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September 9, 2005
Board Member Liability Protection - How to Optimize It
These days, it's getting tougher and tougher to recruit good board members in common interest developments. One has to ask what makes people serve when board members all over the state of California face thankless service, undeserved criticism, false assumptions, low (actually no) pay, sometimes long hours, the need to solve often complicated and difficult decisions, bad press and threats of being sued by every disgruntled homeowner. Board member liability is a big issue. So what protection is there?
Civil Code Section 1365.7 provides some protection for "volunteer" board members (those who are not working for the developer and who own only one or two units and not more)in residential CIDs (common interest developments). The condition is that an association must carry policies of insurance providing coverage for general liability and individual liability of officers and directors of the association for negligent acts or omissions with the minimum amounts of coverage of $500,000 if 100 or fewer separate interests and $1,000,000 if more than 100 separate interests. The statute wording means essentially that a board member cannot be sued personally for amounts up to the Association's coverage but there are other conditions as well. And an Association that sticks to the statutory limits is probably not giving adequate protection for board members because in today's world, these coverages are considered on the low side.
There are other requirements of course. The protection is not intended for rogue directors. The actions of the board member (1) must be performed within the scope of the director’s or officer's association duties, (2) must be performed in good faith, and (3) must not be wanton, willful, or grossly negligent.
Good faith is determined by motive and intent. Most board members are well-intentioned (in spite of what you read in the newspapers). Sometimes that is hard to determine for sure, but it is easy to claim innocence, so a lack of good faith would have to be fairly obvious. The scope of duties could be generally defined but there are situations where the lines blur. For example, what if a board member is out walking the neighborhood looking for rules violations and confronts an owner about the car parked on the lawn, and thereafter the confrontation elevates to a fist fight. What if a board member causes a contractor to leave the site by trying to micromanage the work, after the board member has been warned by the other Board members and the association's attorney that they are not to interfere with or have contact with the contractor. What if a Board member is sued for defamation for bad-mouthing a contractor? What if the Board member misspends association funds (like the one who bought himself an expensive airplane ticket to return early from visiting his father to attend a controversial association meeting). Are these examples performance of the duties or acting within the scope of what would be expected of a board member? Willful and wanton behavior is an act that is intended to or likely to cause distress or harm of some kind. Gross negligence is a lot worse than ordinary negligence. Making a mistake such as poor budgeting is usually ordinary negligence, but making a mistake involving conduct that one knows is wrong, is against the law, or is ill advised crosses the line. These points can be argued by lawyers. The best protection comes from acting reasonably.
There is also protection in the Corporations Code (7231 and 7231.5) in statute commonly known as the "safe harbor" statutes. If a board member acts in a manner he or she believes is in the best interests of the (in an incorporated) Association and with reasonable inquiry or reliance on information, opinions, reports, statements, or other data, financial or otherwise, prepared by officers or employees believed to be reliable and competent in the matters presented, or by independent counsel, accountants or other persons qualified to give opinions, the board member cannot be sued for the action. Again, "good faith" plays a large part in things.
Associations should also carry directors' and officers' liability insurance that protects the Association and Board members from liability (including payment of damages and/or defense costs of any lawsuit). Most governing documents include a requirement to carry this insurance, but many do not specify a minimum, so the statute mentioned above becomes the guide. However industry standards suggest more coverage than the statute dictates. If the association documents do not provide the authority for insurance coverage then I would have to suggest a document amendment. It is critical to provide protection for those willing to do service.
Many board members are covered by individual homeowner's insurance policies purchased to provide protection on their individual units. Many homeowners' policies include some coverage for service on nonprofit boards. This is something a board member might want to explore.
And most governing documents provide indemnification protection for board members that says board members are entitled to a defense of a lawsuit against them or payment for damages they might be adjudged for actions taken on behalf of the Association. The Corporations Code provides authority for corporations to "indemnify" any person threatened with a lawsuit for specific causes of action related to corporate service, or action brought by the Attorney General, and to pay judgments, fines, etc. (Corporations Code Section 7237)
One area where board members can lose some of these protections is by accepting compensation for services as a board member. The statutes only protect uncompensated (volunteer) board members. The Association's insurance policy may have limitations too - it is wise to check this if there is any compensation. Some Associations provide assessment waivers for board members (although not a commonly recommended practice) and it is important to understand that if a board member receives an assessment waiver in any proportion or amount, that could be considered compensation for purposes of analyzing liability protections.
So - there are some common protections and thank goodness for this. Most board members deserve protection from lawsuits and judgments that are a result of acting on behalf of the Association. But it is important to remember that the protections come through good faith actions, keeping within the normal scope of a board member's duties, not accepting compensation, and consulting with the right kind of experts or seeking information from the right (reliable and informed) sources. It is important to optimize the protections, so that Board members can stop losing sleep at night everytime a disgruntled owner threatens to sue. Unforetunatetly, it seems to be a common practice here in our state to threaten a lawsuit before asking how things might be resolved.
Posted by Beth Grimm at September 9, 2005 9:16 PM