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.

0 replies

Leave a Reply

Want to join the discussion?
Feel free to contribute!

Leave a Reply

Your email address will not be published. Required fields are marked *