Business Judgment Rule

Though directors serve as fiduciaries, they are afforded several liability protections under California law. One of those protections is a legal doctrine known as the “Business Judgment Rule.” It generally shields directors from personal liability that may result from their decisions, provided that the decision was made (1) with care, (2) in good faith, and (3) was based upon what the director believed to be in the best interest of the association.

Corporations Code
The Business Judgment Rule is mainly found at Corporations Code Section 7231. Where a director performs his/her duties in accordance with subdivisions (a) and (b) of Section 7231, the director “shall have no liability based upon any alleged failure to discharge the [director’s] obligations as a director.” (Corp. Code § 7231(c).)

A director must perform his/her duties: (Corp. Code §7231(a))

  • In “good faith”;
  • In “a manner [the] 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.”

In performing their duties, directors are entitled to “rely on information, opinions, reports or statements, including financial statements and other financial data,” that are prepared by: (Corp. Code § 7231(b))

  • Officers or employees of the association whom the director believes to be competent;
  • Counsel, independent accountants or other qualified professionals or experts; or
  • Committees upon which the director does not serve, subject to certain requirements.

The Business Judgment Rule has been interpreted by California courts as setting “up a presumption that directors’ decisions are based on sound business judgment. This presumption can be rebutted only be a factual showing of fraud, bad faith or gross overreaching.” (Ritter & Ritter v. Churchill Condominium Assn. (2008) 166 Cal.App.4th 103, 123.); See also “Rule of Judicial Deference.”)

No Automatic Protections for Directors who Remain Willfully Ignorant
“When courts say that they will not interfere in matters of business judgment, it is presupposed that judgment—reasonable diligence—has in fact been exercised. A director cannot close his eyes as to what is going on about him in the conduct of the business of the [HOA] and have it said that he is exercising business judgment.” (Palm Springs Villas II HOA v. Parth (2016) 248 Cal.App.4th 268, 280.) The Business Judgment Rule’s protections do not apply to directors who choose to “remain ignorant and to rely on their uninformed beliefs” as to the issues surrounding their decisions, or their authority to make those decisions in their capacity as directors. (Parth, at 268.)

Davis-Stirling Act (Civil Code)
Elements of the Business Judgment Rule underlie the liability protections for volunteer officers and directors under Civil Code Section 5800.  Section 5800 shields volunteer officers and directors from personal liability “to any person who suffers injury, including, but not limited to, bodily injury, emotional distress, wrongful death, or property damage or loss as a result of the tortuous act or omission” of the volunteer officer or director where all of the following criteria are met: (Civ. Code § 5800(a))

  • The act/omission “was performed within the scope of the officer’s or director’s association duties”;
  • The act/omission “was performed in good faith”;
  • The oct/omission “was not willful, wanton, or grossly negligent”; and
  • “The association maintained and had in effect at the time the act or omission occurred and at the time a claim is made one or more policies of insurance which shall include coverage for (A) general liability of the association and (B) individual liability of officers and directors of the association for negligent acts or omissions in that capacity; provided, that both types of coverage are in the following minimum amount:
    • (A) At least five hundred thousand dollars ($500,000) if the common interest development consists of 100 or fewer separate interests.
    • (B) At least one million dollars ($1,000,000) if the common interest development consists of more than 100 separate interests.”

“Rule of Judicial Deference” to HOA Boards
In the context of homeowners associations, the California Supreme Court has adopted a rule which it termed as analogous to the Business Judgment Rule: the “Rule of Judicial Deference.”  The Rule of Judicial Deference (aka “Business Judgment Doctrine”) generally requires courts to defer to decisions made by HOA boards even if a reasonable person would have acted differently in the same situation:

“…We hold that, where a duly constituted community association board, upon reasonable investigation, in good faith and with regard for the best interests of the community association and its members, exercises discretion within the scope of its authority under relevant statutes, covenants and restrictions to select among means for discharging an obligation to maintain and repair a development’s common areas, courts should defer to the board’s authority and presumed expertise.” (Lamden v. La Jolla Shores Clubdominium HOA (1999) 21 Cal.4th 249, 265.)

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Related Statutes

Related Case Law

  • Palm Springs Villas II HOA v. Parth
    (2016) 248 Cal.App.4th 268

    [Fiduciary Duty; Business Judgment Rule] The Business Judgment Rule does not automatically shield a HOA director from liability that may result from the director’s failure to exercise reasonable diligence or failure to act within the scope of the director’s authority under the HOA’s governing documents.

  • Ritter & Ritter v. Churchill Condominium Association
    (2008) 166 Cal.App.4th 103

    [Maintenance; Board Deference] The deference afforded to HOA boards covers only “ordinary” maintenance; the “Lamden Rule” only insulates directors from liability, not the HOA.

  • Lamden v. La Jolla Shores Clubdominium Homeowners Association
    (1999) 21 Cal.4th 249

    [Rule of Judicial Deference; Maintenance] Courts will defer to decisions made by a HOA Board of Directors regarding ordinary maintenance of a common interest development.

  • Nahrstedt v. Lakeside Village Condominium Association, Inc.
    (1994) 8 Cal. 4th 361

    [Governing Documents; Use Restrictions] CC&R restrictions are presumed reasonable, and are enforceable unless they are arbitrary, impose burdens on the use of land that outweigh their benefits, or violate public policy.

Related Links

Business Judgment Rule Does Not Protect the Willfully Ignorant” – Published on HOA Lawyer Blog (08/16)