is the governing body of a community, with duties ranging from promulgating and enforcing rules and regulations to handling financial matters such as the collection of dues. See Matter of Levandusky v. One Fifth Ave. Apartment Corp., 75 N.Y.2d 530, 536 (N.Y. 1990); Papalexiou v. Tower W. Condo., 401 A.2d 280, 285 (N.J. Super. 1979). Those brave few who volunteer to serve on the association’s board should always remember that it is nearly universally accepted that they owe a fiduciary duty to all of the association’s members. See, e.g., Bd. of Managers of Weathersfield Condo. Ass’n v. Schaumburg Ltd. P’ship, 717 N.E.2d 429, 436 (Ill. App. 1999); Bd. of Managers of Fairways at North Hills Condo. v. Fairway at North Hills, 603 N.Y.S.2d 867, 870 (1993); Schwarzmann v. Ass’n of Apartment Owners, 655 P.2d 1177 (Wash. 1982). But see Smith v. Ridgeview Homeowner’s Ass’n, 2011 WL 1743787, at *3 (Minn. Ct. App. 2011) (holding the governing body of a condominium association owes a duty to members as a whole as opposed to individual unit owners); Office One, Inc. v. Lopez, 769 N.E.2d 749 (Mass. 2002) (holding that members of the governing board of a condominium association, in their capacity as trustees, owe no fiduciary duty to individual unit owners).
When a disgruntled condominium unit owner challenges the board’s decision through litigation, under what standard will the board’s action be governed? The answer depends on the jurisdiction, and even then, the answer is not entirely clear. Most jurisdictions apply one of two standards: reasonableness or business judgment. Under the reasonableness standard, the condominium association’s board of directors must demonstrate its decision was reasonable, thus requiring the court to conduct a fact-intensive inquiry into the substantive and procedural decision-making process. See, e.g., Bolandz v. 1230-1250 Twenty-Third Street Condo. Unit Owners Ass’n, 849 A.2d 1010, 1014–15 (D.C. 2004). On the other hand, the business-judgment rule gives deference to the decision made by a condominium association’s board of directors absent a showing of fraud, bad faith, incompetence, or a variety of other factors varying by jurisdiction. See, e.g., Micheve, LLC v. Wyndham Place at Freehold Condo. Ass’n, 885 A.2d 35, 39 (N.J. App. Div. 2005) (finding the business-judgment rule afforded when the board’s actions authorized by statute or its own bylaws, and when the decision is not fraudulent, self-dealing, or unconscionable); Black v. Fox Hills N. Cmty. Ass’n, 599 A.2d 1228, 1231–32 (Md. App. 1992) (holding the business-judgment rule precludes the judicial review of a condominium association’s board of directors absent fraud or bad faith).
While courts try to distinguish their decisions to neatly fit under one of the two standards, the history of cases involving decisions of condominium association boards of directors proves the two concepts to be anything but neatly distinguished. In fact, case law shows “reasonableness” and “business judgment” in the context of condominium associations to be more like overlapping circles on a Venn diagram than two separate, distinct standards.
Origin of the Reasonableness and Business-Judgment Confusion
One of the earliest cases to consider the standard for reviewing a decision of a condominium association’s board of directors is Hidden Harbour Estates, Inc. v. Norman (Hidden Harbour I), 309 So. 2d 180 (Fla. 4th Dist. Ct. App. 1975). In Hidden Harbour I, the association’s board of directors adopted a rule, subsequently ratified by the vote of unit owners, prohibiting alcoholic beverages from the clubhouse and adjacent areas. Id. at 181. The trial court granted a permanent injunction prohibiting the association from enforcing the rule because the action engaged in by the board constituted a nuisance. The Fourth District reversed, concluding the association can adopt rules passing the test of “reasonableness,” and each case must be reviewed based on the particular facts and circumstances. Id. at 181–82. The Fourth District held the same standard in Hidden Harbour Estates, Inc. v. Basso (Hidden Harbour II), 393 So. 2d 637 (Fla. 4th Dist. Ct. App. 1981). In Hidden Harbour II, the association’s board of directors denied the association members the right to drill a well next to their mobile home unit. Id. at 638. The members drilled the well anyway, and the trial court denied injunctive relief to Hidden Harbour. On appeal, the Fourth District held the board of directors must demonstrate “reasonableness” when the validity of promulgated rules is challenged or when a board refuses an owner’s action where the board has the power to grant or deny the action. Id. at 640. Because Hidden Harbour failed to demonstrate its decision to deny the drilling of a well was reasonably related to its concerns, the Fourth District affirmed the trial court’s ruling.
In between Hidden Harbour I and II, the Superior Court in New Jersey decided Papalexiou v. Tower West Condominium, 401 A.2d 280 (N.J. Super. 1979). In Papalexiou, the board of directors for Tower West Condominium voted to levy an assessment of $100,000 to pay overdue bills and repair leaks in the roof. Id. at 284. All but seven unit owners paid the special assessment. The remaining unit owners secured an injunction restraining the association from asserting a lien or imposing other sanctions on the nonpaying owners. Id. at 282. In beginning its analysis, the court cited Hidden Harbour I for the “test of reasonableness.” Id. at 285. The court also cited Ryan v. Baptiste, 565 S.W.2d 196, 198 (Mo. Ct. App. 1976), in which the Missouri Court of Appeals considered the reasonableness of a board’s actions by weighing the rights of objecting owners against the rights of the entire residential community.
The Papalexiou court inexplicably transitioned from the “reasonableness” rules of Hidden Harbour I and Ryan to a discussion of the business-judgment rule. The court defined the business-judgment rule to require a showing of fraud or lack of good faith before a board’s decisions can be questioned. Id. at 285–86. The court held fraud, self-dealing, or unconscionable conduct must be evidenced before a court will review authorized conduct of directors. Id. at 286; see also Comm. for a Better Twin Rivers v. Twin Rivers Homeowners’ Ass’n, 929 A.2d 1060, 1074 (N.J. 2007). In declining the invitation to review the board’s decision, the court found no fraud, lack of good faith, self-dealing, dishonesty, or incompetence in the decision-making process. Id. at 286–87.
The only link between the “reasonableness” discussion and the “business judgment” holding is the court’s explanation that, while directors are not expected to be perfect, “[a]ll that is required is that the persons in such positions act reasonably and in good faith in carrying out their duties.” Id. at 286. Without rejecting the holdings of Hidden Harbour I or Ryan, the court did no analysis of the particular facts and circumstances nor any balancing test of the objecting owners’ rights versus the rights of the community at large. Left unclear by the court’s decision is whether there remains an argument to be made that boards’ decisions can be overturned by showing unreasonableness.
In an oft-cited and arguably clearer opinion, the New York Court of Appeals addressed the issue of “reasonableness” versus “business judgment” head-on in Matter of Levandusky v. One Fifth Avenue Apartment Corp., 75 N.Y.2d 530 (N.Y. 1990). In accordance with an agreement the board and Levandusky executed, the board of directors for the condominium cooperative issued a stop-work order to prevent Levandusky from moving a steam riser pipe in violation of Levandusky’s proprietary lease. Id. at 533–34. The supreme court initially granted Levandusky’s petition to set the stop-work order aside and held the board’s decision to stop the renovations was “arbitrary and capricious.” Id. at 535. On rehearing, the supreme court withdrew its decision, holding it was “precluded by the business judgment rule from reviewing the board’s determination.” Id. On appeal, a majority of justices in the appellate division agreed with the original supreme court decision, while two justices dissented and agreed the board’s actions were not subject to judicial review under the business-judgment rule.
After a thorough discussion about the role a cooperative or condominium association board of directors plays in governing the affairs of the respective community, and the unit owners’ rights they tacitly relinquished by agreeing to be regulated by the rules and regulations, the court of appeals held the appropriate standard of review for a board’s decisions is analogous to the business-judgment rule. Id. at 536–37. “So long as the board acts for the purposes of the cooperative, within the scope of its authority and in good faith, courts will not substitute their judgment for the board.” Id. at 538; see also Yusin v. Saddle Lakes Home Owners Ass’n, 73 A.D.3d 1168, 1170–71 (N.Y. App. Div. 2010). The court further supported its opinion by citing other cases inside and outside of its jurisdiction (including Papalexiou) applying the business-judgment rule to cooperative and condominium boards. Id. at 537.
The court of appeals then took the extra step the court in Papalexiou did not take by explicitly rejecting the “reasonableness” test. Id. at 538. The court recognized the “reasonableness” standard and business-judgment rule have a lot in common, but pointed out the two biggest differences. Id. at 539. First, the business-judgment rule places the burden on the objecting unit owner to demonstrate the breach of fiduciary duty, whereas the reasonableness standard places the burden on the board to show the decision was reasonable. And, second, citing Hidden Harbour II, the reasonableness standard requires the court to independently evaluate the board’s decision. The court of appeals, therefore, decided the more appropriate standard was the one of limited judicial review.
New York is one of the few jurisdictions in which an appellate court went the extra mile to explain what the reasonableness standard is, what the business-judgment rule is, and why one is more beneficial than the other. Most other jurisdictions fail to provide a clear statement of the standard to be applied. The court selects one of the standards without a thorough review of the other and, in skipping this part of the process, conflates the two. It is understandably difficult to separate them, as the analysis in Levandusky illustrates. But a review of opinions from around the country demonstrates some courts are not just conflating them, but also perhaps mislabeling them.
Does the Business-Judgment Rule Require Finding Reasonableness?
As discussed in Papalexiou and Levandusky, the business-judgment rule restricts a court’s ability to review the substance of a decision made by the condominium association’s board of directors. Some courts looked to stay in line with these early cases on point. The Court of Special Appeals of Maryland cited Papalexiou in adopting Maryland’s business-judgment rule, requiring the court to give deference to a board’s decision absent bad faith or fraud. Black v. Fox Hills N. Cmty. Ass’n, 599 A.2d 1228, 1231–32 (Md. App. 1992). The Superior Court of Massachusetts adopted the business–judgment rule discussed in Levandusky and held trustees of the condominium trust were not liable for actions “taken in good faith and in the exercise of business judgment in the lawful and legitimate furtherance” of the unit owner’s interests. Pederzani v. Guerriere, 1995 WL 1146832, at *1 (Mass. Super. Ct. 1995). The Superior Court of Connecticut also adopted the business-judgment rule as enumerated in Levandusky. Powder Farm Park Ass’n v. SKF Leader Hill, LLC, 2008 WL 4853332, at *4 (Conn. Super. Ct. 2008).
Another one of the leading cases applying the business-judgment rule to condominium associations is Lamden v. La Jolla Clubdominium Homeowners Ass’n, 980 P.2d 940 (Cal. 1999). In Lamden, the Supreme Court of California reviewed several of its past cases in which actions of a condominium association were at issue. Id. at 947–49. The court looked to its then recent opinion in Nahrstedt v. Lakeside Village Condominium Ass’n, 878 P.2d 1275 (Cal. 1994), wherein it concluded that “courts will uphold decisions made by the governing board of an owners association so long as they represent good faith efforts to further the purposes of the common interest development, are consistent with the development’s governing documents, and comply with public policy.” Lamden, 980 P.2d at 950. Staying in line with its holding in Nahrstedt, the court in Lamden concluded the board’s decisions should be given deference when the board is acting on reasonable investigation, in good faith with regard to the best interests of the association and its members, and exercises discretion within the scope of its authority under relevant statutes, covenants, and restrictions.
Other courts have relied on legal treatises and their own body of case law to allow condominium associations the deference afforded by the business-judgment rule. The Court of Appeals in South Carolina reviews conduct of directors under the business-judgment rule and will not disturb their actions absent a showing of incompetence, dishonesty, or bad faith. See Goddard v. Fairways Dev. Gen. P’ship, 426 S.E.2d 828, 832 (S.C. Ct. App. 1993). An Illinois Appellate Court applied its corporate business-judgment rule to a derivative suit brought by unit owners on behalf of the condominium association. Davis v. Dyson, 900 N.E.2d 698 (Ill. App. Ct. 2008). The Davis court makes its analysis of the business-judgment rule based on the holding in Stamp v. Touche Ross & Co., 636 N.E.2d 616 (Ill. App. 1993). The Stamp court concluded the business judgment of directors would not be interfered with absent bad faith, fraud, illegality, or overreaching. Id. at 621. In affirming the rule from Stamp, the court also noted that, for a board to get the benefit of the business-judgment rule, exercise of due care is a prerequisite. Davis, 900 N.E.2d at 714. Because the plaintiffs in Davis alleged “inexcusable unawareness or inattention” as well as illegality, they alleged enough to survive the business-judgment rule challenge at the pleadings stage. Id. at 715–16.
The Supreme Court of Washington in Riss v. Angel discusses condominium directors’ fiduciary duty to “exercise ordinary care in performing their duties and to act reasonably and in good faith.” 934 P.2d 669, 680–81 (Wash. 1997). The court appears to conflate the two differing standards by stating the duty as such, and by concluding “whether or not the business judgment rule should be applied to property owners associations, the decisions of these associations must be reasonable.” Id. at 681. Quoting its business-judgment rule from prior decisions, the court stated it will not disturb the directors’ judgment absent a showing of fraud, dishonesty, or incompetence, but that “reasonable care” is also required, and good faith is insufficient because the standard requires the directors to act as reasonably prudent people in like situations would act.
The business-judgment rule quoted by the Supreme Court of Washington reflects the “pure” business-judgment rule approach. But does this approach support its conclusion? The court concludes the rule does not “exonerate the homeowners for their unreasonable decision to reject Plaintiffs’ proposal.” Why was the decision unreasonable? Because it was an unreasonable decision-making process. Id. at 679. Although the court refers to a “reasonable decision” in several places in the opinion, Washington does appear to adhere to the “pure” business-judgment rule.
Florida is perhaps the most difficult state to understand whether its courts apply the business-judgment rule. As discussed earlier, one of the first cases on point as to the issue of the appropriate standard of review for condominium associations is Hidden Harbour I. In a recent decision by the Fourth District Court of Appeal in Florida, the court in Hollywood Towers Condominium Ass’n v. Hampton cited numerous cases holding the business-judgment rule to be the appropriate standard of review. 40 So. 3d 784, 787 (Fla. 4th Dist. Ct. App. 2010) (citing Garcia v. Crescent Plaza Condo. Ass’n, 813 So. 2d 975 (Fla. 2d Dist. Ct. App. 2002); Farrington v. Casa Solana Condo. Ass’n, 517 So. 2d 70, 72 (Fla. 3d Dist. Ct. App. 1987); Tiffany Plaza Condo. Ass’n v. Spencer, 416 So. 2d 823, 826 (Fla. 2d Dist. Ct. App. 1982)). When deciding on the appropriate business-judgment review test, the court adopted the two-prong test in Lamden, stating the decision must be within the association’s scope of authority and must be reasonable, meaning not arbitrary, capricious, or in bad faith.
But how did the Florida courts transition from the reasonableness standard to the business-judgment rule? Arguably, they never did. In Farrington, the Third District Court found support for its decision to support the business-judgment rule. One case was Papalexiou, a business-judgment rule case. Another is Hidden Harbour I, a case oft-cited for the reasonableness standard. Indeed, many courts outside of Florida have used Florida cases to support their position that the reasonableness standard is the appropriate standard. See Barclay Square Condo. Ass’n v. Grenier, 899 A.2d 991, 996–97 (N.H. 2006) (citing Hidden Harbour I); Hutchens v. Bella Vista Vill. Prop. Owners’ Ass’n, 110 S.W.3d 325, 330 (Ark. Ct. App. 2003) (citing Scudder v. Greenbrier C. Condo. Ass’n, 663 So. 2d 1362, 1369 (Fla. 4th Dist. Ct. App. 1995)). In Florida, therefore, there appears to be authority to support both the reasonableness standard and the business-judgment rule as appropriate standards of review.
Reasonableness Standard Isn’t Far from Business-Judgment Rule
Many other jurisdictions adhere to the “reasonableness” standard when reviewing the decisions of a condominium association’s board of directors. Conceptually, as discussed in Levandusky, the reasonableness standard is going to have a significant amount of overlap with the business-judgment rule. Can there be a scenario where an action taken or decision reached by a condominium association’s board of directors is both reasonable and done arbitrarily, capriciously, incompetently, or in bad faith? But one would expect if a court intends to employ a reasonableness standard, there should be some difference between reasonableness and the business-judgment rule. When looking at the specific standards the courts use, however, it seems clear that the reasonableness standard hardly varies, if at all, from the business-judgment rule.
For example, an Arkansas Court of Appeal in Hutchens v. Bella Vista Village Property Owners’ Ass’n held the power of the governing body for a condominium association is limited by the “reasonableness” test, requiring a determination of whether action is unreasonable, arbitrary, capricious, or discriminatory. 110 S.W.3d 325, 330 (Ark. Ct. App. 2003). The Supreme Court of North Dakota also employs the same reasonableness test. See Buckingham v. Weston Vill. Homeowners Ass’n, 571 N.W.2d 842, 845–46 (N.D. 1997); see also Barclay Square Condo. Ass’n v. Grenier, 899 A.2d 991, 996–97 (N.H. 2006) (finding the amendment at issue “is reasonable and not arbitrary or capricious”). On its face, this standard is the business-judgment rule, almost exactly as defined in Florida, California, New York, and New Jersey, with an additional “unreasonable” defense. Yet neither jurisdiction proposes what “unreasonable” means. Is it procedurally unreasonable, thus making the actual standard the business-judgment rule, since the court does not question the substance of the decision? Or is it substantively unreasonable, thus making the test the more traditional reasonableness standard?
Both Hutchens and Buckingham cite the Ohio Court of Appeals case Bluffs of Wildwood Homeowners’ Ass’n v. Dinkel, 644 N.E.2d 1100, 1102 (Ohio App. 1994), in describing the “reasonableness” test in Ohio. One of the cases cited in Dinkel sheds some light on Ohio’s reasonableness standard. In River Terrace Condominium Ass’n v. Lewis, the First District Court of Appeal in Ohio stated, when reviewing a decision by the association’s board of directors, “the trial court does not substitute its judgment for that of the board of managers or weigh the various elements and considerations to be taken into account as though the court were acting de novo.” 514 N.E.2d 732, 737 (1st Dist. Ct. App. Ohio 1986). In so holding, the court applied a three-part test of reasonableness, looking at whether the decision was arbitrary or capricious, whether the decision was nondiscriminatory and even-handed, and whether the decision was made in good faith for the common welfare of the owners and occupants. The reasonableness standard in Ohio, and by extension in Arkansas and North Dakota, appears to be, for all intents and purposes, the business-judgment rule.
Perhaps the purest “reasonableness” standard can be found in Washington, D.C. On a case of first impression, in Johnson v. Hobson, the D.C. Court of Appeals reviewed a condominium association board’s decision to have cars without valid license plates or registration towed from the premises. 505 A.2d 1313, 1314–15 (D.C. App. 1986). Citing Hidden Harbour I and Ryan (like the court in Papalexiou), as well as Holleman v. Mission Trace Homeowners’ Ass’n, 556 S.W.2d 632, 636 (Tex. Civ. App. 1977), the court adopted the reasonableness standard. Id. at 1317. In a footnote, the court specifically declined to adopt the business-judgment rule as adopted in Papalexiou. Id. at 1317 n.7.
The court’s analysis went through both the substantive and procedural aspects of applying the reasonableness standard. Id. at 1317–18. For substantive reasonableness, the court looks at whether the action taken was within the powers granted to the board by statute or condominium documents; whether the substance bears a relationship to the “health, happiness and enjoyment of life” for owners; and whether the substance has an unfair or disproportionate impact on select unit owners. As for procedural reasonableness, the court should review whether owners had notice the board could regulate the topic at issue and whether the board failed to follow the procedures mandated by the condominium documents. Id. at 1318. The D.C. Court of Appeals definitively affirmed the reasonableness standard, the decision to not adopt the business-judgment rule, and the analysis of Johnson in Bolandz v. 1230-1250 Twenty-Third Street Condominium Unit Owners Ass’n, 849 A.2d 1010, 1014–15 (D.C. 2004). The court in Bolandz left no doubt about the inquiry to make when utilizing a reasonableness standard, citing the quoted language Johnson used from Hidden Harbour I, “[E]ach case must be considered on the peculiar facts and circumstances thereto appertaining.” Id. at 1015.
Other jurisdictions that have elected to apply a version of the reasonableness standard go so far as to explain how the business-judgment rule is properly incorporated. The Supreme Court of Alaska, in upholding the condominium rule at issue, held the reasonableness standard was “supported by case law and commentary.” O’Buck v. Cottonwood Vill. Condo. Ass’n, 750 P.2d 813, 817 (Alaska 1988) (citing Hidden Harbour I and Johnson). In a footnote, the court additionally stated that applying the business-judgment rule advocated by the condominium association, while favored by commentary and with good authority, would make little to any difference in this case because “the rule at issue measures up to any standard of reasonableness.” Id. at 817 n.4. The language in the footnote left some question as to whether the Supreme Court of Alaska would adopt the business-judgment rule in the future because the court elected not to take the association’s invitation to make the business-judgment rule the law. Little doubt remains as evidenced by the holding in Bennett v. Weimar, 975 P.2d 691, 696–97 (Alaska 1999). The Supreme Court of Alaska, this time forced with the argument of reasonableness versus business judgment (as applied in Papalexiou), stayed with its holding in O’Buck in favor of the reasonableness standard. Id. at 697. The court continues to leave itself an “out” for ruling on the business-judgment rule by not taking a firm position and once again stating, “[T]he rule at issue measures up to any standard of reasonableness.”
The Restatement Attempts to Balance the Two
The Court of Appeals of Arizona dealt with the reasonableness standard versus business-judgment rule debate by following a third option. In Tierra Ranchos Homeowners Ass’n v. Kitchukov, the association advocated for the business-judgment rule of Lamden while the unit owner argued Arizona case law did not allow for judicial deference to condominium associations. 165 P.3d 173, 177–78 (Ariz. App. 2007). Because the court found this case of reviewing the decision of a condominium association’s board of directors to be a case of first impression, Arizona law mandated the court look to the appropriate Restatement for guidance. Id. at 179. Under the Restatement (Third) of Property: Servitudes (2000), a unit owner challenging an action by the association must show the association breached its duty to treat members fairly or its duty to act reasonably in the exercise of its discretionary powers. When challenging a discretionary action, the unit owner also has the burden of proving the breach of duty has caused, or threatens to cause, injury to the member individually or to the interests of the common-interest community. Finding the Restatement’s approach to be well-reasoned, the Arizona court adopted it. Id. at 180.
The court discussed the Restatement commentary as it related to the reasonableness standard and business-judgment rule. Id. at 179. The Restatement does not adopt the business-judgment rule because it provides “too little protection against careless or risky management,” but balances the protection taken away from the association by now requiring the unit owner to establish the board’s action was unreasonable, as opposed to putting the burden on the association to prove its actions were reasonable. Id. at 179–80. What the Restatement sees as balancing between the two standards may ultimately be very detrimental to the unit owner. Is the burden of proving unreasonableness a fair burden to put on one unit owner? Can one unit owner ever prove a board’s decision was unreasonable as to all unit owners? In a condominium development of nearly 1,000 units, what sort of time and expense will a unit owner have to endure to prove his or her case? Ultimately, more case law will need to be developed to conclude how effective the third Restatement option really is.
A review of the case law shows three approaches to reviewing the validity of an action challenging the decision of a condominium association’s board of directors. The two most readily recognizable approaches, the reasonableness standard and the business-judgment rule, share so many characteristics that defenses of one are almost certainly defenses to the other. The minority approach, as prescribed by the Restatement (Third) of Property: Servitudes (2000), attempts to be a hybrid between the two majority approaches, but may only create an undue burden on the challenging unit owner as opposed to clarifying the standard. When reviewing a decision by a condominium association’s board of directors, a lawyer should probably allege all substantive and procedural flaws in the association’s decision-making process to avoid missing a successful defense to any of the above standards.