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COURT OF APPEALS MAKES IT EASIER FOR HOMEOWNERS TO SUE BOARDS

A recent Court of Appeal decision just made it easier for homeowners to sue an association for failure to maintain the common area. The case is Lamden v. La Jolla Shores Clubdominium Homeowners Association (1998) 98 C.D.O.S. 2475.

This case was decided on April 3, 1998 and involved the following facts:

Lamden owned a unit in La Jolla Shores. The complex
consisted of three buildings of 104 units, each with a wooden deck or patio. The complex was built in 1971 and faced the Pacific Ocean. For years, the complex was plagued by termite problems. Lamden strongly believed that nothing less than tenting and fumigating her entire building (the primary treatment suggested) was acceptable to correct the problem.

The Board of Governors received a termite report from Western Exterminator Company that recommended fumigation of all three buildings at a cost of $118,000.00, with a one-year guarantee. Western also guaranteed to provide localized treatment if termites reappeared.

The Board decided not to fumigate. Its decision was based on the following:

1. The cost of fumigation;

2. The expense and logistical problems of relocating residents during fumigation;

3. Concerns about the effect of fumigation residue on residents' health and safety;

4. The fact that planned restoration would include replacement of damaged areas;

5. The expense of moving pets;

6. The cost to repair anything broken by the termite company;

7. Potential claims for lost rental income; and

8. The probability that tenting would provide only short-term benefits, since termites were endemic to wood in coastal areas and would likely soon re-infest the property, thereby requiring spot treatment.

Instead of fumigating, the Association's Board decided to take Western's secondary recommendation of spot treating the infested areas until evidence indicated the problem was more widespread. As the Association did repairs for water intrusion and termites were spotted, the affected area was spot treated.

Over a two year span, the Association renovated the complex's walkway system for about $1.6 million. Of the damage, 90% was caused by water intrusion and only 10% was caused by termites.

Decisions involving structural integrity were made by a structural engineer and an architect ensured that the design was installed according to plans.

Lamden demanded that the Association fumigate (primary treatment) instead of spot treat (secondary treatment). She alleged that the Association, by failing to fumigate, breached its responsibility to take adequate action to repair and maintain the complex's common areas to eradicate wood-destroying pests and organisms. The Association alleged that its conduct was reasonable and in conformity with the Business Judgment Rule (Corporations Code section 7231).

When the case came to trial, both parties agreed that the Association was responsible for the repair and maintenance of the common area occasioned by the presence of wood-destroying pests or organisms. Where they disagreed was whether the treatment should be primary (fumigation, desired by Lamden) or secondary (spot treatment, decided upon by the Association).

The Court denied Lamden's request for an injunction and concluded that the Association's Board was not negligent and did not breach a fiduciary or statutory duty. When the Board decided not to fumigate, it did not act arbitrarily, without any rational business judgment or in bad faith. The court declined to "second guess" the Board's decision since the Board had a rational basis for their decision to reject fumigation and acted in good faith and in a manner that they believed to be in the best interest of the Association, and were reasonably prudent. The Court liked the fact that the Board balanced various factors before making their decision. The Court further stated "one or two unit holders cannot dictate what the other 40 are going to do and ignore the business judgment." The Court awarded $40,000.00 for attorney's fees to the Association. Lamden appealed.

The Court of Appeal, citing Frances T . v. Village Green Owners Ass'n. (1986) 42 Cal.3d 490, stated that a homeowners association could not enforce its CC&R's in such a way that violates statutory or common law.

Characterizing the Association as "for all practical purposes" the complex's landlord, the Court imposed traditional tort principles on the Association, as a landlord, that it must maintain the common areas and exercise due care for the residents' safety in those areas under its control.

The Court then imposed on landlords a duty to exercise due care for their tenants' property and stated that it is basic policy of this state that every person is responsible for injuries caused to others by his failure to use ordinary care or skill in the management of his property.

The Court of Appeal said that these common law principles should have been the test, not he application of the Business Judgment Rule.

THE LAW

Corporations Code section 7231 states that nonprofit directors' standard of fiduciary responsibility is the Business Judgment Rule. A court will not review a directors' business decision or hold directors liable for errors or mistakes in judgment so long as they were disinterested and independent, acting in good faith and reasonably diligent in informing themselves of the facts.

The Business Judgment Rule creates a presumption that in making decisions, the directors acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the association. This presumption means that a plaintiff challenging a board's decision has the burden of proving that the decision involved a conflict of interest, or was made in bad faith or without a requisite degree of care and diligence.

The hallmark of the Business Judgment Rule is that a court will not substitute its judgmentfor that of the board if the latter's decision can be attributed to any rational business purpose. (The Business Judgment Rule and director liability are predicated upon concepts of gross negligence.)

The basis of the Business Judgment Rule is that any mistakes in judgment on the part of the board do not justify taking the control of corporate affairs from the board and placing it in the hands of homeowners. To warrant interference by the court, a case must be made that plainly shows that such action is so far opposed to the true interest of the association itself as to lead to the clear interference that no one thus acting could have been influenced by any honest desire to secure such interest, but that he must have acted with an intent to subserve some outside purpose, regardless of the consequences to the association (see Burt v. Irvine Co . (1965) 237 Cal.App.2d 828).

Courts will generally uphold decisions made by the governing board of an owners' association as long as they represent good faith efforts to further the purposes of the common interest development, are consistent with the development's governing documents, and comply with public policy ( Nahrstedt v. Lakeside Village Condominium Ass'n . (1994) 8 Cal.4th 361).

ANALYSIS

The court made a distinction between the Business Judgment Rule (which gives directors wide latitude in handling their affairs) and the common law tort principle of a director's ordinary duty of care not to injure another. Unlike business judgments that affect only the pecuniary interest of investors (homeowners), the courts have a long record of deciding whether a defendant's personal conduct imposed an unreasonable risk of injury on the plaintiff.

The court went on to reason that Lamden had a "dual relationship" with the Association. The Association's Board were fiduciaries required to exercise due care and undivided loyalty for the interest of the corporation. The Association and Lamden also stood in a common law relationship, similar to that of landlord and tenant. This common law relationship required that in performing its responsibilities to maintain and repair the common areas, the Association was to exercise reasonable care to protect Lamden's unit from undue damage.

The Court of Appeal then stated that the standard of care applicable in this case was provided by common law principles rather than the Business Judgment Rule. Thus, the Association's actions should be analyzed under an objective standard of reasonableness rather than the Business Judgment Rule, which focuses on good faith.

CONCLUSION

The Court of Appeal reversed the trial court's reliance on the Business Judgment Rule which supported the Board's decision. The court sent the case back to the trial court to retry the case.

Why Is This Case Important ?

This case is important because it makes it easier for a

homeowner to sue an association and a board.

How Can An Association Avoid A Result Like This ?

Courts adhere to rules to determine if negligence has occurred. The following is an instruction on negligence that is read by a judge to a jury (BAJI 3.10):

"Negligence is the doing of something
which a reasonably prudent person
would not do, or the failure to do
something which a reasonably prudent
person would do, under circumstances
similar to those shown by the evidence.
It is the failure to use ordinary or
reasonable care.
Ordinary or reasonable care is that
care which persons of ordinary prudence
would use in order to avoid injury to
themselves or others under circumstances
similar to those shown by the evidence.
(You will note that the person whose
conduct we set up as a standard is not
the extraordinarily cautious individual,
nor the exceptionally skillful one, but
a person of reasonable or ordinary prudence.)

To avoid a result similar to the fate of the La Jolla Shores Clubdominium Homeowners Association, a board must ask itself, using the standard above: Is the decision reasonable? Is it prudent? If the answer is "no" to either question, then the board could expose the association to liability and should rethink its position.