HOA Directors Must Avoid Conflicts of Interest
A common issue that homeowners associations deal with involves recognizing and addressing conflicts of interest on the part of the association’s directors. A situation that involves a potential or actual conflict of interest occurs when a board member is placed in the position of participating in decision making on behalf of the association that furthers the director’s personal interests as opposed to the interests of the homeowners association. An example of such a situation would be when a director enters into or votes in favor of a contract with a vendor that results in a personal benefit to the director.
Actions that are taken by directors which involve a conflict of interest are generally not afforded the same protections against personal liability as those that do not involve a conflict of interest. In non-conflict situations, an association’s directors are protected by the “Business Judgment Rule” which affords directors protection against personal liability for their actions when their decisions are: (i) made in good faith; (ii) are made in a manner believed to be in the best interests of the association; and (iii) are made with such care, including reasonable inquiry, as an ordinarily prudent person in a like position would use under similar circumstance.
State laws and/or case decisions have held that contracts that an association enters into which result in a personal benefit to a particular director are either void or voidable unless: (i) the material facts of the transaction and the director’s personal interest are fully disclosed to the association’s members, and the transaction is thereafter approved by the members without the interested director participating in the vote; or (ii) the material facts of the transaction and the director’s personal interest are fully disclosed to the association’s directors, the transaction is just and reasonable as to the association, and the transaction is approved by the directors in good faith without the interested director participating in the vote.
Regardless of whether or not a director has a material financial interest in a transaction, he or she cannot make decisions for the association that favor their personal interest at the expense of the association and its members. This does not mean that board members cannot vote on matters that could result in a personal benefit— so long as the benefit is the same benefit that the other association members enjoy from the transaction.
While their presence at a meeting can be used to establish a quorum for the purpose of conducting business, a director who is faced with conflict of interest issues pertaining to a matter under consideration should recuse him or herself from participating in a discussion and vote on the matter. Even though recusal of the director from voting on matters involving a conflict of interest may afford some protections against future liability, the better practice is to completely avoid entering into transactions with vendors or service providers where a director has a financial interest and stands to personally benefit from the transaction.
A good practice for homeowners associations that will facilitate avoiding conflict of interest issues is to have an ethics policy in place that specifies the manner in which conflict of interest situations must be handled by the association. Associations that do not currently have an ethics policy can amend their governing documents or adopt rules to include one. To make certain that proper procedures are followed in connection with the implementation of an ethics policy, the association should consult with legal counsel on the appropriate procedure to follow.