Daily Development for Wednesday, February 21, 2001

ASSOCIATIONS; AMENDMENTS TO DECLARATION: New Jersey will follow business judgment rule for association board decisions, but may in some circumstances apply a "reasonableness" test for changes in common ownership provisions voted upon by owners.

Mulligan v. Panther Valley Property Owners Assoc., 2001 WL 128466 (N.J.Super.A.D. 2/16/01)

New Jersey a major common interest ownership state, which has issued a number of opinions in this area, and consequently this case, certainly if affirmed by the New Jersey Supreme Court, is likely to be quite influential. This note discusses only the first part of the court's decision, in which the court evaluates what standard ought to apply to judicial review of decisions to amend a Declaration. A subsequent DD will discuss the court's evaluation of the amendments themselves.

The residents of a large common interest community, including various types of housing arrangements adopted six amendments to the Declaration. The original Declaration in this case did not require a "supermajority" vote for such amendments; a simple majority was adequate. The subject matter of the amendments varied widely, from simple "housekeeping," to collection of liens to restrictions directed at excluding convicted sex offenders.

A resident challenged five of those amendments. The trial court struck down two and upheld three. On appeal, the New Jersey Appellate Division affirmed the holding with respect to those amendments that had been upheld, and also affirmed with respect to trial court's disallowance of one of the amendments. As to the last amendment under consideration, the court remanded for a fuller hearing.

The court concludes that New Jersey will apply the "business judgment rule" to decisions by the governing bodies of associations, but will apply the "reasonableness" test to decisions made by the voting process within the association, even to decisions made to amend the declarations themselves. The plaintiff claimed that the court should evaluate the validity of the amendments in terms of their reasonableness. In evaluating this claim, the court noted that a series of prior New Jersey decisions, widely cited, have taken the position that at least some decisions made in the context of common interest communities should be evaluated according to what the court appears to believe to be a test more favorable to the association the "business judgment"test.

Under the "business judgment" test, based upon the standard by which courts commonly evaluate the liability of corporate directors for their decisions in managing a corporation, the court looks only to the bona fides of the decision. If it was made honestly and in good faith and, of course, in accordance with the procedural rules of the corporation and its board, and was within an area of discretion committed to the board by the corporate documents there is no liability. Note that the various requirements in fact leave quite a lot of latitude for the court to make a judgment that a given decision did not meet the associational requirements even though made honestly and in good faith.

New Jersey courts approving the business judgment test for review of association decision making have applied the test in the context of decisions by the board of directors of an association. The business judgment test generally is applied by the Uniform Common Interest Ownership Act with respect to board decisions.

Here the court concluded that it would continue to apply the business judgment test for decisions made by the Board, but that it would not apply that test under the circumstances here. It noted that there was no "supermajority" requirement in the Declaration. Further it stated, without really saying why, that the ordinary presumption of validity that might be applied to the initial provisions that all the owners accepted when the moved in ought not to apply to this circumstance. Therefore, the court concluded that it ought to judge independently whether the individual amendments approved by the homeowners were "reasonable."

Comment 1: The "business judgment" test, which emerged originally as a liability test for directors, and not as a test of the validity of their decisions, is not well suited for general application to validate decisions in common interest communities. There may be some justification for applying some variant of the test in a narrow range of decisions. A California case a few years ago differentiated between decisions affecting lifestyle or privileges of residents, and decisions concerning physical management of the facilities, finding that the latter subject to a "reasonableness" test, while other decisions were subject to a test that was the equivalent of the business judgment test. Lamden v. La Jolla Shores Clubdominium, Assoc., 980 P.2d 940 (Cal. 1999), the DIRT DD for 8/13/99. If anything, the editor would be inclined to reverse the categories, finding that courts ought to be more permissive in the review of routine business decisions. But the editor, in the final analysis, would opt for greater enforcement of validly enacted rules in any event.

Even when the "business judgment" test is applied, the court must further determine that the decision maker acted within the scope of its authority, and this often gets us back to the original "reasonableness" of the determination. Further, the process by which the determination is reached often is a separate focus. A great example of this problem is Riss v. Angel, 934 P.2d. 669 (Wash. 1997), the DIRT DD for 7/8/97, where the association got stuck for punitive damages in an architectural approval dispute in which the court found that, notwithstanding the "business judgment" test, the association still had to follow a reasonable decision making process.

In Bennett v. Weimar, 975 P.2d 691 (Alaska 1999), the DIRT DD for 11/3/99, the Alaska Supreme Court rejected the business judgment test altogether.

Comment 2: Section 6.7 of the Restatement of Servitudes adopts the general view that an association, by vote of its members or board of directors has implied powers to adopt rules governing various aspects of the community. It states that such rules must be "reasonable."

But there is a separate section dealing with amendments to the Declaration, Section 6.10, permitting some types of amendments by majority vote and some by twothirds vote. Although, for the most part, there is no stated requirement of "reasonableness" with respect to such amendments, the Restatement provides that there is some control over discretion in this process by indicating that decisions to amend the Declaration are subject to the general duty of the association to unit owners set forth in Section 6.13, discussed below.

The Restatement has separate sections dealing with various specialized decisions, such as assessments, design control, and management of the common property.

Comment 3: The Restatement of Servitudes, as indicated, has a separate section that establishes standards for review of most association decisions: Section 6.13. This Section discusses the "business judgment" test and the "reasonableness" test and concludes that, in practice, they are almost indistinguishable. Rather than attempt to apply ambiguous earlier rules, the Restatement establishes its own standards governing duties owed by the association to its members. The test is a reasonably permissive one, authorizing judicial review of local discretion, but only in a relatively narrow range. Remember, however, that the Restatement nevertheless concludes elsewhere that all servitudes are subject to the general test that they must satisfy "public policy."

Comment 4: The editor recognizes and is symphathetic with the view that certain rules within residential communities ought to be subject to a greater level of judicial scrutiny than normal because the contractual setting is somewhat informal and the interests affected quite personal. But, as veteran readers will know, the editor is skeptical about the expertise of judges in many real estate areas, and in general prefers that judges not substitute their own judgment for the judgment reached through an accepted process within the association.

In an article two years ago, cited by the court here, the author took the position that changes in association policies ought to be upheld generally without analysis as to "reasonableness" but that courts should withhold or moderate enforcement of these policies against existing owners with legitimate "vested rights" arguments.

Comment 5: The bottom line is that there is no easy answer here. We all know that the agreement to be bound by restrictions and other provisions in a common interest community, particularly amendments to those restrictions, is hardly a "freely negotiated" contract. We also know that the political process within many of these communities is helter skelter at best, and certainly does not rise to a standard anywhere close to that guaranteed by the Constitution or state laws. But at the same time, we know that residents of these communities have invested in these communities precisely because they provide some community control over the behavior of their neighbors and some element of assurance that common areas will be properly maintained. They deserve to have the processes in which they invested enforced. It's a rock and a hard place.

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