Business Judgment Rule: The Old Armor Still Works

A common question facing cooperative and condominium boards is: repair or replace? Whether it’s a roof, a boiler or a facade, boards are often faced with this dilemma. One board’s decision on such a matter became the basis of recent litigation when a disgruntled shareholder in a New York City cooperative decided to take his displeasure with the board to court.

Bernard Weinstein had been a shareholder in the co-op at 122 E. 82nd St. in Manhattan since 1988. The proprietary lease required the co-op to keep the building in good repair at its own expense, which is a standard provision. According to Weinstein’s complaint, the co-op board became aware of an “old vertical crack” in the building in 2010. Rather than remedy the situation by “extensive brick work,” as suggested by some engineers, the board opted to hire a contractor to caulk the crack in the facade, and to do so every five years. In a 2011 letter to shareholders, the board announced that it would begin the caulking project in order to protect against future damage to the facade.

In 2017 and 2018, the co-op’s architect found that the facade had sustained substantial internal damage due to improper installation of air conditioner sleeves two decades prior, which allowed moisture to enter the facade and led to deterioration of the facade over time. The board then voted to undertake a significant facade repair project that would cost approximately $1 million and to finance it in part through a special assessment of the shareholders.

Weinstein was not pleased. In 2018 he sent a letter to the board, rejecting the board’s attempt to assess the shareholders for the costs and demanding that the board assert claims against management for failing to ensure that the facade was properly inspected and maintained.

The next year, he followed up his letter with a formal demand that the board bring an action against management. When the board refused, he sent the board a derivative complaint against both the board and management. (A derivative action is a lawsuit brought by a shareholder who claims to be acting on behalf of the corporation – typically against the directors or management – when the board refuses to bring such an action.)

Weinstein claimed in his suit in State Supreme Court that the board had breached its fiduciary duty and the proprietary lease both by failing to properly inspect and maintain the facade and by failing to take steps to hold management responsible for the costs. He also brought an action against management for breach of fiduciary duty and breach of the lease because it failed to inspect and maintain the facade or hire competent professionals to do so.

The co-op’s attorneys took the position that there could be no claim against the board because of the business judgment rule, which holds that courts will defer to the decisions of a co-op or condo board – provided the board has acted in the best interests of the corporation or association, within the scope of its authority, and in good faith.

A Valuable Lesson
As stated decades ago, without a showing of a breach of fiduciary duty, judicial inquiry into the action of directors is prohibited – even if the board’s decision was unwise or inexpedient. Broad statements accusing a board wrongdoing will not suffice; the plaintiff must state with particularity that the actions of the board were taken in bad faith, showed self-dealing, discrimination or misconduct, or otherwise fell outside the scope of the business judgment rule. Weinstein failed to show any of the above, and thus the court dismissed his case.

Management contended that its actions were also shielded by the business judgment rule. The court disagreed. However, bringing an action against management was a decision for the board to make, and the board’s decision not to bring such an action was also protected by the business judgment rule. Therefore, the derivative claims against management were also dismissed.

This case is a useful reminder that the decisions of co-op and condo boards will be respected by the courts – provided there is no bad faith or self-dealing and provided the decisions are made within the scope of the board’s authority. The business judgment rule is alive and well. But the lesson to be learned is that no matter how often the courts uphold this rule, shareholders will continue to attack their boards’ decisions. Therefore, every board should be forewarned to always make educated and well-documented decisions and to always act within the scope of its authority.    

Attorneys:
For Plaintiff: Morris Cohen, LLP
For Defendants: Abrams Garfinkel Margolis & Bergson

Andrew P. Brucker is a partner at the law firm Armstrong Teasdale. The statements and views in this article are his own and not necessarily those of the firm.