The Duty of the Board

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What is the duty of the board and its individual members? These were issues discussed by the court in two recent decisions: Hubshman v. 1010 Tenants Corp. and Carroll v. Radoniqi.

In Hubshman, Barbara Hubshman was a shareholder at 1010 Tenants Corp., which owns the cooperative apartment building at 1010 Fifth Avenue in Manhattan. Hubshman began an action on her own behalf and derivatively against the board, each individual board member, the managing agent, the individual manager and others. Motions to dismiss the complaint were made by all of the defendants.

The court described the facts presented in the complaint. Hubshman was the proprietary lessee of a penthouse apartment in the building. She claimed that the co-op, its directors, the managing agent, and the individual manager failed to maintain the building, as required by the proprietary lease, and that they tried to conceal from the shareholders and possibly governmental agencies dangerous conditions that existed in the B-line fireplaces and flues. The complaint alleged that the board (aided and abetted by the managing agent) encouraged building residents to use their fireplace even though it knew that there were problems with the chimney.

Hubshman claimed there were smoke, fumes, and soot, which, for decades, regularly seeped into her apartment. She said this deprived her of the use of her apartment, endangered the lives of those who have occupied the apartment, and placed other residents in the building in danger. Hubshman stated that the conditions resulted in criminal charges being issued against one of the defendant/board members.

Hubshman claimed that the board was fined by the New York City Fire Department and ordered to stop using the B-line fireplaces until repairs were made, but that the board encouraged residents to continue using them. The board spent significant funds to pay engineers and other professionals to try to remedy the chimney problem and they recommended that a flexible steel liner be installed in the chimney.

According to Hubshman, the board rejected their advice and recommendation and opted to have an illegal fan system in place “to pull up the smoke past all the defects in the flues.” She also said the board encouraged the shareholders to use their fireplaces. Hubshman claimed that the money paid to these professionals was a sham and a waste of corporate assets.

The Department of Buildings (DOB) issued an order on December 9, 2009, ordering that no fireplaces be used at the building. Rather than comply, the board appealed the DOB order and, Hubshman alleged, falsely stated in documents to government officials that the smoke was not leaking outside the chimney. The board asked that the “jury-rigged” fan be approved, even though it was inadequate to address the dangerous conditions identified by the DOB.

Hubshman asserted that when she complained and wrote letters to building residents, the board started a lawsuit against her seeking the immediate removal of her rooftop garden to remedy leaks into the unit below hers. Hubshman complained that the suit was brought in retaliation for her having complained about smoke problems. She claimed that suit was based upon allegations that the co-op knew or should have known were false and that the goal was to harass her and disrupt her life. She stated that the board wanted to deprive her of her contractual rights under the lease by destroying and permanently removing her roof garden.

Hubshman contended that the board’s actions were aided and abetted by the managing agent and manager who did what they were told by the board and that they covered up and actively concealed the board’s misconduct concerning the dangerous chimney from the residents and governmental authorities.

Hubshman sued, claiming, among other things, that (i) the managing agent breached the building management agreement by failing to properly maintain the building and hire competent contractors; (ii) the co-op breached its warranty of habitability by failing to properly maintain and repair the chimney; (iii) she was partially constructively evicted because of the smoke, fumes, and soot; (iv) the co-op and its directors breached their fiduciary duty by depriving her of her rights under the proprietary lease; (v) the managing agent aided and abetted the board’s breach of fiduciary duty; (vi) the co-op created and maintained a nuisance in the fireplace and flues; and (vii) the board, individual board members, and management committed waste and mismanagement in that they failed to properly maintain the building and never should have begun an action against Hubshman concerning the garden.

The court discussed the standard to be applied on the motion. Because these were motions to dismiss (and not for summary judgment), the motions required that the court accord the benefit of every possible inference to Hubshman and determine only whether the facts as pleaded fit into any cognizable theory of law. The court was required to accept the facts alleged in the complaint as true. The court stated that, given this standard, it could not dismiss Hubshman’s claims for breach of the warranty of habitability and partial constructive eviction.

The court next discussed the claims for breach of fiduciary duty. It explained that the New York Business Corporation Law set forth the obligations of corporate directors and provided that “a director shall perform his [or her] duties as a director, including his [or her] duties as a member of any committee of the board upon which he [or she] may serve, in good faith and with that degree of care which an ordinarily prudent person in a like position would use under similar circumstances.”

The court explained that although corporate directors and officers had a fiduciary duty to shareholders, no such duty was imposed on the housing corporation itself. Therefore, the court dismissed the breach of fiduciary duty claim as against the co-op. However, the court noted that Hubshman had pleaded a cause of action against the board for breach of fiduciary duty based upon her claims that the board delayed in having the flues repaired, allowing a dangerous condition to remain unrepaired. The defenses raised by the board were not a basis to dismiss given that this was a motion to dismiss.

As to the individual board members, the court discussed the law that stated that individual board members cannot be held liable for breach of fiduciary duty unless it was alleged that they acted outside their official capacity or otherwise engaged in separate conduct. The court found that the complaint did not attribute any independent inappropriate conduct to any individual director. Hubshman argued that there was a criminal summons issued to a specific officer of the co-op that asserted violations of the administrative code of the City of New York in connection with the fireplaces. The court noted, however, that the officer was the defendant in the criminal proceeding only in her capacity as an officer of the co-op and not in her individual capacity. Accordingly, the court dismissed claims against the individual board members.

The court did not dismiss the claims against the managing agent for aiding and abetting a breach of fiduciary duty because the breach of duty claim was not dismissed against the board.

The court discussed Hubshman’s claim for relief against the managing agent, claiming that she had the right to sue derivatively and as a “third party beneficiary” of the management agreement between the agent and the co-op. The court explained that in order to assert claims as a third-party beneficiary, Hubshman had to establish that there was a valid contract between others that was intended for her benefit and that the benefit to her was immediate, rather than incidental, “to indicate the assumption by the contracting parties of a duty to compensate [her] if the benefit is lost.” The court found that Hubshman was not a third-party beneficiary of the management contract and therefore dismissed those claims.

In the Carroll case, William Carroll started an action, individually and derivatively on behalf of The Charles House Condominium, claiming breach of the duty of loyalty and nuisance against the condominium and Mahir Radoniqi, its superintendent. Carroll was an owner of an apartment at the condominium and began this action to compel the condominium’s board to start legal action against the super. Carroll argued that although the super was required to provide full and undivided services to the condominium during business hours, he failed to do so. Carroll asserted specific instances of misconduct by Radoniqi, which included unauthorized renovations of individual apartments and that he permitted his brother to live with him in his apartment.

Derivatively, Carroll asked that Radoniqi’s employment be terminated, that he be evicted from his apartment, that he be ordered to repay his salary and the value of the apartment during the period of alleged misconduct, and that he disgorge to the condominium any profit he received from his unauthorized renovations. Carroll also sought legal fees.

The condominium argued that Carroll’s demands were an improper intrusion into matters of employee discipline, which were solely within the province of the board. The condominium cited its bylaws for support of this proposition. The bylaws gave the board “all of the powers and duties necessary for, or incidental to, the administration of the affairs of the condominium” and vested the board with the power to bring or defend against proceedings.

The condominium further argued that the board reviewed the derivative claims and concluded that it was not in the best interest of the condominium to pursue the claim. The condominium asserted that it conducted a thorough investigation into the alleged conduct and took action that the board, in its business judgment, deemed appropriate. Carroll asserted, however, that the investigation was a “sham” and that the board “looked the other way.” Finally on this point, Carroll asserted that he should have been entitled to see the evidence pertaining to the board’s investigation, which it had withheld from him.

The condominium asserted that the investigation was conducted by disinterested board members and consisted of meeting with Carroll to allow him to present all of his facts, reviewing correspondence from Carroll and his counsel, requesting that Carroll submit any additional information, interviewing the owners of the apartments at issue, and consulting with the condominium’s general counsel.

The condominium also claimed that the board was fully responsive to Carroll’s demands and that the results of the investigation demonstrated that three of four of Carroll’s allegations were either unsubstantiated or incorrect. As to the allegation that was substantiated, the board spoke with its counsel and determined that the pursuit of a derivative claim was not advisable given, among other things, the expense of litigation.

The court discussed the different procedural standards – the making of a motion for summary judgment as opposed to a motion to dismiss. Here, the court was able to use the standard on summary judgment. Accordingly, the proponent of the motion had the initial burden of setting forth facts that proved that it was entitled to judgment in its favor without the need for a trial. If the party making the motion met that burden, the one opposing judgment had to establish the existence of material issues of fact that would have required a trial. The court explained that a grant of summary judgment was the functional equivalent of a trial. It was a drastic remedy that should not be used if there was any doubt as to the existence of a triable issue.

The court then explained that derivative actions, by their very nature, infringed upon the managerial discretion of boards. Decisions made by a board of a condominium were viewed according to the Business Judgment Rule. Absent a showing of breach of fiduciary duty, judicial inquiry into the actions of directors was prohibited even if the decision of the directors was “unwise or inexpedient.”

The court found that the board established that it had thoroughly investigated the issues one year before Carroll presented his complaints to the board and that Carroll was involved in the investigation. The board decided not to terminate Radoniqi because of his otherwise good job performance, his knowledge of the condominium, and the difficulty of retaining another qualified super. Instead, the board penalized Radoniqi by reducing his annual bonus for a two-year period. As to Radoniqi’s brother, once Carroll brought to the board’s attention that he was performing unauthorized renovations and living with Radoniqi, the board evicted him. Carroll expressed dissatisfaction with the board’s actions. However, the board investigated and determined that Carroll’s complaints had no merit.

Ultimately, the court deferred to the board’s exercise of its business judgment and granted the condominium’s motion for summary judgment dismissing the derivative claims. Comment: These two cases discuss, among other things, a board’s duties to its apartment owners and, we believe, turn in part on procedural issues. The court in both of these actions (the same judge decided both within a month of each other) considered the procedural posture of the motions. Where a motion to dismiss is made, every favorable inference in the pleadings must be given to the plaintiff; when a motion for summary judgment is made, the court has the right to look beyond the pleadings and determine if there are any triable issues of fact that would preclude a grant of judgment. A motion to dismiss is a more difficult standard for a defendant, whereby a motion for summary judgment allows the court to search the record. In addition, the court dismissed the derivative claims brought by the plaintiffs in both actions “on behalf of” their respective co-op and condominium, acknowledging the deference that must be provided to the board under the Business Judgment Rule and, in the Carroll case, the condominium’s bylaws. The court made what we believe is an interesting distinction concerning the breach of fiduciary duty claims in the Hubshman case. There, the court determined (as have other, recent cases) that the cooperative housing corporation owes no fiduciary obligation to its shareholders. Further, the individual board members could not be found to have breached their fiduciary obligations absent allegations that they engaged in inappropriate conduct separate and independent from their actions as members of the board. Yet the court sustained an action against the cooperative “board,” having found that a board owes a duty to the shareholders, which we believe is a novel holding in the cooperative corporation field. We are not certain how this claim will ultimately be determined.