Business Judgment Rule

In running their buildings, co-op boards need to pay attention to the lessons of Levandusky vs. One Fifth Avenue Apartment Corporation. Under the certificate of incorporation and the proprietary lease, a board of directors has broad authority, but it has to exercise this power properly. Let’s look at three common issues that a board may face and see how the Levandusky case, which adopted the Business Judgment Rule as the governing standard for reviewing board action, would apply.

A sale. A shareholder seeks to sell the unit and submits an application package. A board member would like to buy the unit so her mother can live there. How is the board to react to the application package?

A disability. A shareholder claims to have a disability and seeks to keep a dog in the apartment, even though there’s a prohibition against pets.

A fine. A shareholder gets into a dispute with the board and becomes rude and insulting. The board fines the shareholder $25,000 in connection with the underlying dispute.

How does the Business Judgment Rule apply to these situations? The rule prohibits the courts from inquiring into the actions of corporate directors, provided that they are taken in good faith, in the exercise of honest judgment, and in the lawful and legitimate furtherance of corporate purposes. Board actions must have a legitimate relationship to the welfare of the cooperative; cannot deliberately single out individuals for harmful treatment; must be taken with notice or concerns or consideration of all of the relevant facts; and cannot go beyond the scope of the board’s authority. Given those four constraints, let’s go back and look at the situations cited earlier

A sale. A unit is for sale, and a board member would like to buy the unit so her mother can live there. This is a question of possible self-dealing. It also raises the same question we asked earlier: would a board’s decision to turn down the application be in the cooperative’s best interests, or just the board member’s? On the face of it, I think most people would say that’s clearly self-interest. But there may be considerations that a board could point to. For example, it might be a very family-oriented co-op, and there may be a value in having family units. Or there may be a tradition in the building of having only families reside there. But the overriding question would be: is this in the best interest of the cooperative?

A disability. A shareholder claims to have a disability and wants to keep a dog in the apartment, even though there’s a no pets rule. The board must consider whether it has taken into consideration all  relevant facts. The board can’t just say: “No, that’s our rule. You can’t have a dog, whether you claim a disability or not.” The board has to investigate and find out if there is a legitimate disability and whether the dog qualifies as a service animal or emotional-support animal. If so, the board would have to accommodate the shareholder. But before it can make that decision, it has to be aware of the relevant facts. The board has not only the right but the obligation to investigate.

A fine. A shareholder gets into a dispute with the board and becomes rude and insulting. The board fines the shareholder $25,000. One of the four rules that we discussed earlier is that the board can’t deliberately single out an individual for harmful treatment. Has this board done that? The board would have to show that a fine of that magnitude was not simply a punishment. You might have an affluent building where the $25,000 fine is not out of line. But in most buildings, that probably would be considered very high, and a court would probably find that the shareholder had been singled out for harmful treatment.

In each of these cases, the board must look to the fundamental rule set out in the Levandusky case.

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Marc Luxemburg is a partner at Gallet Dreyer & Berkey.