When making decisions, association boards are at risk of upsetting their residents; but, what happens if the court becomes involved? In this case, the business judgment rule may be your best tool as an association. So, what is the business judgment rule and how can it be used?
Jennifer Alexander, Esq., a shareholder at Griffin Alexander, P.C. in Randolph, New Jersey, explains how the business judgment rule can be utilized. The rule may be enacted when “the association, their board of directors or trustees, makes a board decision which cannot be changed or over-ruled by the court based upon what we would call the business judgment rule,” She said. She further explains that the decision is upheld by the court so long as the decision is not “fraudulent, self-dealing or unconscionable.”
For example, if the board passes a rule or a special assessment which is in compliance with the association’s governing documents, such as one concerning parking, then the court will not interfere with the board’s decision or special assessment so long as the decision was made in compliance with the governing documents, and was not made for a fraudulent, self-dealing or unconscionable reason, she says. So, what would happen if a resident were to dislike this rule that the board has initiated or dislikes that they are being specially assessed, and were to ask the court to over-rule the decision? The board decision would be protected under the business judgment rule so long as the board members were acting in good faith.
As a part of a condominium or homeowner association, board members have a fiduciary duty, or obligation to act in the best interest of the association and its unit owners. Alexander explains that the business judgment rule parameters fall under this fiduciary duty as board members must ensure that they are acting in good faith and are reasonable when enacting rules and regulations. But, what if a board member has no prior business experience? How would such a board member be viewed in light of this rule in court?
As far as background is concerned, Alexander explains that “none of that is relevant when it comes to the business judgment rule.”
Courts will not look to experience when considering the business judgment rule. “The standard is the same across all the cases — that you’re not being fraudulent, self-dealing or unconscionable in your decision making.” she elaborates. As long as decisions are made with these parameters in mind, it should be upheld by the court and will not be overturned.
Alexander reveals that should an association be sued, the business judgment rule is “a powerful tool” in their defense. If a resident is unhappy with a decision made by the board and was to sue the association, the business judgment rule defense can assist the Board to prove that they had acted in good faith when making the decision, in seeking the court to rule in their favor.
Alexander explains that even “if there is an unrelated procedural error, that cannot be used to invalidate a community association’s decision under the business judgment rule.” In other words, the court will look at the question that is presented in front of them and make a decision on the validity of that specific rule. The court may consider past behavior, but should not rule on decisions outside of that specific case.
Further, Alexander explains that based on case law, incompetence is not equal to fraudulence, self-dealing, or unconscionability. So, even if the board were to make a decision that was considered incompetent, they could still potentially win the case under the business judgment rule.
However, the business judgment rule does not always offer a remedy for a board member if they were to make a mistake.
According to Alexander, the most commonly used precedent in these court cases is Thanasoulis v. Winston Towers 200 Association 110 N.J. 650,644 (1988). In this case, the association established a rule that charged nonresident unit owners (those who rent out their unit and do not live in it themselves) more for parking than resident unit owners. The court ruled that this parking differential was invalid because the parking spaces were a common element and the plaintiff “was proportionally liable for his share of the common expenses,” she explains. This is an excellent example of an association acting outside the protection of the business judgment rule, as this rule was exceeding the association’s authority. “When [the board] made that decision to treat residents versus nonresidents differently — that was not done in good faith,” she says.
Alexander said that the Thanasoulis case has been cited in more recent cases such as Alloco v. Ocean Beach & Bay Club, 456 N.J. Super, 124 (App. Div. 2018) in which the court ruled in favor of the association in applying the business judgment rule. In Alloco, the appellate division affirmed the lower court’s decision that the association, although the rule making decision may have been incompetent, it was not fraudulent, self- dealing or unconscionable, when establishing new rules, the permissible amounts of elevating homes after Superstorm Sandy so it could also be used for parking.
Alexander noted that it seems settled law in New Jersey that provided an association’s decisions (1) do not contradict its governing documents, (2) do not contradict its obligations under the law, (3) are authorized by its governing documents, and (4) are not based on fraudulent, self-dealing or the unconscionable, then the court will uphold those decisions.
Alexander advises that board members should have a “thoughtful process” when making a decision. Consulting governing documents, not acting in a self-dealing manner, and adhering to standards of equality are all ways to remain protected while acting on a decision-making board. Further, consulting management teams and legal counsel can help avoid any issues to begin with, as they can provide guidance concerning the business judgment rule in rule enactment and special assessments. “Often times I have boards come to me after the fact, and I wish [they] would have come to me before,” says Alexander. This proactive measure could save a lot of associations from possible legal problems and legal costs a poor decision could stir-up.