Daily Development for Monday, February 10, 2003

By: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri
prandolph@cctr.umkc.edu

ASSOCIATIONS; DUTIES OF ASSOCIATION; RESTRICTIVE COVENANTS: Homeowners association has a fiduciary duty to lot owners to enforce restrictive covenant and the developer of a residential subdivision, as a lot owner, could bring a claim for breach of fiduciary duty against the homeowners association for failure to enforce such covenants.

Colorado Homes, Ltd. v. Loerch-Wilson, 43 P.3d 718 (Colo. App. 2001).

Colorado Homes developed a subdivision and sold one of its homes to Buyers. Buyers asserted that Colorado Homes refused to do necessary warranty work and contacted a number of prospective customers of the homes of Colorado Homes to discourage purchases. Buyers also began picketing at the subdivision and displaying a sign through their garage window expressing their views of Colorado Homes.

Colorado Homes made several requests to the homeowners association and the management company hired by the homeowners association to take action to prevent Buyers from picketing and displaying their sign, both of which, for purposes of the analysis here, we can assume were prohibited by the restrictive covenants at the development. (The picketing, they argued, fell under the "noxious activity" prohibition.

This interpretation will be further tested on remand.)

After a long delay, the homeowners association took action and Buyers ceased their picketing activities, but not the sign. Colorado Homes then brought suit against Buyers for damages for tortious interference with business. The homeowners association and its management company later were joined in the suit. The trial court dismissed the tort claim for breach of fiduciary duty by summary judgment but allowed Colorado Homes to proceed against the homeowners association based upon a contract between the homeowners association and the lot owners.

The jury, incidentally, also $600,000 in damages against the Buyers, and $45,000 in counterclaims in favor of the Buyers against Colorado Homes. Most of these claims were not the subject of the instant case, but it should be noted that the trial court vacated a portion of Colorado Homes' award as duplicative, although the bulk of the award was entered as a judgment.

This case involves primarily Colorado Homes appeal of the rulings in favor of the homes association and its management company. The Colorado Court of Appeals noted that courts in other jurisdictions have recognized a fiduciary duty of a homeowners association to the homeowners to enforce restrictive covenants (citing Wayne Hyatt's influential book Condominium and Homeowner Association Practice).

The court pointed to the power held by a homeowners association, its quasi-governmental function, and the impact on value and enjoyment that can result from failure to enforce the covenants. Thus, the court held that Colorado Homes did have a right to pursue its claim of breach of a fiduciary duty.

The court then proceeded, however, to provide some protection for the defendants on the new trial on this issue. It concluded that the homeowners association could defend its decisions regarding enforcement of the covenants under the business judgment rule, apparently a matter of first impression in Colorado. The "business judgment rule" defense is available both for contract claims and for the claim based upon breach of fiduciary duty claims. The court noted that the free speech aspects of the Buyers' activities might properly have justified the Association in delaying its action on the covenant.

As to the claim against the management company, the court concluded that Colorado Homes had not demonstrated that it was a third party beneficiary of the contract between the association and the management company with respect to the issue in question here. The court concluded that Colorado Homes' status as a lot owner, did not automatically make it a third party beneficiary of the management agreement. But its ruling was based largely upon the fact that the record was inadequate because the management agreement had not been introduced into evidence. It left open the issue of whether certain elements of such agreements might in fact be intended to confer a benefit directly on lot owners.

Comment 1: This case is packed with all kinds of useful stuff. The very fact of granting a damages remedy against the unhappy home buyers is a matter of some significance to practitioners in this area, even though those issues were not really part of the appeal to any great extent. It appears that the defendant Buyers perhaps were judgment proof (or had settled) and elected not to appeal.

Comment 2: The notion of a fiduciary duty respecting enforcement of association covenants is a matter of great significance. One wonders, however, whether there is much left of this decision when the following paragraphs introduce the "business judgment" test as a defense. Although the court cites a California decision for authority on this point, the case it cites is from 1983, and there has been much California analysis since that time. See, e.g. Lamden v. La Jolla Shores Clubdominium Assoc., 980 P.2d 940 (Cal. 1999) (the DIRT DD for 8/13/99) (Business judgment rule will apply only to economic decisions, such as repair and maintenance judgments, and not to other issues of Declaration enforcement, where a less permissive "reasonableness" test will apply.)

Comment 3: For another case rejecting the "business judgment rule" for association decisions implementing Declaration standards, even as to economic decisions, see: Bennett v. Weimar, 975 P.2d 691 (Alaska

1999). It might well be argued, however, that in many cases, the question of whether an action fits with "business judgment" or should be viewed as "reasonable" will not make much difference in outcome. The fundamental question is whether the court will give the association leeway not to follow the dictates of the Declaration. Not everyone agrees that an association has such leeway, but it indeed is difficult to conclude that an Association is not justified in being very cautious in controlling free speech on the basis of declaration rules. Perhaps, however, a plaintiff could still make a case that the association has a duty to make a rationale analysis based upon appropriate legal advice as to whether the activity involved really is entitled to free speech protection. A Washington case a few years back held that an architectural review decision was not "reasonable" if it was not based upon a reasonable attempt to seek professional advice as to the probable consequences of the proposed project - suggesting that an engineering consultant might be necessary in contested cases.