Directors & Officers Lawsuits

Prevent the Nightmare

January 1, 2017

Being part of your association’s board can be fun and exciting. It gives you the power to help make decisions that affect the entire association. However, there are things all board members must be aware of to avoid any issues that could bring about a directors and officers lawsuit. There are situations where your neighbors could initiate a lawsuit against the association, the board as a whole, each of the members individually or the property manager. It is better to know the hazards that face a board in order to prevent a lawsuit from happening and a directors and officers claim from being filed.

Common Directors and Officers Claims

  • The board’s failure to adhere to by-laws
  • The board’s failure to properly notice elections
  • The board’s failure to properly count votes/proxies
  • Challenges by members regarding power granted the board by the by-laws
  • Improper removal of board members
  • Decisions by the board resulting in physical damage to the association’s property
  • Challenges on assessments
  • Approval of variances, generally by an architecture committee
  • Breach of fiduciary duty
  • Challenges to decisions of the architectural review board
  • The board’s failure to maintain common areas
  • The board’s failure to properly disburse funds (i.e. insurance proceeds)
  • Defamation by the board of a member of the association
  • Discrimination

The list of things that can initiate a claim can be intimidating; however most directors and officers lawsuits can be avoided. The best way to avoid a lawsuit is to adhere to high ethical standards. Also, make sure your association purchases a directors and officers (D&O) policy that has sufficient coverage to defend and pay out on the myriad of situations that frequently occur within community living situations. Not all D&O policies are created equal. Coverages vary and each association should work with their insurance company to make sure they have the right amount of coverage for their situation. 

The Devil is in the Details
Know all sections of your governing documents; By-laws and Declarations of Covenants, Conditions and Restrictions. The most common problems arise from the failure to understand and follow their directions. Another common issue is that the overall day to day operation of the board and association, are performed in an informal manner and as long as there are no problems. 

When a problem does occur, it is common that the lack of formality and the board’s history of not following the governing documents will be brought up and the board will most likely lose a suit brought against them. A court will give full faith and credit to the governing documents and challenges to those procedures will not be easily won, even if the association has been doing things a certain way for years. Oftentimes the entrance of a newcomer in the community will prompt action and change. This person will look to the governing documents for rules and guidance on a multitude of issues and could easily defeat a lackadaisical association board if a challenge ensues.

Out of Sight Out of Mind
Not only do boards sometimes fail to know or follow the governing documents, they may sidestep the formalization of changes and amendments. Governing documents that are not accurate or in compliance with current laws are a claim waiting to happen.

Penny Wise and Pound Foolish
Associations are budget-driven entities that rely on collecting the costs of running the association from the members. In good times this can be a challenge, but it is especially problematic when the economy is strained.  It is extremely beneficial to retain true professionals for all the layers of need an association has. Retaining a general counsel for legal matters, hiring an insurance expert to assist in securing coverage and managing risk, dealing with an accountant who understands the forms and filings for financial matters, working with a reserve specialist to manage future capital expenditures and securing the guidance of a professional manager will pay for itself in the long run.  Do not skimp when it comes to professionalism.

Failure to Place Emotions and Personalities Aside
Most directors and officers have a difficult time distancing their duties and obligations to the board from their personal emotions, egos and relationships. Don’t fall in the “conflict of interest” trap by hiring your best buddy to mow the lawns; don’t use the insurance agent that is going to give you a break on your personal insurance because you let him/her get the bid on the associations’ insurance; don’t let a neighbor do the financials unless they are professionally qualified to do so. These mistakes can lead to an easy win for the person filing suit against the association. Also, if your association has developed a reputation for in-fighting, it can be difficult to find insurance protection for the board and its volunteers.

What Should Be Done to Avoid Common Claims

  • Follow the rules
  • Memorialize changes
  • Elect board members who are serious
  • Provide training for the board
  • Use professionals
  • Do not let emotions and personalities get in the way
  • Keep good records
  • If considering moving from a “claims-made” policy to an “occurrence” form; do your homework.  Seek professional advice from an insurance expert before transitioning. Very few companies will use the occurrence form and movement between the two could cause gaps in coverage.  

What If We Receive Legal Papers

  • The directors and officers policy is a claims-made format that generally requires the association to forward notice of all possible claims.
  • There is no down side to forwarding potential notices of facts or circumstances. Most insurers will not penalize an insured for providing notice. The insurer is in the business of risk management and can assist in early resolution of claim situations.

There are many risks facing homeowner association boards. If you follow your governing documents and run your board like you would run your business, you can prevent lawsuits against your board. Make sure you always operate with the highest degree of integrity and uniformity and take your position on the board or on a committee seriously.