Protection from Lawsuits Understanding the Business Judgment Rule

The best rule of thumb for boards is to act as ethically as possible. That way, shareholders will never have a problem with the decisions the board makes, right? Wrong.

We live in an increasingly litigious society, where shareholders and residents sue co-op and condo boards for decisions the board makes on their behalf. If the decisions turn out well, everybody’s happy. If they don’t go well, resulting in costly expenses to the community, some people might sue, regardless of the good intentions of board members.

One of the most important legal frameworks governing corporation law is called the Business Judgment Rule, which is a court precedent that holds that a judge or court of law will generally not interfere or hold liable the decisions of a cooperative board as long as that board is acting in good faith in the best interest of their shareholders. The article will further explore how co-op boards can protect themselves from liability when administering their community.

Protection from Corporate Liability

The Business Judgment Rule, a court-created rule that pre-dates cooperative corporations themselves, is a common-law doctrine “by which courts exercise restraint and defer to good faith decisions made by boards of directors in business settings.”

“Despite its age, the rule is no less vigorous today,” says Marcie Waterman Murray, an attorney with Deutsch Tane Waterman & Wurtzel, P.C., a Manhattan law firm that specializes in co-op/condo law and litigation. “It creates a presumption of the validity of a decision of a corporate director (and, it is often thought, of officers as well and sometimes even board committees) in the absence of fraud, self-dealing, unconscionability or other misconduct.”

The origin of the Business Judgment Rule derives from Section 717 of the Business Corporation Law (BCL), which states that “a director shall perform his duties as a director… in good faith and with that degree of care which an ordinarily prudent person in a like position would use under similar circumstances.”

Robert Braverman, managing partner of Braverman & Associates, P.C., a law firm specializing in the representation of co-ops and condos, says that the BCL provides parameters for what may and may not be contained within the governing documents of all corporations, including cooperative housing corporations.

“The key to a board of director’s successful assertion of the Business Judgment Rule is being proactive and not reactive in the adoption of consistent policies, systems and practices,” says Eric M. Goidel, Esq., a partner with the Manhattan law firm of Borah, Goldstein, Altschuler, Nahins & Goidel, P.C.

Important for Boards of Directors

Part of the New York corporate jurisprudence for many decades, the Business Judgment Rule was first applied to cooperative housing corporations in the landmark case of Levandusky v. One Fifth Avenue in 1990 and was revisited by the Court of Appeals (the State’s highest court) in 2004 in the case of Pullman v. 40 West 67th Street Corp.

But Levandusky vs. One Fifth Avenue Corp. (1990) is perhaps the single most important decision ever rendered in the field of co-op/condo law in New York, according to Stuart Saft, who is now a partner at the law firm of Dewey & LeBoeuf in New York.

“Every major co-op or condo decision in the last 10 years has referred to Levandusky,” reports Saft, who is chairman of the Council of New York Cooperatives and Condominiums (CNYC), and has written multiple books relating to commercial real estate.

The case revolved around Ronald Levandusky, a co-op shareholder at One Fifth Avenue who was in the process of renovating his kitchen when he realized that he needed to move a steam riser pipe by two inches to accommodate new cabinetry. After both he and the board of directors of his building hired independent engineers to look at the situation, the board decided not to let him move the pipe. Levandusky, however, failed to heed the order of the board and hired a contractor to move the pipe anyway. The board issued a stop-work order and Levandusky subsequently took them to court.

In this case, the court ruled in the board’s favor, citing two precedents of law: the Reasonableness Standard and the Business Judgment Rule. According to the Federation of New York Housing Cooperatives and Condominiums (FNYHC), under the Reasonableness Standard, the board had to prove that it was acting in a reasonable manner; and the Business Judgment Rule holds that a court will defer to the decision of the board, so long as upon review the court determined that “[the decision] was made in good faith and in exercise of honest judgment in the lawful and legitimate furtherance of the corporate purposes. Further, absent a showing of a breach of fiduciary duty, the exercise of the cooperative board’s powers for the common and general interest of the corporation may not be questioned although the results may show that what they did was unwise or inexpedient.”

“Levandusky established the principle that the courts will not look into the actions of a co-op board (or, by extension, a condo board) unless there is an accusation of bad faith or self-dealing,” according to Saft. “It gave boards a free hand to make decisions with regard to the building, the corporation or the condo, and the shareholders or unit owners.”

This decision, which was handed down unanimously from the New York Court of Appeals, New York’s highest court, gave cooperative boards the authority to manage their buildings in the way they determine is best for the apartment owners as a group.

“The court said that even though there wasn’t any damage, the board was relying on its engineer to adopt the requirement, and the court would not review the board’s decision to maintain a consistent policy regarding the way in which pipes would be handled,” recounts Matthew J. Leeds, a partner in the law firm of Ganfer & Shore, LLP, which represents numerous cooperative and condominium boards. “Accordingly, the upshot was that the Court of Appeals said that the business judgment rule applied as the standard as to whether the court would involve itself in the decision—and it would not—so the tenant shareholder would have to put the pipe back.”

“In Pullman, the court refused to disturb the good faith decision of the board to terminate and evict a tenant shareholder based upon the shareholder’s objectionable conduct,” relates Braverman.

“It is important to note that boards should understand that they can honestly apply their judgment,” explains Leeds. “There can sometimes be more than one reasonable way to approach an issue. Anybody who has ever lived through a remodeling of a lobby in a co-op building knows that.”

“Unit owners should understand that their redress if they don’t like the way a board applies its discretion generally is that, just like voters in a public election, they have the power of the ballot box to vote out the directors who don’t think like they do,” adds Leeds, a former chair of the full New York State Bar Association’s Real Property Section and an adjunct professor of cooperative and condominium law at Fordham Law School.

Boards should also realize that the Business Judgment Rule is intended to protect them only when they are acting in good faith. It is not intended to shield them from liability when they are acting in a discriminatory manner, says Braverman, such as the rejection of a prospective purchaser based on the purchaser’s age, sex, race, creed, or other protected class.

Boards should take care to ensure they are operating within the bounds of the law, relates Goidel. To that aim, his firm operates a special service called “Director Protector” which helps protect boards from legal liability.

Program clients complete a detailed questionnaire and submit copies of their existing policies and practices on such diverse issues as admissions, sublets, alterations, pets, finances, accommodation of the disabled, communications, corporate governance and construction management. From this information, the law firm then reviews specific policies and practices and makes suggestions as to how those policies and practices may be improved upon, with the goal of assisting boards of directors and individual board members in reducing claims of wrongful, illegal or discriminatory practices, according to Goidel.

The service is provided at no additional charge to Borah Goldstein clients and is offered for a fee to other cooperative boards. The cost for the initial review is generally a few thousand dollars and the firm offers a reduced hourly billing rate for legal work commissioned by a board of directors that adopts the firm’s recommendations.

Leeds agrees that boards can not “pick on” a particular shareholder for a malicious purpose. He also points out that boards may not say that “it is acting in pursuit of its business judgment if what they are actually doing is trying to undo or violate some other obligation that it had already agreed to under a contract,” he says.

Boards should also know that they may not act in ways that are motivated by personal gain of one or more of the directors.

Act in Good Faith

Regardless of the board’s good faith and good intentions, we can assume that there will be, at times, irritated shareholders who will try to prove the board was not acting in the best interest of the co-op corporation. How can the board ensure that this happens as rarely as possible?

One thing a board can do is to seek the advice and guidance of their professional team (managing agent, accountant, engineer, and/or attorney) as often as possible in their decision-making process—especially during those times when questions or doubts arise in their minds as to how to address an issue or problem in the building.

Section 717 of the Business Corporation Law provides that directors, in carrying out their duties, shall be “entitled to rely on information, opinions, reports or statements including financial statements and other financial data.”

“In other words, reasonable reliance upon the advice of counsel may be a valid defense to claims for breach of duty,” advises Braverman. “For these and other reasons, we have found that many claims could easily have been avoided had the board received professional advice before acting.”

One way to protect itself from lawsuits “is simply to act honestly,” says Leeds.

“An honest, conscientious board would not act in self-interest, would consider situations as they arise and would think of the corporation and not just themselves personally when they act,” he points out. “Another thought is to apply common sense to responsible operations. A board should consider listening to different viewpoints on issues and obtaining several bids for work to be performed.”

“The last thing that a volunteer board member wants to do is place their own assets at risk by unwittingly taking an action which with forethought could have been easily avoided.” says Goidel.

“While it may not be possible to prevent the initiation of a lawsuit commenced by someone who is just determined to litigate, a board whose members act in an honest, above-board and reasoned manner should feel legally more secure in all cases than those who have acted or voted based on their own private and personal interests or prejudices and not for the benefit of the corporation as a whole,” says Waterman Murray.

Boards that gathers all available information and make a lawful, reasonable decision for the benefit of the corporation should be protected from disgruntled shareholders who are unhappy with the board’s ultimate decision.

“And that’s probably the way it should be,” Waterman Murray concludes.

Domini Hedderman is a published author, freelance writer and a frequent contributor to The Cooperator.

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Comments

  • A very bad idea to have corporations & corporatists, who are basically ruining the world, also wield that sort of misguided authority over people's homes as well!!!