CA Ct. Says Protections of “Business Judgment Rule” Require Showing of Reasonable Diligence

CERTIFIED California Appellate Court decision (June 21, 2016)

This case involved an action by a homeowners association (“Association”) against an individual homeowner and pertains to claims relating to actions that she took while serving as an officer and director of Association. Association alleged that the actions in question were contrary to provisions contained in Association’s governing documents and constituted a breach of fiduciary duties that she owed to Association. The director/officer claimed to be ignorant of much of the content contained in Association’s governing documents that was alleged to have been breached and contended that she was protected by the “business judgment rule” and an exculpatory provision that was contained in Association’s CC&Rs.

The trial court granted summary judgment in favor of the former director/officer based on the business judgment rule. Association appealed the trial court decision contending that the trial court’s application of the business judgment rule on summary judgment was incorrect because there were triable material issues of fact as to whether the director/officer had exercised reasonable diligence in connection with the alleged acts. The business judgment rule in question (California Corporation Code §7231) protects a director who performs their duties “in good faith, in a manner such director believes to be in the best interests of the corporation and with such care, including reasonably inquiry, as an ordinarily prudent person in a like position would use under similar circumstances.” Under the rule, if a director performs their duties in accordance with the stated requirement, he or she would have no liability for actions performed as a director.

In reversing the trial court’s granting of summary judgment in favor of the director/officer, the appellate court clarified the requirements for application of the business judgment rule and the ramifications of a director acting negligently in the performance of his or her duties. The court found that, when courts say they will not interfere in matters of business judgment, it is presupposed that “reasonable diligence” has been exercised by the director. The court clearly stated, “A director cannot close his eyes to what is going on about him in the conduct of the business of the corporation and have it said that he is exercising business judgment.” The appellate court further stated that there are “factual prerequisites” to the application of the business judgment rule. Thus, the application of the business judgment rule raises issues of fact including whether “a director acted as an ordinarily prudent person under similar circumstances” and “made a reasonable inquiry as indicated by the circumstances.” Applying these criteria to the facts of the case, the appellate court ruled that the trial court’s granting of summary judgment based on the business judgment rule was improper because there were issues as to: (i) director/officer’s diligence in connection with her actions while serving as a director for Association; and (ii) whether she proceeded on an informed basis.

On the issue of the application of an exculpatory provision in Association’s CC&Rs which the director/officer contended shielded her from liability, the appellate court stated that application of the protections required a showing of good faith on the part of Owner and, the absence of diligence on the part of the director, could reflect a lack of the requisite good faith.

See case decision: Palm_Springs_Villas_II_Homeo