The vitality of Michigan community associations is directly related to the quality of their volunteer board of directors. However, in this litigious age, potential directors may be concerned about the personal liability faced when their every decision may be questioned by countless other members. Confronted with that daunting prospect, interest in serving on the board may be stifled.
Yet, all is not lost, as industry and legal standards have developed to ensure that directors can put in the hard work needed to be done for the community, without constant fear of legal liability or retribution. This article will discuss those standards, which include:
- Keeping fiduciary responsibilities at the forefront;
- Ensuring the association has both the appropriate insurance policies and indemnification provisions in place; and
- Relying on experts such as association managers and legal counsel.
By taking some simple steps, directors can minimize their potential exposure while advancing the interests of their communities.
Directors are placed in a position of trust and authority to the corporation they serve. Accordingly, directors owe fiduciary duties to the corporation’s members. As mentioned in Wallad v Access BIDCO, Inc., 236 Mich App 303, 307 (1999), a fiduciary duty generally requires one to “act for someone else’s benefit, while subordinating one’s personal interests to that of the other person.” In addition, a fiduciary owes its principal a duty of good faith, loyalty, and avoidance of self-dealing. Prentis Family Foundation, Inc v Barbara Ann Karmanos Cancer Institute, 266 Mich App 39, 49 (2005).
These abstract notions of duty have real-life impact on director decisions. For example, it may be a breach of a director’s fiduciary duties to give an association contract to a family-related vendor, fail to secure confidential board information, or to enforce the association’s governing documents inconsistently. The ramifications for failing to adhere to a director’s fiduciary obligations can be severe and may lead to association lawsuits. Valid or not, defending member lawsuits is usually neither simple nor cheap for an association.
Directors may reduce their personal liability in the legal forum by relying on the business judgment rule. The business judgment rule is codified in Section 541 of Michigan’s Nonprofit Corporation Act, which specifies that directors are required to discharge their duties in the following manner: (a) in good faith; (b) with the care an ordinarily prudent person in a like position would exercise under similar circumstances; and (c) in a manner he or she reasonably believes to be in the best interests of the corporation.. The applicability of the business judgment rule to decisions made by condominium association boards is discussed in 15B Am Jur 2d, Condominiums, § 23, which provides: “It can be gleaned from the case law that so long as a condominium board acts for the purposes of the condominium, within the scope of its authority and in good faith, the courts will not substitute their judgment for that of the board’s.”
The business judgment rule is a powerful defense tool, because as noted above, it presumes corporate directors will act in good faith and in the best interest of the corporation. The Michigan Court of Appeals has held that courts should not interfere with the management decisions of directors (Churella v Pioneer State Mut Ins Co (On Remand), 258 Mich App 260, 270-271 (2003)) and the burden is on party challenging the corporate action to establish that the decision of the board of directors falls outside of the protections afforded by the business judgment rule (In re Butterfield Estate, 418 Mich 241 (1983)). Although every director decision is not infallible, absent fraud or bad faith, courts will generally not second guess director decisions, even when a negative result occurs.
Insurance and Indemnification
To assist the community with attracting and retaining directors in a litigious era, associations should ensure that they have the appropriate director liability insurance coverage in place. It is often the case that the association’s governing documents include provisions requiring the association to carry comprehensive insurance coverage, including a director and officer liability insurance policy. These policies may potentially cover losses as well as legal fees and costs incurred in defending lawsuits where directors are individually named. However, these policies do not encompass all activities. As one may expect, intentional illegal acts are usually excluded.
Directors may also find liability safeguards in their association’s governing documents. Frequently, the corporation’s articles of incorporation and corporate bylaws will reference indemnity coverage for directors; these indemnity provisions typically mirror applicable state law (found in corporate, condominium or common law). Section 54 of the Michigan Condominium Act requires that the bylaws contain an indemnification clause for the board of directors of the condominium association. Of course, like directors’ and officers’ liability policies, the association is not required to indemnify directors for all association activity. Instead, the Michigan statute specifically requires that the indemnification clause exclude indemnification for willful and wanton misconduct and for gross negligence.
Section 209 of Michigan’s Nonprofit Corporation Act goes even further than the Michigan Condominium Act. In 2015, the Michigan legislature updated its provisions to allow an association to eliminate director, officer, or volunteer liability for money damages for nearly any action taken or any failure to take action. There are limited exceptions to this safety net, which include a financial benefit received by a director or volunteer officer to which he or she is not entitled; intentional infliction of harm to the corporation, its shareholders, or members; an intentional criminal act; and liability imposed under Section 497(a) (attorney’s fees and costs relating to derivative actions).
The Michigan Nonprofit Corporation Act, at Section 209(1)(e), further provides that an association may assume the liability for all acts or omissions of a volunteer director, volunteer officer, or other volunteer occurring on or after the effective date of the provision that grants limited liability if all of the following are met:
(i) The volunteer was acting or reasonably believed he or she was acting within the scope of his or her authority.
(ii) The volunteer was acting in good faith.
(iii) The volunteer’s conduct did not amount to gross negligence or willful and wanton misconduct.
(iv) The volunteer’s conduct was not an intentional tort.
(v) The volunteer’s conduct was not a tort arising out of the ownership, maintenance, or use of a motor vehicle for which tort liability may be imposed under section 3135 of the insurance code of 1956, 1956 PA 218, MCL 500.3135.
As can be seen, the Nonprofit Corporation Act gives directors powerful indemnification insulation, but these protections must be included in the association’s articles of incorporation for application. To the extent an association’s articles have not been updated to include these limits on personal liability, the current association board should consider amending the articles to increase protections to existing directors and officers.
The combined protection of liability insurance and indemnification provisions affords directors the much-needed peace of mind to manage the affairs of the community without the fear of personal financial loss.
Lean on the Experts
Finally, while some volunteer directors may have a background which makes them particularly suited to serve, like finance, law or management, directors cannot be expected to have a depth of knowledge on all areas that may impact their community. Instead, directors are encouraged to seek out reliable sources of information from professionals, i.e., association managers, accountants and attorneys so that they have access to the information needed to make important decisions for the community. In fact, Michigan law specifies that directors are entitled to rely on expert information, opinions and the like (MCL § 450.1541a(2)), and that this reliance entitles directors to another layer of protection for their decisions.
Directors develop the trust of their members by showing them that their decisions were made responsibly. Where a director can show they were armed with solid recommendations from experts, the decisions in reliance upon that advice can withstand scrutiny. Thus, investing in the assistance of experts, and heeding that advice, may not only limit potential director liability, but will likely elevate the wellbeing of the community.
The number of common interest communities in Michigan is growing larger by the day, and it is imperative that skilled directors are at the helm. The industry and legal standards discussed in this article provide directors with the roadmap needed to carry out their duties. While scrutiny, and lawsuits, may be unavoidable, personal financial exposure is preventable.