The Business Judgement Rule: A Three Legged Stool (Of Security)

The Business Judgment rule is one of the most important things a good director should know well, because it protects directors from liability.  However, well-meaning directors can accidentally stray outside of its protections.

The Rule

The "Business Judgment Rule" (hereafter, "BJR") is found at Corporations Code Section 7231, which states that a director is personally protected from liability, so long as it operates within the BJR, which is found at subsection (a): 

"A director shall perform the duties of a director ... in good faith, in a manner such director believes to be in the best interests of the corporation and with such care, including reasonable inquiry, as an ordinarily prudent person in a like position would use under similar circumstances."

So, if a volunteer director acts:

• With good faith;
• Believing the action is in the best interests of the entire association; and
• With reasonable inquiry.

Then the director is not responsible personally, even if it turns out the board made a bad decision that financially harmed the association.

It's not that simple

Every day, good people step outside of the BJR, leaving themselves needlessly exposed to risk of personal liability.  The potential tragedy is that most of these people leave the BJR's protection unknowingly but based on a belief they are helping their association. Most times, luckily, it works out.

"Good Faith"

Good faith is not simply good intentions or a pure heart.  Good faith is making a decision which is not bad faith.  The people who decide whether something is in good or bad faith will be judges or jury members.  So what is important is not what YOU think, but what somebody else thinks of the action and the evidence about it.

Could one argue that a decision is based upon a desire to retaliate against "that member"? You know, the one who always criticizes, perhaps even abuses the board?  The law requires that members are treated consistently, so the horrible abusive member is entitled to the same roof repair as the saintly, thankful member.

You may be making a decision that sets aside your differences with a neighbor, but sometimes past statements or even e-mails can be taken out of context, with dangerous results.  Make sure that every statement you make in front of people, and every e-mail, is carefully worded -- and avoid intemperate or sarcastic remarks.   

 

"In Interest of Association as a Whole"

Of course, every action by a board should be in the best interests, and I am sure every director thinks they are doing the best for their HOA.  But who decides if your motivation was correct, and how do they do it?  A judge or jury would look at your actions, your statements and the surrounding facts, and from that determine if you reasonably believed you were working for the HOA's best interests (and not your own).

How fastidious are you in avoiding conflicts of interest, or apparent conflicts?  Do you make sure that, in an overall remodel of the property, the directors' homes are remodeled last (not first!)?  Do you make sure the minutes show that before the board discusses your home or building, you left the meeting during that discussion (or at least sat in the audience and not at the board table)?

"With Reasonable Inquiry"

The board must make sure it has the appropriate qualified input before it makes a decision.  A manager's input may be all that is required, depending upon the size and complexity of the issue.  However, if the matter is serious, large or complex, more expertise may be needed.

Well-meaning directors often innocently violate this requirement by either providing their own expertise ("I think that wall is structurally sound") or by refusing to endorse the hiring of the appropriate consultant ("engineers are too expensive, can't we figure this out?")

A director's job is to make decisions based upon the information brought to the board.  Make sure the board has sufficient and qualified input, appropriate to the decision.  Sometimes the board must spend money to know it is right.  That is why you have lawyers, engineers and other experts.

    

Three Legged Stool

The Business Judgment Rule is a three-legged stool. Skip any one of the legs and you know what happens ... headache!

Thanks to Kelly G. Richardson Managing Partner of Richardson Harman Ober PC, a law firm known for community association advice for this important information.  Direct questions to krichardson@RHOPC.com and check out their website at www.rhopc.com

Pool Sign Regulations Have Changed

The State of California has been working towards an updated "Pool Code", which has been finalized and becomes effective 9/1/2012. There are many new requirements, although almost all are directed at new pool construction and major renovations. Please do not be misled by pool vendors claiming upgrades must be done immediately. The only exceptions are changes related to pool safety signs, which are as follows.

Existing Safety Signs

·         "Artificial Respiration" signs now require CPR procedures be added.

·         "911" signs now require the number of the nearest emergency services, and the name and street address of the pool facility.

Note: The Orange County Health Care Agency (OCHCA) is not currently requiring these signs be updated immediately. This policy is subject to change. It is our recommendation at this time is to update existing signs as they wear out unless the Association receives a citation from the OCHCA during an inspection.

New Safety Signs (required on every entry gate)

·         A sign stating "Persons having currently active diarrhea or who have had active diarrhea within the previous 14 days shall not be allowed to enter pool water" is now required. Letters to be a minimum of 1" high.

·         A sign stating "Keep Closed" is now required in letters at least 4" high.

Note: In the interest of safety and compliance, it is recommend this sign(s) be installed as soon as possible. 

South Coast would like to thank Lewis Hines, owner of Aquatrends Commercial Pool Service for his valuable input on this subject.    

Boards : Corporate Procedures Are Not Your Enemy

In community association management, corporate formalities so often seem to get in the way of "good old common sense."  If someone is doing a good job, and is making good decisions, why allow procedural technicalities to interfere?  In almost 30 years of law practice, I find that clients view corporate formalities as a curse and try to avoid dealing with it as much as possible.  However, the process is very important to you.

Why the Process?

The corporate process is there to protect you volunteers and managers.  It documents that the actions are by the corporation and not you personally.  California law does not recognize actions as corporate if the procedures are not followed.  So, a failure to follow proper corporate process may be that an obligation thought to be corporate may be imposed upon the individual who failed to obtain proper corporate approval.  That could result in the imposition of personal responsibility for an obligation intended to be corporate.  Scrupulously following proper procedures avoids that nightmare.

Corporate Action vs. Individual Action

Corporations are legal fictions recognized by law as "persons" which act through authorized agents, normally a board of directors.  Actions outside the corporate authority are called "Ultra Vires," a Latin term meaning "outside the powers."  In small corporations, certain officers often act as the primary agents.  However, officers have only the powers stated in the bylaws or expressly granted by board.  If the officer acts outside those powers, the action is not corporate action.

The Importance of Minutes

Minutes document the board's decisions, and should also document any authority to act given by the board to a director or manager.  Careful managers or officers should insist that authority to act is recorded in minutes.

Occasions sometimes can arise when there is no time to convene the board and urgency requires a decision to be made immediately -- such as calling an emergency contractor, for example.  In those situations it is imperative to as soon as possible obtain the corporation's approval of the action taken.  That retroactive board approval is called "ratification," and must be documented in minutes.

The Importance of the Open Meeting Act

The Open Meeting Act (Civil Code §1363.05) sets forth a variety of mandatory procedures -- in addition to the procedures in the association's bylaws.  That law bans action outside of board meetings, requires advance notice of board meetings, restricts on the use of executive sessions, and requires prompt availability of draft minutes.

Many associations allow meetings violating the law on the rationale of efficiency or convenience.  If an association violates the law by taking action outside of meetings or by abusing executive session, are the board's decisions susceptible to challenge as outside the corporate authority?  Although the Open Meeting Act does not discuss the consequences of violations, such a result is possible.

The Lone Ranger

Sometimes directors step outside of their authority, in their zeal to "get things done," making all kinds of decisions and commitments without documented board authority.  The "Lone Ranger" is just that . . . alone.  Such a director can sometimes find that the board later may disavow the director's action, leaving the director personally exposed to liability.

Avoiding Shortcuts is Safer

Observing proper corporate process protects you.  Make sure decisions are made properly, and documented properly.  You don't want your volunteer work to be "rewarded" with any personal liability.

Thanks to Kelly G. Richardson Managing Partner of Richardson Harman Ober PC, a law firm known for community association advice for this important information.  Direct questions to krichardson@RHOPC.com. 

Let Your Wood Take The Pressure

I just can’t take the pressure!….but wood can.  Many folks have heard about pressure-treated lumber and perhaps even seen some wood components that have the tell-tale dimples on them that indicate the wood has been chemically treated.  The purpose of treating wood is to thwart termites and dry rot. 

Most commonly, wood for exterior use is treated with Alkaline Copper Quaternary (ACQ).  The key components are copper, which acts as a fungicide and a quaternary ammonium compound, which acts as an insecticide.  The wood is immersed in the liquid and then placed in a pressure chamber where the applied pressure forces the chemical into the wood.  The pressure assures that the chemical makes it to the core of each piece of wood.  The dimples that are often seen on pressure-treated lumber (left photo) are to open the wood’s surface, making it easier for the chemical to penetrate the wood.  It is possible to have some types of wood pressure treated, without having the dimples (right photo) but it is much more expensive.  It is important to use galvanized fasteners (brackets, nails or screws) when installing pressure treated lumber because the high copper level in the wood will adversely affect metals without the zinc coating.

As a rule, pressure treated wood is used where lumber will routinely come in contact with soil or moisture.  It is great for fence posts and other fence members.  It has sometimes been used as the horizontal cap rail on balcony railings or other horizontal surfaces that typically have moisture sitting on them.  In this case, you have to weigh the functional benefit versus the appearance of the wood.

For those of you who enjoy a good campfire or evening in front of your fireplace, you should not burn pressure-treated lumber.  It will give off chemicals in the smoke that could prove hazardous to people who breathe the smoke.  If you have any doubt, don’t burn wood that has the dimples or a green tint to it.

By Bill Butler, bill@primecopainting.com, Director of Business Development for PrimeCo Painting and Construction. If you have questions on painting needs you can contact then via email or through their website at www.primecopainting.com. South Coast would like to thank Bill for his valuable input.  

Bankruptcy & The Motion For Relief From Stay

When a delinquent owner files for bankruptcy relief by filing a petition under either Chapter 7 or Chapter 13 of the United States Bankruptcy Code, the Code provides that an automatic stay, subject to certain exceptions, is immediately put into place. An automatic stay is like a restraining order, and it happens as soon as the bankruptcy is filed. This “stay” applies to creditors, including the association to whom the owner owes money, and it means an association can no longer collect or even attempt to collect any money (or foreclose on the property) from the owner, at least without getting permission from the bankruptcy court. The stay is intended to protect the delinquent owners who file bankruptcy. All actions to collect the delinquent assessments must stop including lawsuits, foreclosures, as well as the suspension of membership and/or common area privileges.

What Is A Motion For Relief From Automatic Stay?

A Motion for Relief from Automatic Stay is a motion filed by a creditor, the association in this case, requesting that the bankruptcy court end the stay as to the particular creditor. If the Motion is granted, the automatic stay is lifted so that the creditor association can resume its collection action that it was pursuing prior to the filing of the bankruptcy case including the foreclosure of the property. The Motion for Relief from Automatic Stay can only be made by a secured creditor, which is another reason that associations should not delay in recording a lien.

If an association was in the process of foreclosure, the automatic stay stops that process. An order granting the association’s Motion for Relief from Automatic Stay allows an association to pick up where it left off.

The law regarding Relief From Automatic Stay is found in Sections 362(d) – (g) of the Bankruptcy Code and it provides a creditor association with methods and grounds for obtaining a bankruptcy court order for relief from the stay. Relief From Automatic Stay only applies to the creditor that filed a motion for it, and only for the activity described in the motion.

Forms of Relief — Termination, Annulment, Modification, and Conditioning

There are four (4) different types of relief from stay: termination, annulment, modification, and conditioning. A creditor association will usually be seeking modification.

Modification of the stay modifies the stay so that the creditor association can proceed with the foreclosure or a lawsuit. For instance, if the association was ready to foreclose, the Court will order that the association can proceed with the foreclosure. If the creditor association is involved in a court case seeking judgment for its claim, then the modification may allow the association to obtain the judgment, but not to allow the collection of the judgment. A creditor may want to do this to have the judgment so that it can proceed if the bankruptcy case is dismissed or if the debt is not discharged.

Annulment of the automatic stay may be necessary in a situation where the creditor association took action against the debtor/delinquent owner or the property while the debtor’s bankruptcy was pending due to the association being unaware of the debtor’s bankruptcy. For example, annulment would be necessary if the association’s lien recorded while the debtor’s bankruptcy was pending.

Grounds for Relief - There are several grounds for relief from the automatic stay. The most common grounds are for cause or because the debtor has no equity in the property, or it is not necessary for the debtor's reorganization in a reorganization bankruptcy (Chapter 11 or 13).

Relief from stay for acts against property is given if the debtor has no equity in the property and because it is not necessary for his reorganization. The 2^nd condition only needs to be satisfied if there is equity in the property and if it is not a Chapter 7 bankruptcy since there is no reorganization in Chapter 7 liquidation. With this ground for relief, the association creditor must prove that the debtor has no equity in the property.

If there is equity in the property and it is not a Chapter 7 bankruptcy, then it must be determined if the stay is necessary for the debtor's reorganization under a Chapter 11 or 13 plan. Property for the conduct of the debtor's business is the most common and obvious reason why property would be necessary for a reorganization. That obviously does not apply to a condominium or home, but it could apply in a commercial condominium or investment property, or perhaps by a delinquent owner that leases their unit or home.

Why Would A Community Association Want To Pay Attorney Fees For A Motion For Relief From Stay?

At this point you may be asking why an association would go through this process and incur the expense considering the fact that many, if not most, of the properties are under water and there is little likelihood that an association will recover money. Given that the bankruptcy may take some time to resolve, (i.e., 6-8 months for a Chapter 7 or 3-5 years for a Chapter 13 Plan), most associations cannot or do not want to wait to foreclose until the bankruptcy case is closed. They want to get a paying owner in that unit or home.

Normally, during this period, the delinquent owners are not paying the post petition assessments. And lenders are not moving all that fast to foreclose. So many associations decide that they want and need to do something and usually that means foreclosure.

If the delinquent owner is not paying the post-petition assessments, before filing the Motion for Relief from the Automatic Stay, we would generally contact their attorney to see whether we can facilitate the delinquent owner’s payment of the post-petition assessments. If the delinquent owner is not paying the post-petition assessments, then the association would have to file a Motion for Relief from Automatic Stay for relief before it can pursue the owner for the money or the unit/home itself through foreclosure for the non-payment of the post-petition assessments.

A Motion for Relief may be necessary to allow the association to proceed with the non-judicial foreclosure of the unit/home while the bankruptcy is pending in order to deal with the owner that has not paid (and continues to not pay) assessments and is living in the unit or home for “free”. Most associations want to do what they can to get the non-paying owner out so that the unit/home will have new owners that will pay the assessments. If the association ends up with the unit or home at the foreclosure sale, the associations, in many cases, have been able to rent the property and collect rent pending foreclosure by the senior lender.

Keep in mind that pursuant to Civil Code Sections 1366 and 1367.1 and the association's CC&Rs, in addition to late fees, interest, collection costs, the association is entitled to recover it’s reasonable attorneys’ fees and costs incurred by the association to collect the delinquent assessments from the debtor/delinquent owner. And this would include fees incurred for legal advice and the preparation of the Motion for Relief from Automatic Stay, which would be recoverable by the Association from the delinquent owner and the unit/home.

By David C. Swedelson at dcs@sghoalaw.com  and Alyssa B. Klausner at abk@sghoalaw.com of Swedelson & Gottlieb. If you have questions on this or other bankruptcy issues they can be reached via email. South Coast would like to thank Mr.Swedelson & Ms. Klausner for providing this information.

How Bankruptcy Affects Assessment Collection

So, your Association has a homeowner who is delinquent on his assessments. Before you are able to make any progress on collection and before a lien is recorded, you receive notice that he has filed for bankruptcy. What happens next?

The moment a debtor files for bankruptcy, an “automatic stay” is imposed. The automatic stay prevents creditors from taking any action to collect from a debtor. This is intended to give the debtor some breathing room and allow him to clearly evaluate his financial position without having to fend off creditors. Therefore, all collection efforts must cease until the automatic stay is either lifted or terminated.

The filing of a bankruptcy will only have an effect on the assessments incurred up to the date that the bankruptcy petition is filed. The debtor remains responsible for paying any debts arising after the bankruptcy petition is filed. Those debts are called “post-petition” debts. Therefore, after your delinquent homeowner files for bankruptcy, he is still required to pay assessments from the date his bankruptcy is filed forward. If he fails to pay those amounts, the Association can make a motion with the Bankruptcy Court for relief from the automatic stay, allowing the Association to proceed and collect on the post-petition assessments. Regardless, once the bankruptcy is discharged and the case is closed, the automatic stay will be terminated and Association will then be free to pursue the homeowner for his post-petition debts.

There are two types of bankruptcies Associations need to be generally aware of. A Chapter 7 bankruptcy provides for a straight liquidation of the debtor’s assets. This means that the debtor's non-exempt property will be sold and the proceeds of that sale will be distributed to the debtor’s creditors in their order of priority. Any remaining unsecured debts are then discharged. This, of course, requires that the debtor’s property have some value. If, however, a sale of the debtor’s property would not generate sufficient proceeds, or if the debtor does not own any non-exempt property, then the debts may still be discharged in a “no asset” bankruptcy. If a homeowner files a Chapter 7 bankruptcy and receives a discharge, the Association will likely not be able to collect upon any of the debts which arose prior to the filing of the bankruptcy petition. However, the homeowner’s obligation to pay post-petition assessments will be unaffected by the discharge. The Association can attempt to collect any “post-petition” debts once the bankruptcy is discharged or the automatic stay is lifted.

Conversely, in a Chapter 13 bankruptcy individuals who have regular income are able to develop a plan to repay all or part of their debts over a period of time in lieu of liquidating their assets. A typical Chapter 13 repayment plan lasts approximately three to five years. Any debts remaining at the end of the plan are then discharged. In a Chapter 13 bankruptcy, the Association may be able to collect on the pre-petition debt through the repayment plan. In order to protect their rights to this debt, the Association should file a Proof of Claim detailing all of the debt owed to the Association up to the time the bankruptcy was filed. Whether the Association will be able to collect on their unsecured debt depends upon whether the homeowner has money remaining once the secured debts are paid under the plan. Once all of the payments under the plan are made, the bankruptcy case will be closed, the automatic stay will be terminated, and the Association will then be free to pursue any post-petition debts.

Of course, this all assumes that the Association has not recorded a lien against the homeowner’s property for the unpaid assessments. By recording a lien, the Association’s debt then becomes “secured” by the property (for more information regarding secured lien priority, follow this link). Secured debts are generally not subject to discharge in bankruptcy and the repayment of secured debts is given priority in a bankruptcy. Therefore, the best way for an Association to protect their right to collect on a delinquent homeowner is to promptly record an assessment lien as soon as possible. This also has the benefit of giving the Association the opportunity to foreclose on the lien if the debts remain unpaid.

By Sean D. Allen is an associate at SwedelsonGottlieb, and edited by David C. Swedelson, Partner, SwedelsonGottieb. Your questions or comments, to Sean can reach him at sda@sghoalaw.com. For more information on his firm check out their website at www.sghoalaw.com. South Coast would like to thank Mr. Allen for providing this information.

Leap Day: February 29, 2012

’Leap Day’ is February 29, which is an extra (intercalary) day added during a Leap Year, making the year 366 days long – and not 365 days, like a common (normal) year. 

Nearly every 4 years is a Leap Year in our modern Gregorian Calendar. 

Traditions and folklore

Leap Day as a concept has existed for more than 2000 years, and is still associated with age-old traditions, folklore and superstition. One of the most popular traditions is that women propose to their boyfriends. 

Brief history of the Leap Day

Leap Years are needed to keep our calendar in alignment with the Earth's revolutions around the sun. It takes the Earth approximately 365.242199 days (a tropical year) to circle once around the Sun. If we didn't add a day on February 29 nearly every 4 years, we would lose almost six hours every year. After only 100 years, our calendar would be off by approximately 24 days!

The ancient Roman Calendar added an extra month every few years to maintain the correct seasonal changes.

But Julius Caesar implemented a new calendar – the Julian Calendar – in 45 BCE (Before Common Era) with an extra day added every 4 years. At the time, Leap Day was February 24, because February was the last month of the year.

Too many Leap Years

In 1582 Pope Gregory XIII refined the Julian calendar with a new rule that a century year is not a Leap Year unless it is evenly divisible by 400. This transition to the Gregorian Calendar was observed in some countries including Italy, Poland, Portugal, and Spain. The transition took longer for other countries; Great Britain started using the Gregorian Calendar in 1752 and Lithuania in 1915.