Q: What exactly is the "business judgment rule"? I have a problem with my condominium board, and the condo attorney keeps referring to this as a defense. Can you explain? Herb.
A: To my knowledge, this "rule" began in Delaware many years ago, created by judges to protect members of a Board of Directors from liability for decisions that they make. In effect, a judge will say "even if the board (or a director) made a mistake, we will not second guess or punish them unless they have done something criminal or truly nefarious".
Many states including Maryland, Virginia -- and more recently the District of Columbia -- have adopted the business judgment rule for condominium associations.
Why? Because service on a condo association board is a thankless, payless, position, and if board members can also be sued and be personally liable for money damages because a homeowner is upset, those board members will not serve. Many board members have told me that but for the business judgment rule -- as well as the Officers and Directors insurance -- they would never have agreed to be on the board.
The courts have consistently held that volunteer board members are not perfect, and will make decisions that are not always correct.
A recent case from New Jersey recent defined the rule as follows: "the test is (1) whether the association's actions were authorized by statute or by its own bylaws... and if so (2) whether the action is fraudulent, self-dealing or unconscionable." If a contested act of the association meets each of these tests, the judiciary will not interfere.(Anklowitz v. Greenbriar at Whittingham Community Association, decided August 29, 2014.)
One author, writing in the Valparaiso University Law Review, pointed out that "the rule is multi-faceted. Most generally, the business judgment rule acts as a presumption in favor of corporate managers' actions. Stronger still, the rule provides a safe harbor that makes both directors and their actions unassailable if certain prerequisites have been met."
In the District of Columbia, for many years the business judgment rule for condominiums was rejected by the courts; instead, the courts imposed a "reasonableness" test: was the board reasonable in taking (or not taking) the action complained of? While this often generated more favorable decisions in favor of condo owners, it created uncertainty and anxiety among board members -- as well as additional time and legal expenses while the court decided each case.
However, the DC City Council recently amended the condominium act. Among many other provisions, the reasonableness test was rejected in favor of the business judgment rule. According to the committee report, that rule "is generally thought to be more deferential to the informed judgment of the association or executive board, giving such bodies confidence to govern without fear of second guessing by courts."
However, the report warned "that it does not absolve officers from their fiduciary duties. They must still work in good faith, stay reasonably informed, and only take actions in furtherance of the legitimate interests of the condominium association they represent... Under the business judgment rule, officers would still be liable for instances of fraud or negligence and actions can be overturned where they fail to adhere to the association's instruments and procedures."
This, in my view, is a good summary of the rule. In effect, it still preserves the element of "reasonableness".
However, I have one disagreement with that statement, namely, board members should be more than "reasonably informed". They should be fully informed. I cannot tell you how many board members who have openly admitted to me that they never bothered to read their association's legal documents; is that good "business judgment".