Daily Development for Friday, August 13, 1999

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

ASSOCIATIONS; "BUSINESS JUDGMENT RULE:" California rules that management decisions of homes associations boards are subject to "business judgment rule" and therefore are valid if made in good faith, fair and nondiscriminatory manner and rationally relate to the interests of the community as a whole.

Lamden v. La Jolla Shores Clubdominium Assoc.,1999 WL 592088 (Cal. 1999) (unpublished opinion)

This case reverses Lamden v. La Jolla Shores Clubdominium Assoc., 72 Cal. Rptr. 2d 906 (Cal. App. 1998) , the DIRT DD for September 22, 1998.

The beach area condominium complex in this case had been plagued forsome time by water damage and related termite infestation endemic tothe area. The Association Board conducted a lengthy analysis of thequestion of how much termite treatment was appropriate, and concludedthat it would continue with a program of "spot treatment" of infestedareas rather than undertake a complete treatment program that wouldinvolve tenting the entire structure (containing 42 units). The board'srationale was that the proposed "complete" treatment would not insureagainst reinfestation, that it was expensive, and that it would involveinconvenience in the temporary relocating of all of the occupants of thestructure. In addition, there was some concern about residue of treatmentmaterials that could cause health risks.

Plaintiffs, owners of one of the units in the building, presented evidencethat the spot treatment program was not effective in preventing ongoingdeterioration, because it did not reach many areas where termites werebreeding and then spreading. Further, they presented a statement by thelocal pest control authority recommending the complete treatment. Plaintiffs acknowledged that termites likely would return over time, butpointed out that the complete treatment would significantly retard suchreturn and insure protection for a longer period than the spot treatment. The trial court determined that the board had conducted a comprehensivefact gathering process, including taking all of plaintiff's evidence intoaccount, and had made a good faith decision based upon that process. Inthe trial court's view of the applicable law, this ended the inquiry, sincethe board's actions were to be measured by the business judgment rule.

The appeals court reversed on the grounds that the appropriate standard to be applied was one of reasonable care, citing Frances T. V. Village Green Owners Association, 42 Cal. 3d 490 (1977). That case found that condominium associations owed the same duty of care as landlords to occupants of their premises in protecting them against physical injury, including (in that case) the risk of criminal attack.

The California Supreme Court has now tried to walk the line of preserving the Frances T. rule with respect to claims of negligence leading to physical injury, but nevertheless maintaining that in most, if not all, other areas of conduct, the association's decisions are to be governed by a "business judgment" test. Notably, in this case, the association and its board were insulated from liability if it could not be shown that their interests were irrational, in bad faith, or made in an unfair or discriminatory manner. The court specifically indicates that the fact that an individual unit owner may be specially injured economically as a consequence of the board's decision is not actionable if the decision is made in good faith in the interests of the community as a whole.

The court also attempted to preserve the ruling of the Nahrstedt case (8 Cal. 4th 361 (1994)), the famous "cats in condominiums" decision, regarding the enforceability of use restrictions in condominium Declarations. Although California statute provides that such restrictions are "enforceable, unless unreasonable," Nahrstedt narrowed the standard somewhat in favor of the Board by stating that "such restrictions should be enforced unless they are wholly arbitrrary, violate a fundamental public policy, or impose a burden on the use of the affected land that far outweighs any benefit." The court appears to view this test as a restatement of the "business judgment" test, although reasonable minds could differ on the point.

The court noted, however, that Nahrstedt involved a challenge to a provision already appearing in the Declaration at the time the unit was sold. The question still before it, then was whether use restrictions and similar governance decisions, such as architectural approvals, were subject to the same standard. The court appeared to conclude that the business judgment standard does apply, although it cites as authority for the point cases that it acknowledges hold that such decisions must be "reasonable."

Whatever the rule with respect to general governance decisions, however, it is incontestable that the court comes down with the conclusion that maintenance decisions, such as those challenged in this case, are to be measured by the business judgment test.

Comment 1: The editor salutes the California court for attempting to reconcile the numerous decisions it has rendered on these matters, many of which have been reported on these pages. It is a daunting task, unfortunately, as the equities tend to shift as individual interests are affect more directly and community interests less at risk. This case involved a relatively straightforward analysis, at least as the Supreme Court decision explained things, as the directors did address the question of whether complete termite treatment was appropriate and, after thinking about the issue, rejected that alternative on the grounds inter alia that there were health risks associated with the treatment and that interim measures would address all the really significant problems from the standpoint of the community as a whole. But many governance decisions are far more dicey, and it will be interesting to see whether the court will "stick to its guns" as the issues pull and tug.

Comment 2: The court did note that it is necessary for the decisions at stake to be "fairly made." This still makes it possible to argue in any individual case that the process by which the board or other governing body made its decisions was inappropriate. This was an important element in the noted Riss decision in Washington State Riss v. Angel, 934 P.2d. 669 (Wash. 1997, where a major damages verdict was entered against an association and its members based upon the faulty process by which they made an architectural control ruling. Riss was the DIRT DD for July 8, 1987.

Comment 3: "I told you so" department: Here is the Editor's comment on the Court of Appeals decision, which now is reversed: "The editor has decried in this and other forums the problemthat minority interests sometime suffer inappropriately in these smallhomeowner organizations. Although technically they have "submitted tothe jurisdiction," in fact they frequently do not appreciate the significanceof the association's control over various aspects of their lives, andleaving their interests to the control of the majority (or even worse tothe unpaid amateur board of directors) may not be consistent with anycontract or property relationship they should be viewed as havingentered.

That having been said, the editor does believe that homeowners buyinginto a condominium building do understand that where issues ofmaitenance are concerned, they are not renters, but coowners. As such,they are part of a formal business organization and will have to abide bythe will of whatever power bloc is established by the declaration andbylaws. Candidly, it is difficult to understand how a condominium buyerlogically should expect anything more or less.

Consequently, wheremaintenance decisions are concerned, the editor believes the "businessjudgment rule" adequately defines the limits on the responsibilities of anassociation to its residents. The editor therefore disagrees with the courthere."

Items in the Daily Development section generally are extracted from the Quarterly Report on Developments in Real Estate Law, published by the ABA Section on Real Property, Probate & Trust Law. Subscriptions to the Quarterly Report are available to Section members only. The cost is nominal. For the last six years, these Reports have been collated, updated, indexed and bound into an Annual Survey of Developments in Real Estate Law, volumes 16, published by the ABA Press. The Annual Survey volumes are available for sale to the public. For the Report or the Survey, contact Maria Tabor at the ABA. (312) 988 5590 or mtabor@staff.abanet.org

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