Upholding Your Fiduciary Duty Transparency is the Best Path for Boards

Being on the board of a co-op or condo is a big responsibility—one that shouldn’t be taken lightly. While some people may run for a board seat just to have the title, they need to be prepared to govern fairly and make decisions that are in the best interest of the community as a whole.  

On Whose Authority? 

Bruce A. Cholst, a partner with the law firm of Rosen Livingston & Cholst LLP in Manhattan, says the authority of the board is to perform its functions and legal obligations deriving principally from its bylaws, Certificate of Incorporation and from relevant statute and case law. Every board member should read the bylaws carefully, because you are charged with the legal responsibility for knowing their contents and seeking legal advice in areas where you don’t. 

This set of directives is commonly known as “fiduciary duty.” These are decisions made on behalf of their fellow residents, made in good faith, and with the best interests of the community firmly in mind. Violating this duty can lead to legal consequences for boards and individual board members who stray.

“In its simplest terms, breach of fiduciary duty is the abuse of power,” Cholst says. “Generally speaking, people only have the legal duty to another person they encounter in the course of their lives. But when it comes to fiduciary relationship, it’s a higher duty; a special obligation that only exists when someone takes a position, like being on a board.”

For example, let’s say there’s a board member who purposely hires someone with whom he or she has a preexisting relationship, even though that person isn't the best person for the job. That could be seen as an abuse of power on the part of the board member. Or let’s say there’s a leak in the building and a board doesn't do anything to fix the problem, either out of apathy, incompetence, or antipathy toward the affected resident. That’s a breach of its fiduciary duty.

Cholst recalls a case wherein a board member placed his name at the top of his building's parking-spot waiting list, jumping over the others who were ahead of him. While not as bad as stealing funds, taking unfair advantage of one's board position is still a breach of fiduciary duty and an abuse of power.

According to Dennis H. Greenstein, a partner with the law firm of Seyfarth Shaw LLP in Manhattan, applicable laws and cases state that board members are obliged to act in the best interests of the community and its unit owners, and this applies universally to cooperatives, condominiums and HOAs.

Still, there are cases every year where he sees boards not fulfilling their fiduciary duties and even going against them. Common breaches he has seen include stealing funds, failing to have needed repairs made, failing to review applications for sales or rentals, violating laws relating to the operation and governance of the building and its unit owners, allowing defaults of unit owners to continue without board action and failing to hold annual meetings.

David Brauner, an attorney with the law firm of Windels Marx Lane & Mittendorf, LLP in Manhattan, and a board member himself for many years, notes that the disposition of a claim of breach of fiduciary duty on the part of co-op or condo board members is highly fact-specific; there are no easy answers or “rules of thumb” to resolve questions. Echoing his colleagues, he says, “In general, a board member has a duty to act, in that capacity, only in the general and common interest of the entity and not in the service of his or her personal interest or bias. This relationship of trust is denominated as a ‘fiduciary’ relationship.”

While fiduciary duty is equally crucial to uphold in both co-ops and condos, the issue is perhaps somewhat trickier in co-ops because the breadth of operational authority is greater. A board member should not vote to reject an otherwise qualified prospective purchaser out of personal animus toward a seller, or because he or she wants to purchase the unit personally. 

“Similarly, vendors should be selected on merit―not on personal relationships or because there's some financial benefit to the board member,” Brauner says. “I would not, however, subscribe to an automatic prohibition on a building doing business with an entity with which a member has a connection. Indeed...such a connection may be of great value in board decisions, but there should be full disclosure, confirmation that the proposal is equal to or better than any other, and the interested board member should recuse him- or herself from advocacy for a particular vendor, and from the vote.”

It’s obviously an important thing to monitor and enforce a residential board’s adherence to its fiduciary duty, and while there’s no actual government body keeping tabs on every board, Greenstein notes action can still be taken, should things slip. “The New York State Department of Law in the Attorney General’s office may investigate and take actions against such board members against whom complaints are filed alleging breaches of fiduciary obligations under the offering plan and applicable laws,” he says. 

Cholst notes that since fiduciary obligation is an elastic concept, which contemplates any abuse of power, it is impossible to chronicle every act that could conceivably constitute a breach. 

“However,” he says, “it's instructive to review the specific kinds of board member conduct that courts have already condemned as a breach of fiduciary duty. These cases break down into three broad categories of misconduct: Use of the board position to derive profit or otherwise promote personal interest at the expense of the association of its constituent shareholders and unit owners; use of the board position as a forum for prosecuting personal vendettas against particular shareholders or unit owners; and manifestation of favoritism among shareholders or unit owners.”

Cause and Effect

In his career, Greenstein says he's seen numerous cases where a single board member has completely usurped control of a cooperative or condominium, with barely a whisper of dissent from the other board members. 

“In one instance, a board member bought and sold the apartments of shareholders in default on their monetary obligations to the cooperative. He made self-dealing monetary decisions affecting the cooperative, causing assessments to be levied against all of the shareholders,” Greenstein says. 

If a board member is found to be neglecting and breaching his or her duties, the penalties can include personal liability to all board members. “Owners can bring derivative actions on behalf of the entity to recover damages caused by board members’ malfeasance,” Greenstein continues. “It could also lead to loss of insurance coverage protection and indemnification under the bylaws, as well as personal liability and judgments.”

Taking Action

If a shareholder or unit owner believes there is misconduct on the part of a board member, they have the right to file a claim and pursue the issue before a court of law.

According to Cholst, favoritism toward certain selected shareholders or unit owners, to the detriment of others, also constitutes a breach of the fiduciary obligation in the sense that it violates the equality aspect of a board member's duty of utmost good faith towards his or her shareholders or unit owners. He has seen this be a major issue throughout his career.

He cites an example of a shareholder who tried to sell his apartment to his daughter, but the unit was also coveted by the board president and the board refused to permit the transfer. The case went to court because it appeared to be a power move by the board president. Another case involved a co-op deciding to hold up a sale until the departing shareholder agreed to settle his pending litigation with the association, which is against the bylaws and therefore a breach of duty.

“The consequences of a finding of breach of fiduciary duty can be severe,” says Cholst. “A board member will be held personally liable in money damages sustained as a result of the misconduct and that includes all judgments and legal fees.” Being guilty of this also negates any directors and officer’s liability insurance, so it can be a very costly proposition for the offending member.

Besides legal action, if a board (or board member) is neglecting its fiduciary duty to its community, there are some steps that members of the community can take to right the situation.

“A majority of the members of a board can remove an officer,” Greenstein says. “The board, and generally condominium owners or shareholders owning at least 25 percent of the common interests of the condominium or outstanding shares of the cooperative, can petition the board to hold a special meeting of the unit owners or shareholders to remove board members.” Furthermore, a derivative action could be brought to remove cooperative or condominium board members and seek other relief.

Brauner says that issues normally arise in litigation by or against boards or decisions made by them. “It should be noted that the courts are by nature an expensive, imperfect and retroactive method of addressing these issues. If co-op shareholders or condominium unit owners feel that one or more board members are not acting appropriately, they have the ability to remove and replace them at the next regular election or, in an emergent situation, by special election.”

The Final Word

True, there are some horror stories that exist with board members failing to live up to their fiduciary responsibilities, but for the most part, boards do take their role seriously and a much greater percentage never see a problem.

After all, these people live in the building, too, so it doesn’t behoove them to neglect that leak or do something that will hurt their property values. If you feel there is a problem, sometimes just bringing it to the attention of the board will rectify the situation and help right the ship.

Keith Loria is a freelance writer and a frequent contributor to The Cooperator. 

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Comments

  • Activist Shareholder on Wednesday, April 24, 2019 2:56 PM
    I see myself going the derivative way in the near future. I see the trifecta of personal gain, vendettas, and favoritism. Elections are not producing any + effect.