Archive for April, 2015

Co-op volunteer liability: myths and realities

Sunday, April 12th, 2015

The issue

You’re a member of a housing cooperative, you agree to join its volunteer board, and something goes wrong. You get blamed. If you did, indeed, act improperly, must you pay? If the damage was extreme, could you even go personally bankrupt?

I have been hearing members of a Berkeley co-op talk about this question. Most of what I hear is speculative. No facts, just presumptions. What most seem to believe is that volunteer directors are completely shielded from liability. If they mess up, they say, somebody else will pay.

True or false?

The myths

If it’s obvious to you that directors of a housing co-op can cause major damage, you don’t need to read this section. Otherwise, here’s a realistic scenario.

Mary wanted to help build a caring community at Senior Tower. Polly, her mentor, suggested she offer to serve on the board of directors of the cooperative corporation that owned the property. Mary agreed, turned in her form, and got elected.

Then, one day, the board interviewed Henry, who was proposing to buy in. Henry seemed kindly enough, and the friends he had named had said complimentary, even if vague, things about him. After the interview, the chair told the other community members to leave the room so the board could make its decision in secret. Jim protested, saying this secrecy was against the law, but Mary and the other directors persisted, because Jim was a chronic complainer. Behind closed doors, they exchanged perfunctory words and voted to admit Henry. He moved in three weeks later.

That’s when trouble began. Henry made friends with almost everybody, but several friendships were unusually close. A few months later police detectives and FBI agents began contacting community members, asking whether they had given anybody power of attorney. Rumors started circulating, and then a scandal went public.

Henry, it turns out, had a long record. Before moving to California, he had left elderly victims in four states. They had trusted him to do as he wished in their bedrooms and bank accounts. The risks of letting Henry into Senior Tower would have become evident from a criminal background check or a credit check, or if the board had insisted on talking with his last few landlords or employers. But Mary and the other directors didn’t authorize any investigations. That would smack of privacy invasion. And why bother? Henry was a funny guy and an avid gardener. He told entertaining stories about his upbringing. “I can judge character”, Mary said.

Before he suddenly disappeared, leaving his lender holding the property, Henry had, yet again, done damage. Whatever down payment he had forfeited was dwarfed by the monetary “gifts” received from a few Senior Tower residents, who were now facing foreclosure. Medical consequences of his relationships, too, began to surface, potentially overshadowing even the economic losses.

Claims were made, and not only against in-absentia Henry. They were made also against the co-op, for recklessly letting a known predator in, and individually against each and every director, since they had all participated in this “grossly negligent” and “illegally secret” decision.

At first, Mary assumed that she had been named in the legal complaints only as a formality. Polly and others had assured her that she couldn’t possibly be liable personally for anything that she might do wrong while a director. After all, she was a volunteer, responding to an invitation from Peerless Community Management. It had defined the “fiduciary duty” of a director as nothing more than “the greater good”. That’s what Mary was striving for, so she assumed that she knew her obligations. Surely the insurance policy would cover everything. And, if it didn’t, the community itself would. Pay personally? Unthinkable.

The realities

Some limited protections for volunteer directors exist, but the limits are not precise and disputes can arise over them. Unless you learn some facts about your particular co-op, you can’t know whether you have any protection at all.

Here are seven realities that a co-op director, or potential director, would be prudent to consider. The cited code sections apply to California consumer cooperative corporations that own housing communities (common interest developments); other organization types have their own code sections, which may not be identical.

Reality 1. If you agree to join the board without examining the co-op’s and your own insurance coverage, you are not managing your risk. Smith-Chavez et al. (2011, p. 8-27) advise attorneys:

Before a client agrees to become a board of directors member, obtain a copy of insurance coverages for the association and review them to ensure that coverages are adequate and that the limits are sufficient. Request that the insurer notify the board of any insurance coverage changes or terminations.

Reality 2. Once a director, you put yourself at risk if you tolerate illegal conduct. Smith-Chavez et al. (2011, p. 8-27) advise further:

Moreover, caution a director client to submit a written resignation from the board if the board appears to be acting in bad faith or otherwise conducting association affairs improperly.

Reality 3. Your statutory protection from personal liability isn’t absolute. Civil Code Section 5800 protects you only after $500,000, so you might have to pay anything up to that amount not covered by insurance. In addition, you get no protection if any of these is true:

  • You acted outside your duties as a Director.
  • You didn’t act in good faith.
  • You acted willfully, wantonly, or with gross negligence.

Reality 4. Insurance policies can contain exclusions. For example, one insurer of director liability (Ironshore, 2007) excludes claims by the community against a director. Another insurer named all the so-called troublemakers in a community and excluded any claim by any of them from coverage. And, in a community whose directors had already been sued, one insurer excluded coverage for any act similar to the acts alleged in the previous suit.

Reality 5. When the insurer doesn’t pay, the community, too, may fail to pay, leaving you with the debt. Corporations Code Section 12377 prohibits the community from covering your obligation if any of these is true:

  • You didn’t act in good faith.
  • You didn’t act in a manner you reasonably believed to be in the best interests of the corporation.
  • If the case is criminal, you had reasonable cause to believe your conduct was unlawful.

And its bylaws may impose more restrictions. One co-op’s bylaws prohibit the community from indemnifying you if:

  • You are sued on behalf of the Corporation.
  • Your liability is due to self-dealing.
  • You have not acted in the best interests of the Corporation.
  • You have not acted with the care of an ordinarily prudent person.
  • Your liability is to the Corporation and your indemnification has not been approved by the court or the Attorney General.

Reality 6. You may have to hire and pay your own attorney. One insurer (Ironshore, 2007) won’t pay unless the community “tenders” (hands over) the defense of the claim to the insurer. What if the community fears that the cost of your defense will reduce the remaining insurance limit and increase the community’s future insurance costs? It might refuse to tender the defense. Moreover, insurance policies may fail to cover defense costs if the claim itself isn’t covered, and some insurers cover only claims for money. If the insurer doesn’t pay, the community might, but Corporations Code Section 12377 prohibits this if any of these is true:

  • You didn’t act in good faith.
  • You didn’t act in a manner you reasonably believed to be in the best interests of the corporation.
  • You didn’t act with that care, including reasonable inquiry, as an ordinarily prudent person in a like position would use under similar circumstances.

Even if these prohibitions don’t apply, the community may choose not pay your legal costs. And, if it does agree to do so, under Corporations Code Section 12377 you must first promise to repay the community unless it is determined ultimately that you are entitled to be indemnified.

Reality 7. You might have to pay not only your own legal expenses, but also those of the persons who complained against you. This is a complex topic. It is difficult to find clear answers in the law and in some insurance policies. A cautious community member could conclude that a director might, in fact, be required to pay out of pocket for a complainant’s legal costs.


References:

Elizabeth A. Smith-Chavez, Richard J. Stratton, James R. Trembath, and Ronald W. Carrico, Real Property Litigation (California Civil Practice), Vol. 1, Section 8, “Disputes Involving Condominiums and Common Interest Developments” (Thomson Reuters, 2011).

Ironshore, Inc., “Not‐for‐Profit Entity and Directors, Officers Liability Insurance Policy”: Specimen (Ironshore, 2007).