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The California Business Judgment Rule – Bruised and Confused

By Stanley Feldsott
Feldsott Lee Pagano & Canfield

Ever since the California Supreme Court published its opinion in Lamden v. La Jolla Shores  Clubdominium Homeowners Assn. (1999) 21 C4th 249, 87 CR2d 237, 980 P2d 940, we have seen a proliferation of defendant directors asserting as an absolute defense the business judgment rule. Although for a while it appeared as if all activities of a Board of Directors would be protected under the umbrella of the business judgment rule, much of this came to an end with the decision of the court in Ritter & Ritter v. The Churchill Condominium Association (2008) 166 CA4th 103, where the justices correctly pointed out that Lamden by its very language only dealt with the business judgment rule in the context of ordinary maintenance decisions. It did not, for example, address activities that resulted in threats to safety, personal injury or many of the other activities that directors and associations find themselves engaged.

Recently, the California Court of Appeal for the Fourth District, Division One, in the case of Palm Springs Villas II Homeowners Association etc. et al. v. Parth (2016) 248 CA4th 268, set forth a useful discussion of the application of the business judgment rule, taking the reader from the common law rule to California's statutory provisions dealing with the business judgment rule.

Initially, the court pointed out that at common law, the "business judgment rule" was really a judicial policy of giving deference to corporate directors in the exercise of their discretion in making corporate decisions. Under this rule, a director was not liable for a mistake in business judgment which is made in good faith and in what he or she believes to be the best interests of the corporation and where no conflict of interest exists.

In California, the Corporation Code codifies the business judgment rule, making it applicable to nonprofit corporations. Corporation Code §7231 states that:

  • "(a) A director shall perform the duties of a director . . . in good faith, in a manner such director believes to be in the best interests of the corporation and with such care, including reasonable inquiry, as an ordinarily prudent person in a like position would use under similar circumstances."

The statute goes on to state that:

  • "(c) A person who performs the duties of a director in accordance with [the preceding subdivisions] . . . shall have no liability based upon any alleged failure to discharge the person's obligations as a director . . ."

Section 7231.5 sets forth limited liability on the same grounds for volunteer directors and officers.

It should be kept in mind that the business judgment rule, when applicable, protects directors but not the Association itself. For example, in the Ritter & Ritter case, supra, all of the directors were sued, along with the Association. Although the jury found that none of the directors had been negligent, the Association was nevertheless held liable. As pointed out by the Court, ibid, deference to a director’s business judgment does not always immunize the director from liability in the case of his or her abdication of corporate responsibilities. Additionally, the Court notes there is no conflict between the business judgment rule on the one hand and the concept of negligence on the other. A finding of protection under the business judgment rule presupposes that reasonable diligence has, in fact, been exercised. A director cannot close his or her eyes to what is going on in the conduct of the business of the corporation and have it said that he or she is exercising business judgment. Likewise, a director who fails to attend a board meeting may incur, if facts warrant, for any liability that might flow from decisions made at that meeting by the directors present.

Whether a director has exercised reasonable diligence is a factual prerequisite to application of the business judgment rule. The burden of proof is on the director/board to establish the factual prerequisite for applying the rule of judicial deference at trial. Where, for example, there was no evidence that the board engaged in ‘reasonable investigation’ before choosing to continue its ‘piecemeal’ approach to sewage backups, judicial deference will not apply. The codification of the business judgment rule is for the most part set forth in Corporations Code §7231(a) which mandates that a director perform the duties of a director, including duties as a member of any committee of the board upon which the director may serve in:

  1. good faith;
  2. a manner such director believes to be in the best interests of the association; and
  3. with such care, including reasonable inquiry, as an ordinary prudent person in a like position would use under similar circumstances.

The Code goes on to provide that a director shall be entitled to rely upon information, opinions, reports or statements, including financial statements and other financial data, in each case prepared or presented by (a) one or more officers or employees of the association whom the director believes to be reliable and competent in the matters presented, and (b) counsel, independent accountants or other persons as to matters which the director believes to be in within such person’s professional or expert competence.

So, for example, if you are dealing with a property management issue, reliance upon the advice of your property manager would afford the director protection. Obtaining what is tantamount to a legal opinion from the property manager would not bring the director within the ambit of Corporations Code §7231. There is no liability of a director for the acts of a committee on which the director does not serve, where the committee members are protected, or in a situation where they are protected by the business judgment rule, so long as:

  1. the committee is acting within its designated authority;
  2. the director believes their actions merit confidence;
  3. provided the director acts in good faith after reasonable inquiry when need therefor is indicated by the circumstances; and
  4. does not have knowledge that would cause such reliance to be unwarranted.

The application of the business judgment rule to a large extent involves many factual determinations: Did the director really believe he was acting in the best interests of the association? Was the reliance reasonable? Was it a matter that does entitle the director to judicial deference? These are all determinations that are made after the fact. Having appropriate insurance with reasonable policy limits cannot be over-emphasized. A full and complete discussion with your broker as to the types of policies you should have and the policy limits is a director’s first line of defense.

An insurance company’s duty to defend in California is broader than its duty to indemnify. In most cases, when a claim is made the insurance company will provide a defense (and often payment to settle) with what is called the reservation of rights letter, in which the carrier in essence is saying some or all of these claims are not or may not be covered by your policy, but we will nevertheless provide a defense. The costs of increasing policy limits frequently makes good sense.

Director duties and potential liability: is your board protected?

By Jacqueline Pagano, Esq.

Volunteer directors serve an important, often underappreciated role in community associations. Having been vested with considerable power, board members also have specific legal duties, and with these duties come potential personal liability. The following shall summarize what you need to know in order to protect your board and shield your directors from potential liability.

Directors of community association are fiduciaries who owe a duty of due care and a duty of loyalty to the association and its members.  To fulfill this duty, directors must be diligent and careful in performing the duties they have undertaken, and directors must act in the best interest of the association, even if at the expense of their own interest.  If a court finds that the directors breached their fiduciary duty, it may rule the board’s action  invalid and hold the directors individually and personally liable.

In addition to being fiduciaries, directors are also held to a statutory duty to exercise ordinary care in their actions as directors. Thus, a director must perform his or her duties in good faith, in a manner the director believes to be in the best interest of the association, and with such care, including reasonable inquiry, as an ordinarily prudent person would use. In exercising such care, a director is entitled to rely on information, opinions or reports presented by competent professionals.

A director who acts in accordance with the above requirements is shielded from personal liability based upon any alleged failure to discharge the person’s obligations as a director. Breaches of the above duties, however, may subject a director to personal liability.  Breaches might include mismanagement of association funds, failure to enforce governing documents, and failure to maintain the premises so that property values depreciate. Directors further have a duty to exercise sound fiscal management in managing the association’s funds. Failing to adequately fund reserves and/or failing to adhere to operating budgets may constitute breaches of the directors’ fiduciary duty and duty of ordinary care for which directors can be held personally and individually liable.

While vested with a duty of ordinary care, directors of community associations are not guarantors of the success of the association and are not liable for mere mistakes in judgment. Courts recognize that directors must sometimes make difficult cost-benefit decisions and will not second- guess those decisions as long as the directors acted in good faith, in a manner they believed to be in the best interest of the association, and as reasonably prudent people. Thus, directors are protected against personal liability by the "business judgment rule" only to the extent that they have acted reasonably and made decisions based on reasonable inquiry, investigations and reliance on experts’ opinions. While the "business judgment rule" may protect the directors from individual liability, it does not shield the association from potential liability for acts or omissions sanctioned by the board.

Finally, individual directors who satisfy both their fiduciary duty and their duty of ordinary care toward the association and its members can still incur liability for both negligence and intentional torts.  For instance, directors may be held personally liable for negligently failing to maintain the common areas where such failure results in personal injury, emotional distress, property damage or loss.  Personal liability for tortious conduct (including negligence), however, is limited by Civil Code §5800.  Under this section a volunteer director acting in good faith and within the scope of his or her duties will not be personally liable in excess of insurance coverage, so long as the act was not wilful, wanton, or grossly negligent and the association maintains both general liability coverage and director and officer liability coverage in the minimum amounts of $500,000.00 for developments of 100 or fewer separate interests, and $1,000,000.00 for developments with more than 100 separate interests.  By failing to maintain insurance in the statutorily-required amounts, an association is exposing its volunteer directors to potentially having to pay out of their own pockets should they be found liable for failing to maintain the common area resulting in injury, property damage or loss.  Accordingly, associations should always maintain adequate director and officer liability coverage.

A Duty to Disclose Construction Defects to Prospective Buyers?

Posted on April 1, 2016
In a case from 1996, Kovich v. Paseo Del Mar Homeowners’ Assn., 41 Cal.App.4th 863; 48 Cal.Rptr. 2d 758, a homeowner bought a townhouse, but soon after moving in, he discovered cracked walls and slabs. The association was engaged in a construction defect case against the developer during that time, but never provided a disclosure of it in the escrow packet. The homeowner was upset at the discovery of these defects after moving in and naturally decided to sue the association, even though the association was not a party to the transaction. The homeowner’s position was that the association knew about the construction defects and had a duty to disclose such information.

Kovich v. Paseo Del Mar Homeowners’ Assn., 41 Cal.App.4th 863; 48 Cal.Rptr. 2d 758 disagreed and held that the Association owes no duty to prospective purchasers about construction defects or the existence of a civil action against the developer to repair the defects. The Court in this case took a strict view of privity of contract. It was unwilling to extend the disclosure obligations between a seller and a buyer onto a third party homeowners association. While the seller has a duty to disclose information materially affecting the value or the desirability of property to a buyer, the homeowners association only has a fiduciary relationship with its members.

The Appellate Court also agreed with the trial court in that the Davis Stirling Common Interest Development Act, specifically Civil Code §1365, 1365.5 and 1368 (now amended Civil Code §5300, 5500 et seq., and 4525), already lists the escrow disclosure requirements of the homeowners association, and that such laws do not require a voluntary disclosure of the existence of construction defects or pending litigation.

Nothwithstanding Kovich v. Paseo Del Mar Homeowners’ Assn., homeowners associations are still under the obligation to disclose construction defects and pending litigation to its members. If a member is selling his/her separate interest, it is his/her duty to disclose to the buyer. The buck stops with the seller with this disclosure burden.

Properly Conduct a Disciplinary Hearing

Posted on April 1, 2016
Parking violations. Architectural violations. Nuisance violations. These are just a few examples of the many violations that homeowners associations deal with on a regular basis. We frequently see associations simply fine the homeowner without a notice and hearing. Most of the time, people pay it and move on, but sometimes, the fine is challenged. Without giving the violating homeowner due process, the disciplinary measure is invalid.

Here is what is required under Civil Code §5855 for a proper hearing:

"(a) When the board is to meet to consider or impose discipline upon a member, or to impose a monetary charge as a means of reimbursing the association for costs incurred by the association in the repair of damage to common area and facilities caused by a member or the member’s guest or tenant, the board shall notify the member in writing, by either personal delivery or individual delivery pursuant to Section 4040, at least 10 days prior to the meeting.

(b) The notification shall contain, at a minimum, the date, time, and place of the meeting, the nature of the alleged violation for which a member may be disciplined or the nature of the damage to the common area and facilities for which a monetary charge may be imposed, and a statement that the member has a right to attend and may address the board at the meeting. The board shall meet in executive session if requested by the member. (c) If the board imposes discipline on a member or imposes a monetary charge on the member for damage to the common area and facilities, the board shall provide the member a written notification of the decision, by either personal delivery or individual delivery pursuant to Section 4040, within 15 days following the action.

(d) A disciplinary action or the imposition of a monetary charge for damage to the common area shall not be effective against a member unless the board fulfills the requirements of this section." (Emphasis supplied.)

This is the bare minimum required to have a proper disciplinary hearing. Oftentimes, the association’s governing documents require additional documentation and disclosure language. We have seen some By-Laws require a formal complaint with a procedure for a written response prior to the disciplinary hearing. All of this might seem oppressive, but the point of it all is to protect the Association’s interests in the event the matter is litigated.

TURF WARS – What New Drought Legislation Means for Your HOA

Posted on February 27, 2016
Nearly six months have passed since Governor Brown signed into law urgency legislation which, effective immediately upon its execution on September 14, 2015, seriously restricted the ability of homeowner associations to restrict members’ installation of artificial turf on their separate interests. Despite the passage of time, and the clear mandate set forth in the law, recent correspondence to our office suggests that some homeowners and associations are still unclear on what they can and cannot do. So, here is a recap.

Civil Code §4735 was enacted in 2014 to promote water conservation by voiding any CC&R provision which prohibited, or had the effect of prohibiting, the use of low water-using plants, and prohibiting HOA’s from assessing fines against owners who reduced or eliminated watering. The law was later expanded to also apply to provisions of architectural and landscape guidelines or policies, and to clarify that low-water using plants may be used as a replacement for existing turf.

On September 14, 2015, Governor Brown signed into law an amendment which further expanded Civil Code §4735 to provide that in addition to provisions restricting low water-using plants, provisions of the governing documents which sought to prohibit, or had the effect of prohibiting, the use of artificial turf or any other synthetic surface that resembles grass are void and unenforceable.

So where do we stand today? (1) An HOA may not prohibit, or include conditions that have the effect of prohibiting, an owner’s use of low watering plants or artificial grass as a replacement for existing turf or otherwise; (2) An HOA may, however, apply landscaping rules established in the governing documents to the extent the rules do not prohibit the use of water friendly plants or turf; (3) Unless your community uses recycled water, an HOA may not fine an owner for reducing or eliminating watering of vegetation or lawns so as long as the drought remains in effect; and (4) Upon the conclusion of the drought, the HOA may again require owners to water vegetation and lawns, but may not require owners to remove and replace installed water-efficient landscaping measures.

So, as long as our state remains in a drought, owners in common interest developments get to install artificial turf and low water-using plants, and the turf and plants get to stay even after the drought. Accordingly, if your association does not already have in place landscape guidelines regulating the installation or artificial turf and establishing standards requiring use of high quality turf products, it would be prudent to immediately consider adopting same. Otherwise, you may end up stuck with an owner’s roll-out putting green lawn or carpet-like turf for the remainder of the foreseeable future.

Recall Elections – The Kind of Stuff Lawsuits Are Made Of

Posted on February 27, 2016
Association elections can be heated, and none so much so as a recall election. Perhaps because emotions are high, or because of the rather complicated statutory framework associations are required to follow, recall elections are more likely than any other association vote to land an association in court. To avoid the perils of those who came before you, follow the below the suggestions:

1. Pay Attention to the Petition. Recalls can be emotional, but take the membership petition seriously. The members have a right to call a special recall meeting by submitting a petition signed by at least five percent (5%) of the total members to the board. The board should avoid looking for technical defects in a recall petition and, instead, immediately notify the association’s legal counsel.

2. Watch the Clock. Receipt by the board of a valid recall petition starts two different clocks. "Clock 1" relates to noticing the recall meeting and requires that notice of the meeting be mailed within 20 days of receiving the petition. This notice should also include a call for candidates should the recall measure pass. "Clock 2" refers to the meeting date and requires that the recall meeting take place not less than 35 days and not more than 90 days from the date the petition is received. Throw in the Corporations Code requirement that notice of meeting be sent 20 to 90 days before the meeting (or any different notice requirement contained in your bylaws), and the requirement that ballots be distributed to the members at least 30 days before a meeting, and what you get is a lot of clocks. This is why it is important to immediately notify counsel when a recall petition is received.

3. Know the Vote Requirement. The number of votes required to pass a recall measure is determined by the Corporations Code and depends on several factors, including the size of your association, whether or not the entire board is being recalled, and, if not, whether cumulative voting is authorized by your bylaws. In associations that utilize cumulative voting, unless the entire board is being removed, a director may not be removed if the votes cast against removal, or not consenting to removal in writing, would be sufficient to elect the director if voted cumulatively at an election at which the same total number of votes were cast and the entire number of directors were being elected. A rather complicated formula is used to determine the number of votes needed to defeat recall of one or a select few directors. Associations are wise to rely on legal counsel to do the math.

4. Master the Meeting. The day of the recall meeting, the inspector of elections should first establish whether quorum has been met using the same quorum requirement set forth in the bylaws for all other membership meetings. If quorum is not met, you may anticipate a motion from the floor either to permanently adjourn the meeting or to adjourn the meeting to a later date at which a reduced quorum requirement may apply if provided in your bylaws. Any such motion to adjourn passes by a hand-raise vote of those members in attendance. If a quorum is established for a recall meeting, then ballots will be counted. A ballot for a recall meeting should contain two separate initiatives: (1) a vote for or against recall, and (2) a vote to elect one or more replacement directors should the recall measure pass. If the first initiative passes, then the votes cast for the second initiate should be counted, tallied and reported by the inspector of elections. General notice (i.e., positing, etc.) of the tabulated results of the election must be given to members within 15 days of the recall meeting.

5. Stay Impartial. The association, as an entity, has no stake one way or the other in the outcome of a recall election. A recall election is essentially a battle between the incumbent directors and the challengers who would like to take their seats. While the incumbent directors, as individuals, obviously have a stake, the board, the association and the managing agent should all remain neutral.

Brown Lawns

Posted on September 11, 2015
Grass might just be a thing of the past for Southern California. Check out this interesting article about lawns here. This podcast episode from 99% Invisible does a really good job of describing the controversy surrounding lawns and also providing a little bit of history about how we came to value the lawn in the United States.

Opening Board Meetings With Prayer

Posted on November 14, 2014
I have not been to many meetings where this happens, but sometimes, it does — a board meeting that commences with prayer. In an age of diversity awareness, it just seems unusual to me whenever it happens. Homeowners associations have historically been likened to small municipalities. As such, it would seem to follow that homeowners associations would be run and regulated like a city and that the Establishment Clause of the First Amendment would apply.

The problem is that homeowners associations are not public entities. They are common interest developments, often times incorporated, and created to regulate private property. Because of this fact, many laws that regulate public entities do not apply. Southern California Housing Rights Center v. Los Feliz Towers Homeowners Association, 426 F.Supp.2d 1061 (C.D. Cal. 2005) held that the Americans with Disability Act (ADA) does not apply to homeowners associations because it is not a place of "public accommodation."

Nonetheless, there have been several instances where Courts have treated homeowners associations like a public entity.

Country Side Villas Homeowners Assn. v. Ivie,193 Cal. App. 4th 1110, 1120(Cal. App. 6th Dist.2011) held that homeowners have freedom of speech rights when homeowners speak out about "private conduct that impacts a broad segment of society and/or that affects a community in a manner similar to that of a governmental entity. In the same case, the Court reasoned that "[M]atters of public interest … include activities that involve private persons and entities, especially when a large, powerful organization may impact the lives of many individuals."

Cabrera v. Alam,197 Cal. App. 4th 1077, 1078(Cal. App. 4th Dist.2011) found that a homeowner’s association’s annual meeting was a public forum and that candidates for the board of directors were "limited purpose public figures."

In light of the conflicting treatment of homeowners associations (private entities in some instances and public entities in others), how would the Establishment Clause of the Constitution apply? There is currently no case law directly on point. If the Courts were to find that meetings are "public forums," it may be the case that Courts would preclude prayer under the Establishment Clause. However, if Courts were to find that meetings located on private property with only members of the homeowners association, then prayer might be acceptable. From a policy standpoint, homeowners should be not disenfranchised at board meetings. A religion-neutral zone would be the safest standard.


Posted on November 14, 2014
Though you might not believe it, disputes arise between homeowners associations and their members. Yes, it’s true. The Davis-Stirling Common Interest Development Act ("the Act") requires associations to provide for an internal dispute resolution process ("IDR") meant to be relatively informal, cost-free and expeditious. The default IDR provided for in Civil Code §5915 requires that if a member makes a written request for IDR to an association, then the association’s board must designate a director to promptly meet with the member at a convenient time and place, that each of the parties explain their positions to each other, and that they confer in a good-faith attempt to resolve the dispute. The Code also provides that the association may not charge a fee for participation in the IDR, and that each party must absorb the cost of their own counsel. Civil Code §5900 et seq. contemplates the welcome prospect that a quick and civil conversation between one director and a member will lead to a fair resolution of a dispute without having to incur the expense and adversity of litigation or alternate dispute resolution ("ADR").

In what turned out to be a controversial move, §5900 et seq. was recently amended to provide that parties to an IDR may bring attorneys and other advisors to the IDR meeting. Even before the amendment was passed, nothing in the Act forbade parties from brining their counsel to IDR meetings, and it has not been uncommon for parties to invite their counsel to attend. Although involving attorneys increases the cost of an IDR, oftentimes the involvement of attorneys increases the chances that a resolution can be found during the IDR process, thereby allowing the parties to avoid expensive litigation or ADR. Thus, involving attorneys during IDR in more contentious or complicated disputes may actually save the parties money in the long run. Nevertheless, some associations have enacted IDR procedures forbidding the presence of attorneys at IDR meetings. The recent amendment to the Act no longer allows such restrictions.

Many have voiced concern that the new amendment, in effect, will ensure that no IDR will occur without the presence (and expense) of an attorney. If each party knows the other has a right to bring counsel, then each is likely to bring his own counsel to "even the playing field". The new amendment sets up a classic prisoners’ dilemma scenario that seems to ensure a lose-lose outcome. However, there is a solution to the dilemma for the cost-conscious association. Civil Code §§5905, 5910 allows associations to enact their own customized IDR procedures, and nothing in the new amendment forbids an association from requiring a party to give notice if they plan to invite their attorney. Enacting such a notice provision will allow the parties to avoid having to preemptively hire legal counsel for each and every IDR process, and allows for the possibility of that simple, quick and cost-free procedure that the Code originally contemplated as an IDR.

Management Companies and Liability Concerns

Posted on October 16, 2014
(1) Contractual Liability
The management company/community manager acts as the agent for the association/board of directors. Under general laws of agency, the association/board of directors is the principal and the management company/community manager is the agent. So long as this agency relationship is disclosed to the third party (i.e. contractor), it is only the principal and not the agent that has any contractual liability to that third party.

In entering into contacts for maintenance with respect to the common area, it is absolutely essential that the contact clearly indicate that it is the association that is contracting with the third party and the management company and/or community manager is signing that contract as an agent for the association. All proposals should be directed to the association in care of the management company. Additionally, the proposal should clearly indicate that the association is a corporation. If the community manager is going to sign the contract or proposal on behalf of the association (this is not usually a good idea), the signature line should include the community manager’s name and immediately following such "authorized agent and community manager."

If a proposal is submitted in the name of the management company regarding the association, the contractor should be requested to resubmit the proposal or alternatively the proposal should be modified to make clear that it is being submitted to the association in care of the management company. Keep in mind that once a proposal is accepted it becomes a contract. If the proposal is to the management company, even if it is signed by an officer of the association, the management company can find itself named in a breach of contract lawsuit.

(2) Tort Liability Arising Out of Common Area Maintenance
"Torts" is the legal profession’s word for private wrongs. The existence of an agency relationship does not shield the agent or the principal from tort liability. Tort law covers a number of different claims, including negligence, assault, battery, trespass, libel, slander, and so on. Most tort claims involve acts of intention. For example, if the community manager uses a baseball bat on a homeowner, a claim by a homeowner based on battery could be brought against the community manager, the property management company, and the association/board of directors, assuming the act occurred during the course and scope of the community manager’s employment. Course and scope of employment is always a factual issue. Keep in mind that torts of intention are not covered by any insurance.

The largest number of common area claims that are asserted against the management company, the community manager, the association and members of the board of directors will be based upon negligence. The scope of volunteer directors’ liability has, if certain criteria are met, been greatly circumscribed. The general rules of negligence, however, apply to the association itself, the property management company and the community manager. In general, in order for a plaintiff to prevail on a claim of negligence, the plaintiff must prove duty, breach of duty, cause in fact, proximate cause and damages.

The duty owed is often referred to as "the reasonable man or prudent businessman standard", i.e. a person owes a duty to exercise that degree of care that the average reasonable man would under the same or similar circumstances recognize, that the failure to exercise would pose a foreseeable risk of harm to a foreseeable plaintiff. So, for example, permitting green slippery slime to remain on a common area sidewalk that members of the association frequently walk on could easily satisfy the elements of duty and breach of duty. A homeowner takes an evening stroll on that sidewalk unaware of the existence of the slime, falls and breaks his leg. This scenario is very likely to provide for the assertion of a successful claim for negligence.

(3) Management Company Protection
One of the problems with lawsuits based on negligence grounded in a failure to properly maintain the common area is that what "the average reasonable person would have done" is always determined after the fact. It is therefore extremely important that a management company not only carry its own insurance, but makes certain that it is also named as an additional insured on the association’s insurance policy. Deductibles and coverage are often slightly different on the two policies. Coverage and policy limits are thus maximized for the management company.

The second line of defense for the management company is to have a well worded indemnity clause with the association providing for both indemnification and defense in connection with any claims asserted against the management company related to the activities or conduct of the management company carried on in the course and scope of its employment. This indemnification should typically include both contract and tort liability. Issues often arise between the association and the management relative to the breadth and scope of the indemnity clause. In one sense, the real issue is whose insurance company (the association or the management company) is going to pay for the defense and indemnification. In today’s insurance market, with ever increasing deductibles and exclusions, the language contained in the indemnification clause takes on greater significance.

The first line of defense for community managers and directors is, of course, to act prudently, cautiously and exercise sound business judgment. No doubt the vast majority of the field already possesses and acts in accordance with these traits. What may be helpful is to understand the importance of carrying adequate insurance. The difference in cost between an insurance policy with a $1,000,000 policy limit and a $2,000,000 policy limit is generally not that great. Do not limit yourself to minimum insurance requirements.

As a community manager, make certain that all contracts are executed properly, with the association clearly identified as a corporation and as the contracting party. Have your attorney review the "indemnity clause" in the management contract. If your association bylaws permit a non-owner who is not a tenant of a separate interest to serve on the board of directors or if you own more than two units within the development, be aware of the fact the Civil Code §5800 does not shield you from personal liability; i.e., liability in excess of required type and amount of insurance. Major decisions involving the nature and extent of common area maintenance or its deferral should always (oh, how lawyers hate the word always) be made after seeking competent professional advice

Court of Appeals Takes Stand on Partial Payments

Posted on October 16, 2014
In an opinion filed on October 14, 2014 and certified for publication, the California Court of Appeal has held that a homeowners association must accept a partial payment made by an owner of a separate interest in a common interest development and must apply that payment in the order prescribed by statute (i.e., to assessments first). The Court further held that the association’s obligation to accept partial payments continues after a lien has been recorded against an owner’s separate interest, and the association’s ability to pursue foreclosure of its lien depends upon the amount and the age of the assessments following application of the partial payments. (See opinion filed in Huntington Continental Townhouse Association, Inc. v. Miner (2014) Case No. G049624.)

In making its ruling, the Appellate Court relied largely on Civil Code §5655(a) in the Davis-Stirling Common Interest Development Act, which states that: "Any payments made by the owner of a separate interest toward a debt described in subdivision (a) of Section 5650 shall first be applied to the assessments owed, and, only after the assessments owed are paid in full shall the payments be applied to the fees and costs of collection, attorney’s fees, late charges, or interest." The Appellate Court held that the above provision both permits an owner to make a partial payment at his or her whim and requires the association to accept the partial payment and credit it to the owner’s account.

The Court further stated its opinion that the Legislature intended for section 5655(a), requiring an association to accept partial payments, and section 5720(b), limiting foreclosure, to apply both to judicial and nonjudicial foreclosure and to prevail to the extent of any conflict with Civil Code section 2924c, subdivision (a)(1) (which governs foreclosure pursuant to a power of private sale).

The Huntington Continental case involved a situation where an association had recorded a delinquent assessment lien against an owner and filed a judicial foreclosure lawsuit in Superior Court. Prior to trial, the owner attempted to submit a payment which would cover only his delinquent dues and not any interest, late fees, attorney’s fees or collection costs. Acceptance of the partial payment would have brought the assessment debt below the statutory threshold to foreclose. Because the payment was rejected by the association, the Appeals Court held that the association was not entitled to foreclosure and, thus, reversed the judgment for foreclosure entered by the trial court.

At the end of the day it seems that the Court wanted to further restrict an association’s right of foreclosure and has elected to construe certain provisions of Davis-Stirling to support this result.

What To Do with That Big Pool of Money (aka Reserve Funds)

Posted on September 11, 2014
All associations have (hopefully) an adequately funded reserve. These funds are primarily used to pay capital improvements. Just like your 401(k) or any other savings fund, a common question becomes, what can we do with this big pool of money? We all know that a board of directors has a fiduciary duty to its membership and must therefore prudently protect the principal of a reserve fund, but the law does not provide an investment plan.

The law, Civil Code §5515(c), simply says this about what to do with your reserve fund:

"The board shall exercise prudent fiscal management in maintaining the integrity of the reserve account, and shall, if necessary, levy a special assessment to recover the full amount of expended funds within the limits required by this section. This special assessment is subject to the limitation imposed by Section 5605. The board may, at its discretion, extend the date the payment on the special assessment is due. Any extension shall not prevent the board from pursuing any legal remedy to enforce the collection of an unpaid special assessment." (Emphasis supplied.)

Admittedly, this is a law firm and not a money management firm. We are writing as lawyers and not financial managers. However, it is worth it to investigate the issue of "prudent fiscal management." Frequently, we see reserve accounts being held in money market accounts, certificates of deposit, or simply savings accounts. While these investment products definitely protect principal, are they necessarily prudent?

Inflation rates are roughly 2.3% (between 2013 and 2014; see inflation calculator). Savings accounts barely exceed .05%. With inflation growing the way it is, it would actually seem not to be prudent to keep your reserve fund there. You might as well stuff your reserve fund in your mattress.

Some board of directors wonder why they can’t simply invest the money and try to make up the inflation in an alternative way. Although an association may invest money in equities or riskier investments, the question becomes whether it should invest the reserve account that way. A director’s duty to the membership is to protect the reserve account so that the money is there when the association needs it. This duty outweighs the potential benefit that may be derived from any profits from riskier investments.

For the sheer practical purpose of diminishing liability from losing any of the reserve account money, we typically advise our clients to only put reserve funds investments guaranteed by the federal government (e.g., FDIC). A money manager could be helpful in identifying a product that has the highest rate of return that is also backed by the federal government. If your board of directors is working with a money manager, we recommend also seeking advice of counsel.

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