Condo and Co-Op Boards Face Legal Consequences for Breaching Fiduciary Duties

What every board member needs to know about fiduciary responsibility—before it's too late

Board decisions get questioned all the time, particularly when money is involved. The worst case scenario is when aggrieved parties take a board to court. There, the court will examine the decision from a couple of perspectives. It will determine if the board carried out its fiduciary duty and if the decision was made in good faith. If a board fails to fulfill this responsibility, a court can step in and overturn a board decision. Two recent New York court cases—involving the Parc Vendome condominium and a Tribeca co-op—provide sobering examples of what can go wrong when fiduciary duties are breached and the legal consequences individual board members might face.

Fiduciary Duties

"The fiduciary duty has essentially two components," explains Scott Pashman, a member at the law firm Cozen O'Connor. "They are the same components if you're serving on a condominium or cooperative board or as a director of a corporation: first is the duty of care and second is the duty of loyalty."

The duty of care requires board members to educate themselves about relevant information before making decisions. "It doesn't have to be ultimately the right decision, but you at least have to demonstrate that you took steps to understand what the issues were," says Pashman. In practice, this often means seeking advice from management companies, accountants, lawyers, architects, engineers, or other professionals who can provide guidance on complex matters.

The duty of loyalty means that "the board should be making decisions that serve the best interests of the condominium or cooperative as a whole," Pashman continues. "There should be no self-dealing by board members. There should be no favoritism shown to any party over another. The guidepost should be what is going to serve the best interests of the building as a whole."

Closely related to fiduciary duty is the business judgment rule, which protects board decisions from judicial scrutiny if those decisions were made in good faith and with proper care.

"The business judgment rule simply says that the courts won't say whether a board did the right thing or the wrong thing. It won't interfere with the decisions of the board," explains Andrew Brucker, a partner at the law firm Fox Rothschild. "If there was bad faith in the decision, then yeah, they did not do their fiduciary duty."

“Bottom line, if your board is sued for a decision it made, as long as these duties of care and loyalty have been followed (with limited exceptions) that decision will not be reconsidered by the court." adds Pashman. Boards need to pay attention to their governing documents, however, because if its actions violate the condo declaration or bylaws the business judgment rule will not offer protection.

When Things Go Wrong: The Parc Vendome Case

The Parc Vendome condominium case provides a compelling example of what can happen when a board fails in its fiduciary duty. The case involves a commercial unit owner, Park 56 LLC, which purchased the ground floor and basement of the Manhattan condominium in March 2020. A few months later, Park 56 entered into a long-term lease with a tenant who wanted to operate a daycare facility.

Park 56 needed the board to take certain actions before the lease could become effective and it asked the board for four items: to waive its right of first refusal for the proposed lease, to enter into an alteration agreement, to execute a PW1(form a plan/work application) to amend the certificate of occupancy and to approve submitted alteration plans. When the requests were not met, Park 56 sued.

The court’s decision was stark. It found that the board had acted in bad faith. 

The question is, why did the board act the way it did? Amending a building’s certificate of occupancy can upend many things, particularly if there are conditions today that would not meet current building codes. Perhaps, says Pashman, the board was concerned that amending the certificate of occupancy would trigger Department of Buildings inspections, potentially forcing costly upgrades to common elements in the 1920s building. The board tried to shift these potential costs to the commercial unit owner through provisions in a proposed 8th amendment to the condominium declaration, but the amendment failed to be adopted by the unit owners. 

Complicating the matter was the fact that the board had previously granted similar approvals to a prior commercial unit owner. "One of the things that clearly did not help them was that when there was a previous owner of the commercial unit, they had been through this whole exercise once before and had apparently approved everything for that prior owner," says Pashman. "So a lot of the court's anger directed at the board here was based on the fact that this stuff had all been previously signed off on."

Once the court ruled against the board and condominium, the unit owners realized that they could be on the hook for the damages and legal costs, which could amount to between $12 million and $18 million. To protect themselves, they filed a second lawsuit against the board, claiming its members violated their fiduciary duty and acted in bad faith. "What they're really seeking here is to make all of the members of the board individually responsible for what could be very substantial damages to the commercial unit owner, as well as the costs of all of that prior litigation," says Pashman. "Most people don't believe they're subjecting themselves to [this level of personal liability] when they join a board."

The Tribeca Case: A President Out of Control

Another case involved a Tribeca co-op where the board president, Michael Smith, egregiously violated his fiduciary duty during an apartment renovation.

"The president, who has a fiduciary duty to be careful, to be forthright, not to self-deal, to do all these things—he went ahead and put in an alteration agreement and then installed things that were not even close to what he put down in the agreement," says Brucker. Smith was supposed to do a small upward expansion of his apartment but ended up adding multiple floors to the building's roof. "It's one thing if a shareholder does something wrong," Brucker continues, "but when the president does it, it goes way beyond what somebody should do when they're a fiduciary. They're supposed to be protecting and be forthright and be saintly, not devious and fraudulent and untruthful."

Making matters worse, Smith controlled all aspects of his renovation: he signed Department of Buildings filings, gave reports about the construction progress at annual meetings, and misrepresented Environmental Control Board violation findings to the board. "For lawyers, there is an expression, and maybe board members should learn this expression: lawyers are supposed to pull back when there's a potential conflict... 'the mere appearance of impropriety,'" says Brucker.

Brucker recommends that board members not only recuse themselves from voting on matters where they have a personal interest but also remove themselves from discussions entirely. This applies to various scenarios: apartment alterations, admissions decisions, or even noise complaints involving a board member's neighbor. "Any decision the board makes could conceivably have a conflict or personal interest," notes Brucker.

Protecting Yourself 

Most boards need new members to provide a respite from burnout and to offer fresh ideas. However, new members should find out if there is ongoing litigation and then make sure they are protecting themselves. Pashman suggests thoroughly reviewing board records: "At a minimum, once you realize as a board member that you are involved in a difficult situation such as the Parc Vendome situation you're going to want to take a look at as many minutes of board meetings as you can."

In extreme cases, resignation might be the safest option. "If you're really a dissenting board member where you feel like 'I'm the only person on a board who's going to do the right thing, and everyone else here is doing the wrong thing,' perhaps it's most prudent to resign," Pashman advises.

It’s important to make sure that your building maintains directors and officers (D&O) insurance. It’s not unusual for a board to be sued for its decision-making, and if the court finds that it has acted in good faith and proper care, the board will prevail. However, D&O policies typically have exceptions for intentional misconduct or bad faith actions. In the Parc Vendome case, it's unlikely the D&O policy will cover the damage award due to the court's finding of bad faith.

When it comes to procedure, Pashman emphasizes the importance of following bylaws to the letter: "Along each step of the way, if somebody sends in a proposed alteration agreement, you need to make sure you're following your bylaws and respond in a timely fashion…Parc Vendome got in quite a bit of trouble, partly because they started taking positions in court that they were no longer eligible to take because they didn't timely respond."

Bottom Line

The lesson from both cases is clear: board members must take their fiduciary duties seriously. "Board members owe loyalty and good faith in everything they do," says Brucker. "They have to be more careful than they are with their own funds... because it's not their money, it's not their building. They in effect are the safekeepers. They're the guardians for all those shareholders that depend on them to do things in good faith."

“The Vendome board acted in bad faith,” Brucker concludes. “They refused to honor an alteration agreement that was binding. They refused to waive or exercise their right of first refusal (a condo board must do one or the other). They refused to sign DOB docs until the commercial unit owner paid for all sorts of things having nothing to do with their alteration.” If you add all these things up, the business judgment rule will not protect them and “the court really threw the book at them.”

When boards operate with transparency, seek professional advice when needed, avoid conflicts of interest, and act in the best interests of all residents, they fulfill their fiduciary duties and protect both the building and themselves from potentially devastating legal consequences.

"I don't think anybody who knew they were going to get in this much trouble would've persisted," reflects Pashman on the Parc Vendome case. "At some point it's like, 'Sorry, board members, but none of this had to happen. None of this had to happen. It's your fault that it happened as found by the court and affirmed on appeal.'"

SIDEBAR

The Parc Vendome Case: A Cautionary Tale

The Facts

• Park 56 LLC purchased the ground floor and basement of the Parc Vendome condominium in Manhattan in March 2020.
• Park 56 entered into a long-term lease with a tenant planning to operate a daycare facility.
• Park 56 needed the board to take four actions:
  1. Waive its right of first refusal for the proposed lease
  2. Enter into an alteration agreement
  3. Execute a PW1 form to amend the C of O to allow operation of a daycare
  4. Approve the submitted alteration plans
• The board refused these requests, effectively blocking the commercial tenant from opening the daycare.
• Park 56 sued the board, with potentially millions in damages at stake.
• In a second lawsuit, unit owners sued their own board, claiming its members violated their fiduciary duty by acting in bad faith and should be personally responsible for damages.

Court Findings

The court determined that:

• The board had acted in bad faith by refusing the four requested actions
• The board and its counsel had "tried to perpetrate a fraud on the court" by taking frivolous legal positions they knew were unsupportable
• The board submitted documents citing an unapproved 8th amendment to the declaration that had never been adopted by unit owners
• The board had previously approved similar changes for a prior commercial unit owner, yet took a contradictory position with Park 56
• Many aspects of these findings were affirmed on appeal

Potential Consequences

• Individual board members may face personal liability for damages estimated between $12-18 million
• Directors and officers insurance may not cover the damages due to the finding of bad faith
• Unit owners are asking the court to prohibit the board from passing these costs along through common charges or special assessments
• The case is still on appeal, but according to Pashman, the appellate division is likely to affirm the decision given they've already shown agreement with the lower court's reasoning