Board Determination Not Protected By Business Judgment Rule Where Board Members Failed To Inform Themselves And Were Self-Interested
Many determinations made by a Condominium Board of Managers will be protected by the Business Judgment Rule, where they are made in good faith and for the lawful purposes of the Condominium. However, the protections of the Business Judgment Rule are not unbounded and may be lost where a board fails to reasonably inform itself of relevant facts and acts in a self-interested fashion. Tsui v. Chou, 2016 N.Y. App. Div. LEXIS 427, 2016 N.Y. Slip Op. 428 (1st Dep’t Jan. 21, 2016), is such a case.
The lawsuit was brought by unit owners who made a demand on the Board of Managers, requesting that the Board commence legal action against two board members and the property manager. The Board unanimously voted to reject the demand and not to bring suit. Plaintiffs then sued derivatively on behalf of all unit owners in the Condominium, alleging that the members of the Board of Managers had breached their fiduciary duties by, among other things, “failing to disclose various lawsuits and [one board member’s] criminal record, failing to account for missing monies and receipts, commingling funds, denying access to information and documentation, and improperly renewing [an affiliated company’s] management agreement.” Plaintiffs further alleged that the board members had improperly extended their terms in office beyond the period allowed by the By-Laws.
The defendant Board of Managers members moved to dismiss the lawsuit. A lower court granted the motion, but an appellate court reinstated the unit owners’ claims for breach of contract and breach of fiduciary duty. According to the appellate court, the Board of Managers’ determination was “arbitrary and therefore not protected under the business judgment rule” because there was “nothing in the record to indicate that the board discussed or informed themselves as to [the unit owners’] allegations.” With respect to the claim that the board members had improperly extended their terms, the board members were also “clearly self-interested” and therefore the Business Judgment Rule did not apply for this additional reason.
However, the court affirmed the dismissal of claims for trespass and constructive trust. As to these claims, the Board had considered the allegations underlying the claims and the voting board members did not have an interest in their outcome. This case is a reminder that when a shareholder demand for litigation is received, a board of directors or board of managers must carefully evaluate the allegations and evidence and must make an informed and properly documented decision as to whether or not to take action.