Thursday, July 31, 2014

Right Outcome, but the Court of Appeals is Confused as to the Business Judgment Rule

Right Outcome, but the Court of Appeals is Confused as to the
Business Judgment Rule


            In a recent decision the Court of Appeals correctly found that it would not second guess the decisions made by a board of directors as to how corporate assets should be applied to remedy existing problems.  At the same time, however, the Court was off base as to what is the Business Judgment Rule, and was off base as to who owes and who is the beneficiary of the fiduciary obligations in a corporation.   Davis v. Innwood Condominium Property Owners Association, Inc., No. 2013-CA-001221-MR, 2014 WL 2938486 (Ky. App. June 27, 2014).
            Davis owned a condominium in the Ironwood development, a low and fixed income complex. The property has in recent years faced a number of challenges including the need to expend some $100,000 in brick repairs in order to remedy a code violation, significant repairs to the heating system, and an increase in insurance premiums after a fire.  A special assessment of the owners was made in order to increase reserves.
            Davis, who at various times has served on the board of directors, brought suit alleging that the board had failed to satisfy the terms of the master deed as to a number of issues including exterior maintenance, limitations upon occupancy of units and failing to require background checks on occupants.  In addition, he alleged that the board had failed to maintain the property as a “first-class condominium.”  Collectively, he asserted that these failures, characterized as breaches of fiduciary duty, reduced the fair market value of his unit.
            After discovery, the trial court dismissed the complaint as being subject to the “business judgment rule”; this appeal followed.

            Davis’ argument was that the Master Deed set forth requirements, that even though some issues were being address the board was not requiring full compliance with those requirements, and a breach of fiduciary duty therefore resulted.  The Court of Appeals affirmed the trial court’s determination that the Business Judgment Rule precluded court intervention, it writing:
The business judgment rule is “a presumption that in making a business decision, not involving self-interest, the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company.” Allied Ready Mix Co., Inc. ex. rel. Mattingly v. Allen, 994 S.W.2d 4, 8 (Ky.App.1998). The record below indicates that the Board sought guidance from its management company, Prudential Parks, and Weisberg Realtors in making decisions as to how to best address the issues raised by Davis. The record further reflected that the Board did not have all of the necessary funds at its disposal to immediately fix each of the problems raised by Davis. However, the Board, based upon the advice it received, in consideration of the financial status of the tenants and owners at Innwood, did vote to approve a Special Assessment for repairs and maintenance. By considering the economic standing of its residents and the problems at issue and making such a decision, this Court is not persuaded that the Board breached any fiduciary duty in this instance.
Finding there to be no assertion of fraud or conflict of interests that precludes the application of the Business Judgment Rule, the trial court’s dismissal of the complaint was upheld.
            That said, before the quoted language above the court misidentified the source of the Business Judgment Rule as being in the statutory formulae of the standards imposed upon corporate directors, those being KRS §§ 273.215 and 271B.8-300.  Sorry, but that is not the case.  Those cases recite the standards of performance and the standards of culpability imposed upon directors.  The Business Judgment Rule, in contrast, applies not to corporate directors but rather to the courts called upon to assess the actions taken by the directors, and creates a presumption against judicial review of decisions made by a corporate board.  In no manner is this presumption against judicial review “codified” in the the Kentucky statutes on business and nonprofit corporations.
            Another point, this one clearly dicta, in which the Court of Appeals was on less than a sound footing was in finding that there exists a fiduciary duty running from the corporation’s board to the individual owners thereof.  The Court of Appeals acknowledged that this determination is in contrast to that made in the then not final Ballard v. Willow Council of Co–Owners, Inc., 430 S.W.3d 229, 2013 WL 6134150 (Ky. 2013).  A motion for reconsideration in Ballard was denied on June 19, 2014, and that decision is now final. Hence the suggestion in Davis that a fiduciary duty is owed directly to the owners should be treated as moot.

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