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The Ethics of the Fiduciary Duty from the Litigators' Lens

06/01/2024 7:39 AM | Anonymous member (Administrator)

By Wes Wollenweber & Lee Freedman, WF Legal

The topic of an association's board of directors' fiduciary duties is not new to this publication. However, as trial attorneys that have seen a lot of HOA litigation, including representing community management companies, we have seen how this duty plays out in court cases for both board members and community managers. Moreover, as our industry has changed, we have seen how certain business practices have raised ethical considerations when those practices are called into question during litigation. With that, it is helpful to review the various duties that are owed and look at their implications in litigation. There is no black and white, right or wrong answer to certain practices, but the ethics of these practices should be examined in light of litigation risks.

The Duties

As most of us know, board members owe a fiduciary duty to their associations, meaning their membership. These duties flow from the Colorado Nonprofit Act, CCIOA, and case law. Does a community manager or management company owe that same duty? This has been a topic of hot debate for years but in a recent court case in Colorado state court, the court emphasized that community managers share a special relationship of trust with boards and community members and, as such, owe a certain fiduciary duty to their community clients. This duty requires board member and managers to act reasonably and not in an arbitrary or capricious way. Board members also owe a duty of care to act in compliance with a vote the board has authorized. Additionally, they owe a duty of loyalty to act in the best interest of the membership and solely for the benefit of the association. This also requires a duty of confidentiality in certain situations. Yet, this duty also requires certain disclosures, especially concerning known or potential conflicts of interest.

Ethical Concerns from the Litigation Lens

In any type of HOA litigation, one of the biggest red flags is a board member or members who are accused of having acted in a self-interested manner. A common example is engaging a contractor that is related in some manner to a board member and whom may not have had the requisite skill for the work contracted or charged beyond industry standards for such work. These issues really rise to the top of an insurance recovery/bad faith dispute. Insurance defense attorneys will use this type of self-dealing to their advantage to argue that associations and their contractors are trying to game the system. Not all conflicts are necessarily detrimental to an association, but they should be disclosed in accordance with the association's conflicts governance policy. In selective enforcement cases involving use of construction defect proceeds, evidence that a board member's damaged home was repaired earlier and more thoroughly than a neighbor's home can lay the basis for a claim of breach of fiduciary duty based on self-dealing. These are ethical concerns because of the overarching duty to act in everyone's best interest. 

Revenue sharing agreements have placed community management companies under the microscope in certain cases we have handled. In insurance litigation matters, it has allowed defense counsel to make the argument that a manager induced a board to hire a particular contractor because the manager stood to gain financially. Why does that matter in and of itself? The inference is that the manager chose a contractor more likely to overcharge. While these practices might not result in a breach of fiduciary duty claim because of the nature of the case, they raise ethical concerns that give life to the defense counsel's case theory.

Breaches of these duties can even play a role in civil rights litigation. In a Las Vegas Fair Housing case, litigated in federal court and where the homeowners had no legal counsel, the board's disclosure of the owner's confidential, disability-related information to certain members, that was then spread to other owners, cost that association a significant verdict. Where a decision or practice can be questioned as to its ethics and fairness, evidence around those decisions and practiced will often be spotlighted in litigation.

In litigation, perception can equal reality. If something can be portrayed as unfair or unethical, it can support other legal theories in the case. Given that risk, boards, and managers working with boards, should make decisions under the scrutiny of whether that decision is ultimately in the best interest of everyone in the community. In that process, it may be prudent for an association to ask its general counsel if a decision might have ramifications in a future court case. Conflicts require full disclosure, dialogue, and careful consideration. Finally, document decisions and the legitimate basis for them. If the basis for the decision is reasonable and well documented, it may erode any argument of questionable behavior and a viable legal claim.

Wes Wollenweber and Lee Freedman have handled complex and bizarre HOA litigation for many years. Lee is on the current HOA Task Force and Wes mediates and arbitrates HOA related disputes.

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