Thursday, June 23, 2016
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C.A. Revives Homeowners’ Suit Against Ex-President
Good Faith Not Necessarily Enough for ‘Business Judgment’ Rule to Apply, Panel Says
By KENNETH OFGANG, Staff Writer
A corporate officer or director who acts in excess of the authority granted by the entity’s governing documents will not necessarily be protected from a breach-of-fiduciary-duty suit by the “business judgment” rule, the Fourth District Court of Appeal ruled yesterday.
Div. One partially overturned an order granting summary judgment to Erna Parth, former president of Palm Springs Villas II Homeowners Association. The court reinstated the association’s breach of duty claim but upheld the dismissal of a claim for breach of the governing documents, which the panel said was “at best, duplicative of the” revived claim.
The current board claims that Parth, between 2006 and 2011, repeatedly exceeded her authority, to the detriment of the association. It alleges she:
•Incurred more than $1 million in expenses for roofing repairs, yet never showed invoices to board members and paid for work that was deficient, overpriced, and/or unnecessary;
•Pledged the association’s assets as security for loans that at least some board members weren’t told about and that the board did not approve;
•Entered into a landscaping contract with the approval of two of the other four directors, with no idea whether she had any authority to do so, after a meeting that at least one director wasn’t notified of;
•Improperly joined with two other directors to terminate the association’s management contract, and hire a new management company, without prior notice to the other board members; and
•Entered into a contract with Desert Protection Security Services without review or approval by the board.
Final Straw
Matters came to a head when the board approved a proposal to terminate Desert Protection’s services and hire a competitor. When informed by Desert Protection that it had entered into a one-year contract with Parth six months earlier, board members complained they had not ratified, or even seen, the contract.
Desert Protection sued the association for breach of contract, and the association cross-complained against Parth and the security company. The association and Desert Protection eventually settled.
Parth testified in her deposition that she “did not investigate anything” with respect to the qualifications of the roofing company, that she had not reviewed the CC&Rs or bylaws regarding her authority to execute a promissory note and did not know whether she had such authority, did not know whether she had authority to enter into the multiyear landscaping contract, and made no effort to determine the extent of her authority to borrow money on the association’s behalf.
Riverside Superior Court Judge John G. Evans granted Parth’s motion to throw out the cross-complaint. He reasoned that even if Parth acted in excess of her authority, she met the other requirements of the business judgment rule—that she was personally “disinterested” in the transactions and acted in good faith and with reasonable diligence on the basis of information known to her at the time.
The trial judge erred, Justice Cynthia Aaron wrote for the Court of Appeal, because there were triable issues as to whether Parth acted with reasonable diligence, even if she did not engage in intentional misconduct.
While Parth did not act “ulta vires”—in excess of the corporation’s authority—she may be liable for actions taken in excess of her own authority as an officer or director, the justice explained.
“The trial court’s erroneous conclusion that ‘there [was] no evidence that Parth did not use reasonable diligence’ reflects a misapplication of the business judgment rule, summary judgment standards, or both,” Aaron wrote. “To the extent that the court viewed the Association’s evidence regarding Parth’s diligence as irrelevant, in light of her ‘belief[] in [her] authority to act and the need to act,’ the court failed to apply the reasonable diligence requirement in any meaningful way. Permitting directors to remain ignorant and to rely on their uninformed beliefs to obtain summary judgment would gut the reasonable diligence element of the rule and, quite possibly, incentivize directors to remain ignorant.”
Case Distinguished
The jurist distinguished Biren v. Equality Emergency Medical Group, Inc. (2002) 102 Cal.App.4th 125, holding that the “business judgment rule may protect a director who acts in a mistaken but good faith belief on behalf of the corporation without obtaining the requisite shareholder approval.”
Biren, Aaron explained, found the business judgment rule applicable under the circumstances. “However, the case law is clear that conduct contrary to governing documents may fall outside the business judgment rule,” she wrote. “Even if Biren establishes an exception to this principle where the director has satisfied the remaining elements of the business judgment rule, in this case, triable issues of material fact exist as to other elements of the rule and render Biren inapplicable, at least at this stage.”
The case is Palm Springs Villas II Homeowners Association, Inc. v. Parth, 16 S.O.S. 2940.
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