One of the more common common conflicts of interest that arise in the context of homeowners associations involves situations where a contract is awarded to a company in which a director of the association (or a relative of the director) has a material financial interest. Such “interested transactions” may render the contract void or voidable unless:
- The material facts as to the transaction and to the interested director’s conflict are fully disclosed or known to the membership and such contract or transaction is approved by the members, with the interested director abstaining from voting; or
- The material facts as to the transaction and the interested director’s interest are fully disclosed or known to the board or committee, and the board or committee authorizes, approves or ratifies the contract or transaction in good faith by a vote sufficient without counting the vote of the interested director or directors and the contract or transaction is just and reasonable as to the corporation at the time it is authorized, approved or ratified. (Corp. Code §§ 310, 7233; Civ. Code § 5350(a).)
Where the decision to approve a transaction or contract benefiting an interested director is challenged, the most significant facts which are considered include:
- Full Disclosure of Material Facts. Whether the interested director made full disclosure of all material facts regarding the actual or perceived conflict to the remaining members of the board.
- Recusal. Whether the interested director recused himself from board discussions on the proposed transaction or contract, as well as the board’s vote, in order to avoid influencing the board’s decision.
- “Just and Reasonable”. Even if the interested director disclosed all material facts and recused himself from the discussions and vote, the contract or transaction must still be “just and reasonable as to the [association] at the time it is authorized, approved or ratified.” (Corp. Code §§ 310, 7233; See also Harvey v. The Landing Homeowners Association (2008) 162 Cal.App.4th 809.)
“Just and Reasonable” – Burden of Proof
Where the validity of an interested transaction is challenged as not being “just and reasonable,” the party who bears the burden of proof depends upon whether the interested director participated in the decision to authorize the transaction or contract, or instead recused himself in order for the transaction or contract to be approved by a “disinterested majority” of the board:
“Where a disinterested majority approves the transactions and there was full disclosure section [7233(a)(2)] applies, and the burden of proof is on the person challenging the transaction. [Citation.] Where, however, the approval was not obtained from a disinterested board vote, section [7233(a)(3)] applies and requires the person seeking to uphold the transaction to prove it was ‘just and reasonable’ as to the corporation.” (Harvey, at 823-824 (Emphasis added.).)
Recusal & Quorum
An interested director’s presence at a meeting of the board or a committee thereof which authorizes, approved or ratifies a contract or transaction may be counted for the purpose of establishing quorum. (Corp. Code §§ 310(c), 7234.) However, the interested director should recuse himself from the board’s discussion and abstain from voting on the interested transaction. (Robert’s Rules, 11th ed., p. 407.)
Prohibited Actions by Directors & Committee Members
As provided for in Civil Code Section 5350(b), a director or member of a committee is prohibited from voting on the following matters affecting the director or committee member:
- Discipline of the director or committee member;
- An assessment against the director or committee member for damage to common area or facilities (i.e., the vote to levy a “Reimbursement Assessment” against the director or committee member);
- A request, by the director or committee member, for a payment plan for the director or committee member’s delinquent assessments;
- A decision whether to foreclose on a lien on the separate interest of the director or committee member;
- Review of a proposed physical change to the separate interest of the director or committee member (i.e., voting to approve the director or committee member’s architectural application); and
- A grant of exclusive use of common area to the director or committee member.
Related Case Law
- Harvey v. The Landing Homeowners Association
(2008) 162 Cal.App.4th 809
[Conflicts of Interest; Burden of Proof] The burden of proof transfers onto the person challenging the interested transaction when the interested Director makes full disclosure of all material facts and recused himself from the board’s discussion and vote.